Step away from the assumptions!

This has been by far the most challenging blog update I’ve had to write…

Having procrastinated in an olympic fashion for the last three weeks I’ve given myself the deadline (today – Saturday) to get the following out of my brain and into the real world.

Maybe this proceeds an incoming mid-life crisis or is just the symptom of a frustrated trader not taking the opportunities that present themselves.

Not to make light of the facts but really my performance to date does pretty much suck. This has led me to question a number of assumptions about trading (as presented by numerous organisations, books and courses) as well as my own biases and why people take certain paths to try to conquer the mountain.

I apologise in advance for the length of this post. I’d also like to point out in advance that I’m not ‘down on trading’ even though some of what follows might sound slightly negative 😉

It’s been a couple of weeks and of course we’re in the midst of a full on ‘lizard brain’ attack in the financial markets. While I did short the Dow at one point the volatility gave me a significant pain in the neck and I decided to stand on the sidelines 😉

Another reason for doing this has been that I’ve not had the opportunity to watch this type of market before so have very little appreciation or understanding of what’s happening. At the moment I’d reckon that putting my toe in the water could get me my leg bitten off!

Also I’m un-satisfied with how I’ve been approaching trading and have been looking at some ways to improve my overall performance. What’s contributed here is that I’ve been reading the book ‘Thinkertoys’ which outlines some creative and different ways of solving problems.

The main question I’ve been asking myself is: –

How do I become a profitable trader?

Looking at the amount of stuff I’ve already waded through in pursuit of this goal as well as the outlay I’ve begun to wonder if I’m missing a significant piece of the puzzle somewhere?!?!

I’d suggest that 90% of the information about trading, certainly related to technical trading, is pretty much the same or variations on a theme which goes something like this: –

Strategy (entry/exit), Risk:Reward, Money Management, Psychology is all… etc.

Now, maybe I’m being somewhat unrealistic but I still suck at this subject after more than 9 months and a great deal of time, money and emotional investment. I don’t think I’m retarded or particularly slow on the uptake.

Either I’m over-thinking it or my approach is flawed… so I’ve been looking for flaws by asking different questions about what I’ve been doing to see what sort of answers I come up with. Thinking sideways through a problem which encompasses trading but includes some of my own biases and the way I approach life/finances in general.

Let’s take a step back from strategy, entry/exit etc. and the specifics as I try to break this down into easily manageable pieces.

In it’s most basic form a ‘trade’ is an idea. If I’m shorting the FTSE then my ‘idea’ is that confidence is leaving the market, people are moving their money out of stocks into safer havens (cash/bonds) and the index as a whole will fall.

Now, here’s another question… How can I be certain my idea is correct? In other words when I enter a position how do I know what my odds are that the position will come good? What is my percentage chance of being right? If you are a professional card player then you will know the odds. How is it possible to take a trade and decide based on the odds what amount of capitol to risk if you don’t know what your odds are?

Here’s where I believe there’s a significant issue with the information that exists out there in the land of trading education… Very few trading strategies seem to be taught or promoted that include data about their relative level of success (win/loss ratio) in a given market. If we define ‘retail traders’ as people with <£10K in a trading account then it’s no wonder that 80% (average figure I’ve heard quoted) don’t make any money!

They (and me) are tossing a coin in the air.

Now in an earlier post I mentioned that Richard Farley had spent some time looking at ‘trend following’ and calculated the odds are 55/45 in favour of this type of approach. I’d like to have at least an idea of the chances of being right in a given set of circumstances before placing a trade. Am I asking too much?

Back to the idea – again, making it as simple as possible… Shorting the FTSE based on a bunch of technical indicators (moving averages, trend lines, broken support or pick something more esoteric) implies that you believe confidence is lacking and buyers are leaving the market.

Let’s look at it another way… Going short because the 50MA crosses under the 200MA isn’t strictly following an idea. It’s more like following a cue for action based on a number of other ideas which are collected together and the symptoms result a chart on which the price is dropping/EMA cross over.

If you do this then you’re not trading based on the primary idea (cause) but on the effect or result as described on a chart.

Doing anything when you’re one step removed from the primary data means there’s a lot of room for error and miss-interpretation. You’re going to always be playing catch up with the market. It’s certain that more informed parties are acting on information you don’t have access to and your action is happening right at the death of a particular move.

Here’s the leap… Using only technical indicator movements to trade from charts (as most ‘retail’ traders do I think) is hoping that you have the the ability to judge the prevailing wind about a stock/index in the moment when you’re divorced from the idea that is already driving the price in a certain direction.

