Long & Wrong

So after much thought I came up with my mantra, “Trade Like Blaise“, but should now explain it a bit.

Blaise Pascal was a French scientist and philosopher born in 1623.  He is perhaps best known for Pascal’s Wager in which he argues that  even though the existence of God cannot be proved, a person should wager as though God exists, because the potential benefits exceed the potential downside.

Pascal used decision theory to build a matrix that summed the ‘pros and cons’ of living as if God exists (for example if you believe in God and he does exist then you will live for eternity in Heaven) or living as if he doesn’t for the two scenarios that God actually does exist or he does not. Summing all the possibilities, he concluded that on balance it is better to live your life as if a supreme creator does exist, even though it is unprovable.

What has this got to do with trading? Well, my belief is that no matter what the prophets on Bloomberg tell you is going to happen, they don’t know and you don’t know either.  The statement ‘major support will hold’  is analogous to Pascal’s unprovable God.

So I construct a matrix (I do this notionally, not for real, that would just be too weird!) and chose the option that provides the best outcome on balance, that provides the  positive expectancy.  I don’t know if a key support level will break or not but I live my trading life, plan my entries and exits, in a way that maximizes expectancy without knowing what will actually happen.

That should now complete my alienation of the ‘show us some charts’ crowd. I promise to be more ‘practical and applied next week’.

A few weeks ago Swamiguru published his trading mantra.  Ever since then I have been thinking long and  hard about doing the same (daytime TV in the UK isn’t as diverting as it used to be).  So here it is,

Trade like Blaise.

I need to explain it? Really? I suppose I should then, and that will be my next post.

You need a buy-stop just above 1.6400.

I had planned a post based around the equity curve simulator that I take every opportunity to plug. I do this  because I feel it is really important that people understand the extent to which the variance in their trading account is nothing but cruel, unfeeling, performance-independent chance.

I had only recently noticed, or at least properly appreciated, that the equity doesn’t converge as the number of trades increases. Contrast this to the way that the percentage of heads will tend to 50% as the number of tosses of a coin increases, as the standard deviation=square-root(N*0.5*0.5) where N is the number of tosses.

This non-convergence suggests that we can all trade until the cows come home but the amount of money in our bank will never absolutely reflect how good or bad we are at a trading.  I tried to do something really clever with the maths at this point to reach an important and paradigm-shifting conclusion.  However,I failed, so I am left with only half an argument, half a brain and half a post. I’ve let you down, sorry.

Even then, the money in the bank doesn't accurately reflect how good we are at trading.

Lets end the week with a positive thought.

I can’t guarantee this is true, I have no interest in sports betting, but was recently told that on betting exchanges you can sometimes get odds of better than evens on the toss of a coin. People bet on the outcome of the toss  at the start of a cricket match and believe that because one team’s captain is a ‘good tosser’ <insert own joke here> (has a strong record of winning the toss) then they are more likely to do so again.

Why is this a positive thought? Because while there are people who are prepared to be that irrational with money then there is hope for all of us who apply a bit of logic to this irrational world.

And of course this also allows me to link to a video of possibly the best few seconds of cricket ever,

If you google “head and shoulders pattern” then it returns 543,000 pages, only a few of which are about the shampoo.  One of the sites on the first page of results describes it as a “powerful reversal pattern“, but is it?

You have to dig very deep to find any kind of quantitative answer to that. This strikes me as strange, there is no shortage of data on which to test the idea(!) and no difficulty formalising the pattern as an algorithm.  Why is it so difficult to find an analysis of the value of this pattern (and indeed many patterns and indicators)? The cynic might answer “because it doesn’t sell books“.

But I did dig deeper and found this study, Head and Shoulders: Not Just a Flaky Pattern (you can download the pdf of the paper), by Carol Osler.   I’d really be pushing your attention span, and mine, to critique or adequately summarise this paper, you can however read a journalist’s slightly uncharitable interpretation here.

Head & Shoulders

My point is not about this paper in particular but rather the general observation that quantitative evaluation of technical analysis is noticeable only by its absence, or at the very least its scarcity.  It only takes a cheap PC and a free download of OpenOffice Calc to be able to do a rough and ready back-test  for yourself.

