To help pyou gain an insight into a typical winning trader s mentality To show you how your belief structure stands in the way of your being

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2 OUR OBJECTIVES To help pyou gain an insight into a typical winning trader s mentality To show you how your belief structure stands in the way of your being profitable To help you understand how your natural wiring is not ideal for the most consistent trading outcome 2

3 WHERE ARE YOU IN THIS? Please take a moment to answer the following poll question: (poll) 3

4 YOUR EXPECTATIONS You have an expectation of how each outcome should be You believe that if you take a certain number of steps, you will achieve your expectation and will be rewarded What you perceive is possible and what you expect out of the market is not what you are getting This has nothing to do with the market. Your disappointment is the result of your attitude and false beliefs of the market 4

5 WHAT MOVES PRICES IN THE MARKET Buyers believe that prices will move up and can sell for higher prices Sellers believe that prices will move down and can buy back at lower prices There are only TWO outcomes of any given trade. Do you believe this? 5

6 THE FORCES THAT MOVE THE MARKET There are fundamentally 2 forces that move the market: Participants who believe that prices are too cheap and won t go any lower Participants who believe that prices are too expensive e and won t go any higher Each one of these participants each trader executing a trade is a variable that has an effect on the product you are trading and on the final outcome of the trade 6

7 THE FORCES THAT MOVE THE MARKET Most people overlook a THIRD force. What is this 3 rd force that can move the market? It is the participants who have not yet taken a position and can enter at any time 7

8 MEASURING MARKET FORCES Can we measure the first 2 forces? Yes! What are some of the tools to measure them? Volume profiling Market Delta VWAP Volume histograms Bid/Ask Spreads Fibonacci Retracements Candlestick formations, price patterns, etc 8

9 MEASURING MARKET FORCES Can any of these tools measure the 3 rd Force? Absolutely not! This 3 rd Force is the unknown and is the greatest threat to your very next trade Again, each participant is also a variable and represents a threat t to your very next trade 9

10 TRADING MISTAKES What are some of the most common things traders do to sabotage their consistency? You wait too long for a pre-defined area to do business and take the trade too late. You are waiting for confirmation You take the trade and take profits very quickly because you don t want to lose You take the trade and it hits your stop (if you had one) and now you are too afraid to take the next trade. You are now waiting for double confirmation You take a loss and you fight back to make Mr. Market pay for what he did to you. You are now revenge trading You know what you have to do but are frozen by fear while you watch as someone else takes the trade you passed on and feel sick to your stomach as it gets to its targets You have been doing this for years and keep repeating the cycle of making one or more of these mistakes and then starting over 10

11 RESISTANCE TO THE UNKNOWN Our minds are programmed since birth to operate in terms of cause and effect Our entire education, career and daily life is based on an almost guaranteed outcome for the effort expended. E.g = 4 or if I buy a ticket t to the game, then I will be admitted and will have fun How does this tie in with the Market Forces described earlier? Is trading the right business to be in for those who want a guaranteed return on their effort? This is what makes trading what is possibly one of the most difficult endeavors especially for those coming from engineering, intellectual, medical and other highly educated backgrounds 11

12 RESISTANCE TO THE UNKNOWN Knowing all of that, how does it help you to understand the difference between a consistently profitable trader and one who is not? The consistently profitable trader knows with every cell in his being that the outcome of the next trade cannot be known It is key to distinguish between thinking that you don t know and knowing that you don t know. This is an important distinction Now let s look at our relationship with losses. 12

13 A POLL ON LOSSES Let s looks at the results of the poll posted on June 2 nd, on my blog The question: q There is an outbreak of Asian Flu at your location. If nothing is done, they predict that 600 people will die. Two courses of action have been suggested. If program A is adopted, 200 people will be saved. If program B is adopted, there is a one-third probability that 600 people will be saved and a twothirds probability that no people will be saved. Which of the two programs do you favor? 13