Now, this is where the argument breaks out between technical traders and fundamental traders and I’m going to attempt to avoid engaging with it too much except to say that if you have an idea you want to base a trade on which is backed up by a good chart then I’d suggest that it’s more than likely your trade will work out.

If you have an idea based only on a technical trade setup without understanding the environment it will be less likely that your trade will work.

Here’s why I think ‘retail’ traders rely so much on and are emotionally attached to technical trading (charts) and indicators… It’s an excuse to trade in a lazy way without having your own ideas about the world and what’s going to happen.

Talking to people about charts, Gann, Elliot waves and Fibonnacci turns something that is rather pedestrian into something different, difficult and challenging. It also means you can hint at a ‘magic’ formula which needs to be understood in order to actually come good as a trader. This makes ‘selling the mystery’ of trading good business 😉

Now, let me emphasise here that I’m not going to suddenly stop looking at charts! I reckon they’re extremely useful to help visualise what’s happening but expecting to make money from a technical system without reference to context is (I think) unlikely to come good.

Phew!

Here’s an example… I believe that economic and social conflict will escalate in the US during the next decade driven by the disparity between the rich/poor, the failure of the US government to lead, politics moving from debate to fixed faith in ‘fact and sound bytes’, competition for resources and disillusionment fuelled by unmet expectations.

This will be further compounded by China’s expanding sphere of influence driven primarily by having to secure the resources it needs to ensure internal social unrest is kept to a minimum. The communist party will try to maintain control through creating happy citizens who are economically better off.

Ironically they are now pursuing the model that the US has followed in the last 60 years but maybe they can avoid the hangover that the United States is currently experiencing 😉

Now, there are a whole bunch of trading ideas here. Long companies making riot gear, CCTV or providing security services. Find a way to invest in companies specialising in exploration for resources. Invest in sectors engaged in or producing the ‘shiny thing make it all better’ products of the future for a growing Chinese consumer base…

I’ve not looked at a single chart yet but I feel more confident about these ideas because these are backed up by beliefs rather than some technical voodoo (sorry, overstating the technical downer there a little!)

When financial confidence melts down then perfectly good companies also get punished – Google dropped last week and they’re an amazing company (IMHO) so it’s obviously important to pay attention to the environment.

So… Ideas? There are probably millions of them.

I’d not posted anything for two weeks because I was really having a quiet moment to look at what I was doing. As with many things in life you then stumble onto something that helps turn the tiny spark of an idea into something concrete…

When did this change of thinking really come into focus?

See my next post – Ooh! Cliff-hangar!!

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5 thoughts on “Step away from the assumptions!

  1. Millbrook

    Hi Robert,
    I’ve heard it said that there are only 2 ways of trading. Positional and momentum.
    I trade on momentum so in the context of your recent post I’m using TA to hop on the coat tails of the big traders (euro/$). I don’t give a monkeys about fundementals because I’ll never understand them like the pro analysts do nor will I ever be party to the size of trades entering the market.

    So I aim to react not predict. I look at price movement, momentum indicators, supp/res. I’ve also learnt a characteristic of this particular instrument (backfilling) which has an impact on exit/entry and stop size.

    I also have a goal of 10 pips a day – modest given the daily range of euro/$. In a good run 10 pips is easily exceeded. On a bad run I can clearly see where trading errors cause problems. I can only describe these errors an internal bias which I drop back into and have to continually try to relearn my way out of.

    In short my belief about trading is that you have to find an edge which suits your own make up then continually analyse what is the difference in behaviour when you succeed and when you fail.

    As always Good Luck.

    Reply
    1. robertsweetman Post author

      Thanks Milbrook for the comment and best wishes

      Completely agree with your point = you have to find something that works for you.

      The fact that I can’t seem to succeed intra-day not helped by the fact that I’m really supposed to be doing something else (day-job-lol) and multi-tasking is not my forte at all…

      I’m certainly not ‘down on TA’ either although I think context is important when considering what to trade. I hope to post up some significantly better results in the next few months. If it was easy, everyone would be doing it 😉

      As with all these things (to quote Monty Python)… “Yes! We are all individuals!”

      Best regards

      Rob

      Reply
  2. Pascal

    Hi Robert
    I have been following your emails for a little while now and just wanted to say that your journey (both financially and emotionally) is very interesting and very true-to-life.
    Like you, I too started exploring trading as a hobby and as a means of funding an alternative lifestyle. My interest started passively maybe 5 years ago and I started subscribing to various investment magazines to gain a better understanding. I started actively trading about 8-9 months ago and I can appreciate the emotional and psychological rollercoaster when you start trading and learn to deal with gains, losses and good deals missed!

