Long & Wrong

… then it probably is a duck, (James Whitcomb-Riley)

This week I looked like an idiot and sounded like an idiot. Did that make me an idiot..?..

It quacks, it's yellow, it has feathers...

I met up with a friend from university that I hadn’t seen for a few years (he works in a proper job in London and I work in an improper job in the darkest, deepest countryside).  He was interested in trading, as most people seem to be, and knew enough about it to make the conversation interesting but not enough to make it boring.

We talked about how I traded forex, which particular pairs and why. Then, returning from buying the next round he said ‘I’m going on holiday to Las Vegas at the start of next month, you’ll be the person to ask about the exchange rate’. And I said…

…

…

nothing.

I stared at the floor, I took a sip from the full glass, I was silent. After what seemed like a long time I blurted something about the difference between interbank and tourist exchange rates (I should of course asked why he would want to go to Las Vegas!?).  The fact was that I had no idea what the GBP/USD rate was. I felt like an idiot, I felt like a fraud. He looked at me very suspiciously then, being a friend, changed the subject.

But was I an idiot? When I thought about it later I realised that I don’t know the numerical value of many of the markets that I trade, even the FTSE. I know it is greater than 4,000 and less than 6,000 but that’s about as far as I go.  Surely any half-serious trader should know a number like that even if he doesn’t know his wife’s birthday?

Perhaps I am just making excuses for myself but I think I can justify my apparent cluelessness…  The value doesn’t matter.

The change in value matters. The patterns on the chart matters. The support and resistance levels matter (which are  lines, not  numbers) and the ‘big picture’ across different timescales matters. But like I said, the value itself doesn’t matter.

What’s more, I trade directly from the chart so don’t ever have to type the value in. Some people I chat with trade the future like me, others the ‘daily rolling’ offered by spread-betting companies.  These numbers will be different so why get involved with them when it is easier, and more instructive, to say for example, ‘yesterday’s HOD’ or the ‘NFP spike low’.

Perhaps I am an idiot or perhaps I am just a ‘visual person’ who concentrates on what really matters.  I won’t ask you to decide, I couldn’t take the criticism

Quack.

The much used, but as far as I can tell entirely unsubstantiated, statistic is that 90+% of new traders fail to make money. For the purpose of this post lets just accept that a majority of people will not be able to make a consistent profit from trading, when though is the time for them to throw the towel in?

The blogosphere provides a snapshot of this dilemma; some just disappear, some trail off into inactivity, some take a break and others provide an articulate explanation of the reasons behind the tough decision to quit.

The classic description of this issue was centred on ‘availability’.  The argument was that success (the ***** with the red Porsche 928 in 1987) was more available ( aka “in your face”) than failure (back to stacking shelves in Tesco with massive debts).  We were biased to seeing only the positive outcomes and failed to recognise that we weren’t destined for the same result.

But perhaps the Internet has changed that slightly.   It is easy to find tales of adversity but I suspect the people who really succeed at trading no longer bother with forums/blogging etc,  (I am ignoring, and suggest you do to, the apparent successes that make so much money that they have to sell signals for $59/month).

One further confusion is that the severe frustration that can often lead to giving up is so often the precursor to a break-through. Multimillionaire Bo Bennett said “Frustration, although quite painful at times, is a very positive and essential part of success“. He would say that though, he succeeded.

And anyway what is the alternative? I would have given up trading a long time before profitability if I had a realistic chance of finding something that offered the same flexibility and (non financial) rewards. Unfortunately for me at least the alternatives were lacking in satisfaction that extended much beyond the idea of a regular income and a drunken Christmas Party.

So far all I have managed is a few disjointed thoughts on this subject. I don’t know what the answer is, and in many ways my answer counts for nothing as it is the individual’s circumstances that are key, we all have different thresholds for financial and emotional pain. All I would say is that learning to trade should be treated like any other serious project (excluding the bit about employing overpaid project managers on contract to earn four times the salary of those doing the work and whose sole contribution is a weekly Gantt chart ).