14 A POLL ON LOSSES Poll Results: (302 samples) Conclusion: Because lives were at stake, the great majority of those who took the poll are risk-averse in that they would gain by saving 200 and accept that 400 will perish. Program B gave us a chance of saving everyone but the probability was only 33%. Both Program A and Program B have the same outcome of only saving an average of 200 people If the wording had said Program A guarantees 400 people will die the majority would have chosen Program B. People are risk-seeking when thinking in terms of loss, but are risk-averse when they think of lives saved. 14

15 YOUR INNER MONKEY Consider that based on that information, you are likely to give more room and more time to avoid closing a losing position You are also more likely to be risk-averse when you see a profit and will close the position for a small profit 15

16 THE TWO-PRONGED ENIGMA So far, we have explored the nature of the market by defining the various variables that are essentially unknown in their action We have also defined the nature of our highly educated and highly programmed minds that we have a propensity to risk-aversion with our profits and risk-seeking with losses Let s now look at more specific loss patterns typical to trading 16

17 THOSE DARNED LOSSES How many have in the past put on a trade without first defining and accepting the risk? (poll) 17

18 THOSE DARNED LOSSES Why would an intelligent trader who knows that there are unknown forces in the market ever consider putting on a trade without first defining the risk or cost of finding out if the trade would work? Have you defined what the market has to do for you to be wrong? Have you defined what the market has to feel like for you to be wrong? Have you defined how far you would allow it to test against you for you to be wrong? 18

19 THOSE DARNED LOSSES What is the key reason why we would initiate and repeat tthis behavior? Answer: A typical trader will not trade until he has convinced himself that he is right! A typical trader will not trade unless he knows that there is no risk Defining a stop-loss or the risk to a trade means that there has to be a conscious effort to prove oneself wrong. Right? Given what we have learned about market Forces and our Inner Monkey, how true can knowing be??? 19

20 THOSE DARNED LOSSES Let s shift gears for a second and look at another aspect of integrating losses within our beliefs: Which one would cause you more pain? 1. Takingastop-loss? a 2. Losing an opportunity that you had? (poll) 20

21 DEFLECTING RESPONSIBILITY If missing an opportunity truly causes you more pain, then you are likely risk-seeking and absolutely need to have strong risk parameters in place. Missing an opportunity that you had and planned for is very painful because the blame can t be shifted to the market If you prefer to have your stop-loss triggered, then your are risk-averse. Be cautious of conversations with yourself where you use the words they did this or the market did that. It is much easier and less painful to blame the market for your loss 21

22 THE PERFECT TRADE Most traders spend a majority of the effort in research to technically find a trade or setup that can get as close to guaranteeing a positive outcome as possible The reward of a positive outcome is the satisfaction of success, the release of Endorphins and a general feeling of well-being To short-circuit this effort, most traders will gather as much information as possible to emotionally guarantee a positive outcome to the next trade in order to even put it on 22

23 THE PERFECT TRADE How does all of this information gathering g work with regards to determining the risk of any given trade? It works against the effort revealed in the last slide where an inconsistent trader will not likely put on a trade until he has convinced himself that he is right The logic is: I would not put on the trade anyway y unless I think I m right. If I didn t think I would be right, then I wouldn t put on the trade anyway. The result: Forget defining i the risk or using a logical l or dynamic stop-loss (i.e. I know that this will be a winner! ) 23

24 PROBABILITIES AND OUTCOMES A consistent trader has the following core characteristics: 1. A probabilistic mentality that is a key to his or her approach hto the market 2. An approach that is based on a reading at any given moment of what is the more likely dominant force as the market rotates 3. An acceptance that the outcome of any given trade cannot be known until the trade has unwound itself 4. An acceptance that the market, like the weather, will be the final commander of what happens next 24

25 PROBABILITIES AND OUTCOMES Let s have a look at some simple truths existing in the market You can take the exact same data, same prices, same setup and same time of day and quantify it This data, to a less experienced trader, will result in the conclusion that the outcome should be identical Every moment in the market is a unique moment Why is this moment unique? o Because we do not know if the same participants will be there and will do the same thing as last time 25

26 PROBABILITIES AND OUTCOMES 26

27 PROBABILITIES AND OUTCOMES The outcome of any trade can only yield one of two results: 1. The trade is a winner 2. The trade is a loser We do not know within any setup where the next winning trade will show up and where the next losing trade will show up. There is no way to know Once the trade has been put on, we know that this is a unique moment and we do not have any control except to manage the trade according to our plan 27