    Fortunately, I have been doing fairly ok and have made some decent gains. I have realised small losses but I have a little bit of holding power and am able to hold off paper losses until my initial hypothesis is realised and my gain materialises. Where we differ in trading strategy perhaps is that I don’t spread bet and I don’t bet on indices. My approach is fairly basic and straightforward. I identify stocks that I believe are fundamentally strong and have good growth prospects across various sectors and then I just wait and monitor them until they hit a price that I believe is good value and I buy them. I know this sounds almost too simplistic but after reading as much as I can, I have come to the conclusion that no one really knows what direction the market will go – Hence you are right that there are themes you must believe in and can justify to yourself. From your description, I think you are probably involved in management consulting (as am I) so use your strategic and analytical skills to identify a trend. I hope you keep up the blogs and share your experiences. I think you are on the right track in taking a breather and reassessing your strategy, for what it’s worth. Good luck!

    Reply
    1. robertsweetman Post author

      Thx Pascal for the interest and your comments 😉

      My day-to-day job is as a project manager (or herder of many cats) so the similarity there to trading (imho) is trying to see and make sense of the big picture. Ironically I previously dismissed anything like this approach with trading as I’d been completely sold on the ‘technical analysis’ is all you need approach by a couple of companies/sources.

      This comes back again to the interesting technical analysis argument that ‘everything’ is in the price whereas I’m coming around to the idea that ‘everything’ actually doesn’t include the future impact of much longer term ideas… Can price action be so all knowing that it includes events which are ‘priced in’ beyond the next 4 weeks or 4 months?

      I think there’s an inconsistency here between (1) Identifying a long term trend (2) The ‘health’ of the market as a whole or possibly more accurate would be the amount of liquidity in the market at a given time. As we’ve seen in the last weeks the ‘trend’ may have been up but all of a sudden everyone got kicked in the teeth. On this basis a simple approach definitely has a lot of benefits.

      This has also happened to me previously with FTSE stock bets where I’ve taken a long position, the market has decided it’s nervous, my stop has been taken out only for the price to leap up to new highs. Of course there are lots of reasons why this could happen but ‘general market sentiment’ has huge power to knock perfectly legitimate winning trades. Maybe I just need wider stops 😉

      These sort of observations are what I’m trying to put into my trading strategy so it’s actually repeatable.

      The blog definitely helps as a focus for crystallizing ideas, any feedback is invaluable and all encouragement helps enormously!

      Reply
      1. Pascal

        Hi Robert
        I personally think you hit the nail on the head in your last posting i.e. that a fundamental theme/idea supported by a technical trend has a higher degree of success than the reverse. Ultimately, there are too many variables that can impact the final outcome. Using my basic knowledge of statistics, I would say that if the variation was general “noise” then this is just normal “systematic risk” and ultimately this will even out. However, unsystematic risk events like the last couple of weeks (say the downgrade in the US, etc) are not within the usual realm of our expectations (a black swan, I guess) and you probably have to accept that you plan for the risks which are expected. There are some who would disagree and say these were foreseen but hindsight and rationalisation are wonderful things.

        The key thing regarding index betting that I cannot understand is how this can be predicted with a significant degree of success given the number of variables, combinations and outcomes? I am sure there are mathematicians and actuarists who can prove me wrong but as a layman I think of this rather simplistically – 200 countries x thousands of listed companies x economic/financial indicators, etc = each one leading to a potentially unique outcome for the index to move in one direction. I can’t see it. If I can’t even accurately predict how one stock price will go, doesn’t this deteriorate even further at an index level?

        If I were to draw an analogy with your PMO/Consulting work – the ultimate success of a project is driven by so many activities and interdependencies – just one can impact your critical path and timelines. Now imagine this magnified several times more in this globalised connected world, manifested in a stock exchange index.

        I like your blog – A lot of what you post I can identify with. I’m not a great success by any means but your latest blogs I think are heading in the right direction – Stepping back and seeing the big picture. I recently read Confessions of a Hedge Fund and what struck me that despite the brightest brains in the business, etc ultimately after 4 years, the fund made huge losses. So, you get it right some of the time, but not always. But if you get it right more often than wrong then you’re winning.

        For myself, I like the trading. I find it the ultimate computer game -multiple players on multiple platforms. I win some and I lose some. So far I’m winning a little more than I’m losing so I’m no beating myself on the losses (although it’s tough!).

        Keep up the postings and sharing your journey! Pascal.

        .

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