Long & Wrong

Note the question mark in the title above. I’m not promoting the skeleton of a trading strategy here, I’m just recording a few thoughts on this topic.

I’m obsessed with how easy it is to lose money trading, I know I did for long enough, but I’ve never been convinced that it should be that easy.  So I’ve been thinking about what a trading strategy would look like if our aim was not to make a fortune but  rather was just  not  to lose money.  Here’s what the back of my envelope looked like after 10 minutes,

1. If we don’t want to lose money then our cost of doing business should be minimised.  The profit target for each trade should be very much greater than the spread.
2. The  distances between our entries and exits should also be sufficient to minimise our exposure to ‘noise’ (we could use ATR for this but we aren’t that clever yet, anyway the human eye is an excellent judge). Noise is just a 50/50 gamble and we want (slightly) better than that.
3. We will only trade with the trend.  ’The trend‘ is the slope of the price on the chart (time-frame) that we plan to execute our trades on.  Once again we’ll just rely on our eyes.
4. In order to further nudge our system towards an edge, any edge, we will place our stop the far side of support/resistance (s/r) and our target will be at s/r.  Once again we are not trying to be clever here, s/r is a horizontal line from where price has deflected significantly in the past; no fibs, no wedges etc.
5. We will aim for a modest risk:reward of between 1.0 and 1.5:1, rejecting trades if this isn’t possible given the 4 points above.
6. Once the trade is open we will leave it well alone.  More information does become available with time but a little information is a dangerous thing if you don’t know how to interpret it, e.g. it becomes an excuse to get out too early, so we’ll ignore it.

Now there are two things I don’t know, actually there are lots but I am trying to be specific,

1. Will this simple approach lose money? I don’t think it will, but I wouldn’t bet my house on it.
2. Is there any point to aim this low, to not lose money?

Is it possible to start like this, and maintain capital ,whilst you learn about the market and increase the expectancy of the method by gradual refinement? Are new traders blowing accounts partly because they try to trade like highly profitable traders from Day 1 (which is like learning to  drive in a Formula 1 car and crashing it on the first lap).

Like I said, this is just a topic for thought/discussion.  I’m on holiday this week but I am so committed to my meagre readership that I took time out to post this.

Oh OK then, I wrote this last week and scheduled the post for today.

Many trading bloggers seem to be taking a rest during these long days of summer (it hit a scorching 18 C / 64F today as this British summer looks like most others  i.e. consisting entirely of a hot and sunny week in late May!).

At least the weather is better than yesterday.

Well I’m about to do the same and not post properly this week.  It’s not the weather, it’s the markets. I’ve noticed a shift in mood in recent weeks and that has required a subtle shift in strategy. It’s not a problem, it happens all the time BUT it does mean that trading isn’t so ‘automatic’, it requires more effort.

So I am sat here on the day that I normally post something of incredible insight and wide-ranging interest (!), feeling more tired than normal and a little bit poorer than normal. I’ll hope you’ll excuse me and let me have the week off.

If I did have the energy then I would be writing about how to recognise the difference between when it is time for a new approach because the market has changed and when it is just ‘statistical noise / natural drawdown’ and the temptation to change should be avoided.  So in a way I’m glad I don’t have the energy this week, as I’m not sure I know  the answer to that!

Trading? That’s just gambling for the middle-classes!

Is that a fair accusation? Lets think about what we mean by ‘gambling’; in its purest form it is just a random guess at a random outcome (Roulette, a lottery, scratchcards etc).   The chances of winning the (UK) National Lottery are 1 in 14 million, even the young and healthy are more likely to have died by the time the draw is made than to win the jackpot. This kind of gambling is, as a wise man once said, little more than a tax on the stupid.

But that is just one form of gambling, when everyone’s chances are equal(ly bad) and there is no skill involved at all. The next step up (or down) the ladder involves the introduction of an element of skill. That skill may be fairly slight (or perhaps I am being unfair on those who bet on the number of corners in a football match?!) or more significant like in poker.

Poker shares much of its strategy, some of its vocabulary and a big chunk of psychology with financial trading. I could spend a post, or series of posts, discussing the similarities and differences between these two activities but that would be a digression. What is worth noting is that this type of gambling is now about both chance and skill. As chance should average out in the long term then it almost becomes possible to say that a poker career is all about skill, this is why the final tables of big tournaments often feature the same (poker) faces.

Jennifer Tilly at the 2006 World Series of Poker. More visually appealing than Doyle Brunson!

So I’ve written a bit about how I see some gambling as 100% luck , and which offers little more than excitement ,and other gambling which over the long term comes down to skill and shares a lot with financial trading. But to set financial trading in context there is a further kind of gambling that is overlooked.

We gamble when we resign from one job to take up a new one. We gamble when we decide to invest the money required to go to university.   These ‘life-decisions’ are gambles and they all have much greater financial implications than shorting one FTSE future contract.  They are rarely thought of as gambling though. A salesman’s job seems very like gambling with clear costs (time, petrol, a PowerPoint licence!) being risked with the hope, but no guarantee, of winning sales.

So is trading gambling? Yes, I think it is. But it is the type of gambling where skill predominates and that seems very different from the ‘wing and a prayer’ alternatives. But if trading is gambling then so is applying for a new job. We all gamble in life, we just need to be comfortable with the risks we take and confident that we have the skills to ensure the outcome we require.

An emergent property is a property that a system has but which the individual members do not.  Let me give you a couple of examples chosen for their impact rather than relevance..!..

If you take a Sodium atom (sodium is a metal that reacts violently with water) and combine it with a Chlorine atom (a poisonous green gas) then you get Sodium Chloride (or table salt, that makes chips taste better).

An alternative example is that of consciousness (let it not be said that this blog  avoids the ‘big questions’!), an emergent property of the relatively simple, but numerous, chemical processes that go on in the wet, grey stuff between our ears.

So to return to relevance, another example is  ‘price’.  The complex market – with all its participants, their hopes and fears and greed and differing opinions – produces an emergent property we call price. And that emergent property is about all I am interested in.

I know why people put their stops just below prior support and I know why support levels exist. I know what happens when those sell stops are triggered and I know the reasons why that might happen and probable outcomes. But I don’t care about that, I don’t waste my few brain cells on it, I just worry about price as that encapsulates all I need to know about the underlying complex system.

In that scenario price behaves in a certain way. A formal definition of emergent properties describes how they often exhibit patterns not apparent in the individual members of the system.  It’s those very patterns that I exploit. And I exploit them without worrying too much about the underlying mechanisms.

The emergent property of price is all I need for an easy life and hopefully a profitable one.