During a heated debate on a trading forum about the value of pin bars I did exactly that. I analysed OHLC data for 8 years of hourly EUR/USD data and found they had no (actually slightly worse than ‘no’!) predictive value.  The problem of course is that crunching numbers in this way doesn’t allow for these signals to be placed in context, that limitation doesn’t however entirely negate the result. What was most telling was when people disproved  my analysis by showing me an example when a pin bar had bagged them 70 pips(!).

So my hope is that we become more prepared to shine the light of analysis on our cherished beliefs, and equally prepared to ditch any that don’t stand up to the scrutiny.

I have provided a number of links in the text above where I feel some terms may need further explanation.  I know the vocal minority are smart enough not to need them, please  don’t feel patronised.

The steadily growing traffic for this blog (thanks to those that kindly link here) is only a sign that new people are visiting, they may be visiting and hating it, if so I’d like to know. The silent majority are encouraged to comment, as of course are the vocal minority, even Solfest.

I often write and talk about taking the emotion out of trading. Now though those clever people at Philips have created a device that will warn home traders, by changing colour to red,  if your emotional state is not compatible with making trading decisions. 

"An emotion mirroring system for online traders", not a funky watch and fruit-bowl.

It seems utterly crazy to me but then I said the same about the iPod. You can read all about it here and form your own opinion. I turn a shade of green whenever I see 9 pips of slippage but I’m not even sure that is relevant.

I had done all of my homework, I was prepared for this.

[Open*]

I was vaguely aware of other voices in the room, people asking me stupid questions, I occasionally mumbled an answer.  I remember feeling nauseous and worrying that I might actually throw-up.  My heart was beating so hard and fast that I thought I might be having a heart-attack. If this went wrong, I had no idea how I could pay the mortgage.  I tried to focus on what was happening but was unable to ignore the nightmarish vision of being homeless and penniless.

[Close*].

24 minutes later it was over and I was £45,000 richer.

I am also a liar, sort of. Let me fill in the ‘*’ and explain…

* The door.

There were 24 minutes between me opening the door and closing it behind me again. I was £45,000 better off only after I had worked there for a year. It was the interview from hell.

My point is that our lives are full of gambles. These gambles, the outcome of which is very often a mixture of skill and luck, have serious financial implications. So please don’t have a go at me, and friends and family do, for being ‘irresponsible’ by trading.  There is a lot more risk-management at work in my trading then is ever possible in real life or in any kind of business venture. I’m not drawn to trading because I am reckless, I am drawn to trading because it is a simple, controllable system. 

Learning to trade, putting it all on 27.

The biggest gamble is investing the time and effort to learn, not knowing if it will ever pay-off.  It takes a lot longer than 24 minutes which is probably why very few, quite sensibly,  take the risk.

[14:31 GMT, I'm really hoping lots of people are gambling on EUR/JPY not breaking through 132.00. I hate counter-trend trades but this was too hard to resist.  My FX trades have improved since Monday, thankfully.]

My first foray into full-on forex (I may be better at alliteration than trading!) was delayed last week.  You tell people about how flexible your trading activities are and then they expect you to be flexible!

So I got up early this morning and have already completed 3 trades, risking one percent per trade. The result? I’m down 3%. A loss, a loss and (for the less mathematically inclined of you) a loss.

So I’m hugging my spreadsheet like a child hugs its favourite soft toy. It soothes me by telling me that the chances of 3 losing trades in a row are ~20%. It doesn’t tell me why I missed my EUR/JPY entry by 0.1 pip and that would have made me 1.8%.

Time to clear the mind and wait for the next trade to come along. I’ll have a cup of tea as well, but not the posh stuff, I’ll save that for more profitable times. 

As reported by the BBC yesterday,

The FTSE 100 index of leading shares has enjoyed the best three months in its 25-year history.  The index, which has just closed at 5133.9 points, gained 21% between July and September.

This is why I only worry about the next couple of hours, at most, when it comes to trading.  I’ve lost count of the number of times I have finished for the day, zoomed out to the daily chart and thought ‘This can’t go on’.  If position trading were my thing then by now I would have had to rename this blog ‘Short & Wrong & Bankrupt’.

So I’ll stick to the 5 minute charts, those repeating patterns of human behaviour and fickle sentiment, and leave the longer term view to those who know something about it.  It really does look like a great short from 5,450 though doesn’t it?!