SMART objectives are a good idea as are regular reviews. It’s very difficult to pull the plug, especially as the losses and effort increases, but sometimes it is the right course of action. You need the opportunity to pause and reflect and  evidence on which to base the decision.

Throughout this I’ve talked about ‘quitting’ and ‘throwing in the towel’ both of which are regarded as pejorative phrases.  Recognising that a road is the wrong one is a positive outcome, even if it always seems to feel like nothing of the sort!

You know how the argument goes… shorter time-frames are just “meaningless, almost random, noise”.  So it should be easy to tell the difference between a daily chart and a 3 minute chart shouldn’t it? So see how you get on deciding which is which…

No prizes/comments/conclusions from me, you’ll have to provide all 3 for yourself.

I’ll put the answer in the comments section next week. Anyone who trades the FX pair that I chose and recognises the daily chart then that counts as cheating. Anyone who recognises the 3 min chart then that counts as a need to get out more.

Two aviation-themed true stories and how, in my strange world, they relate to trading.

Story 1. A DC10 pilot and flight engineer are both bored as the aircraft has been flying on autopilot for some time . The engineer wonders if the autothrottle would respond if he tried pulling on the manual throttle of engine number 1.  The pilot knows this is risky as the engine is already running at full speed but, presumably out of boredom, decides to try the experiment anyway.  The experiment is spectacular as it causes the engine to increase speed to such an extent that it blows up, smashes a window on the starboard side of the aircraft through which a passenger is sucked to their death.  Lesson 1 These people were  highly trained professionals in safety-critical roles, yet they were still susceptible to boredom and this boredom led them to a catastrophic decision.  Traders are generally much less professional and, although the results are a lot less serious, need to be aware of just how powerful an influence boredom can be.

Story 2. Israeli air force trainers noted that when their students flew exceptionally well, and they praised them, they almost always flew worse the next day.  Similarly, when their performance was poor, and they criticised them, they almost always responded to this criticism and flew better the next day.  Their conclusion was that it was best to reprimand pilots for poor performance but not praise them when they did well.  Lesson 2. This is faulty logic, exceptional performance (good or bad) is a deviation from mean performance and it is statistically likely that the pilot will revert back towards the mean next time. The same is true for good or bad trading days. If you had a bad day today then don’t give up as tomorrow is likely to be better. Likewise a good day is not an excuse to trade additional contracts tomorrow, your glittering performance is unlikely to be repeated.

I have become fixated with expectancy, I have forgotten about the number of trades per unit time.

I’ve been agonising over my foray into FX trading in recent months. The only thing outstanding about my performance is its mediocrity. But, to some degree, I have been looking at it in the wrong way.

I have been comparing my expectancy in this market, and individually for each of the pairs I trade, to that which I achieve with the indices.  But that of course isn’t the whole picture, what actually matters is the expectancy multiplied by the number of available trades (=P/L).  I might only see a few of these per day with the indices but with FX the greater number of markets and the longer hours offers a greater wealth of candidate trades.

Graphically, it looks something like the following (highly schematic) chart, which shows a decreasing average expectancy as the number of trades taken increase.

Maximising profit....P/L (left axis), Expectancy (right axis).

So the aim is not to maximise expectancy but to find the maximum on the orange line above (I’m assuming margin isn’t a problem for all these additional trades).

More fundamentally, any trade with a positive expectancy is, all other thing being equal, a good trade.  So if the (probability of the trade being profitable multiplied by the size of the win) is greater than (probability of it losing multiplied by the size of the loss) then this is a good trade.  Which also makes the point (funny where these trains of thought take you!) that it is not about achieving a certain win-rate or R:R, but about the above bold text.

Some simple maths shows that my return from FX, as a percentage per month, would be about a third that of my index trades.  This surprises me, and means that I should plug away at FX with real money (not 50p/pip as currently), but I’m not exactly looking forward to doing this when I feel that my entries are poor, my exits are worse and it often feels more like gambling than trading. Early results though seem to confirm the maths.