28 PROBABILITIES AND OUTCOMES If the outcome is only 50/50 (win/loss), then why bother trading at all? You might be mixing the distinction between the outcome of the next trade within a set of trades and the skew of the entire set of trades For example: You might have a setup that yields a 62% probability of winning over the long-run. Still, you do not know where the 38% loss will occur. It could happen as a streak at the beginning or it could be randomly distributed across the sample or it could happen at the end It only takes one trader or variable to negate the outcome of your edge on this next trade Are we in agreement on this? 28

29 PROBABILITIES AND OUTCOMES Let s look at a couple of real-life examples of an exercise that t my traders do. Here are the rules: A trader flips a coin. Heads is long. Tails is short. As soon as the outcome of the coin-toss is revealed, the trader enters the market short or long at market The trader automatically enters a target of 4 ticks in ES and a stop of 4 ticks in ES As soon as either the target or the stop-loss is triggered, the trader tosses the coin and does it again Minimum sample must be 20 trades Let s look at the outcome received from 2 out of 4 independent followers last week on Twitter 29

30 PROBABILITIES AND OUTCOMES Eternum_ft: 28 trades (14 short, 14 long Randomly generated!) 20 losers 8 winners 28.8% Win Rate 8 Trades max losing streak Expectancy: <0.43> pts per trade 30

31 31 TRADE SUMMARY FOR ETERNUM

32 32 TRADE SUMMARY FOR ETERNUM

33 PROBABILITIES AND OUTCOMES Kathy (used 6-tick target, 6-tick stop): 20 trades (10 short, 10 long Randomly generated!) 13 losers 7 winners 35% Win Rate Expectancy: <0.5> pts per trade 33

34 HOW CAN WE USE THIS EXERCISE The point of this exercise is simple: The entry and direction of trade is undoubtedly random. How important is trade entry really? The random entry yielded an average of 33% win percentage on the strategy Without improving the entry at all, can this method be made profitable? 34

35 MAKING DUCK SOUP OUT OF DUCK #*$% With a little bit of study, we can turn this approach into a marginally profitable or breakeven system in theory We enter some risk and money management parameters to achieve this Here are some rules: 1. Only 2% of account equity can be at risk 2. We can only trade this system in a balanced market 3. Our targets have to be at least 3 to 3.5 times our stop-loss 4. We trade only in times of less directional bias (i.e. avoid first and last hour of cash market trading) 5. All other rules remain the same 35

36 HOW MANY TRADES CAN THIS SYSTEM TAKE? Given the limited account equity risked, how many trades can this system take before it has to stop trading? 36

37 HOW MANY TRADES CAN THIS SYSTEM TAKE? 450 % of Account Risked per Trade assuming $100,000 account and stop at $2,000 of equity remaining % 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% No. of Trades 37

38 THE EDGE AND IMPROVING IT The Trader s Edge is simply a measure of the skew or favorable probability of your setups Your edge can be a function of market understanding, research and a sample of trades large enough that will indicate that you will have a consistent positive outcome at the macro level Risk control and money management are key to drastically raising the outcome of your trading as shown in the random example earlier 38

39 EMOTIONAL CAPITAL Emotional capital is essentially the amount of stability and positive belief you have in your ability to achieve your objective Think of it as a bank account: The more often you execute good trades (regardless of outcome), the more equity you deposit in your emotional capital account The more often you get emotional and lose control of your execution, the more debits you will have in that same account If you make enough debits on our emotional capital account, we go into Overdraft Protection ti where we experience excessive fear with every trade Trading with fear results in hesitation, seeking more confirmation to guarantee winning trades, etc. Does that sound familiar? So let s go back to the most common trading mistakes that we discussed earlier 39

40 THE MONKEY SYMPTOMS Mistake You wait too long for a pre-defined area to do business and take the trade too late. You are waiting for confirmation You take the trade and take profits very quickly because you don t want to lose You take the trade and it hits your stop (if you had one) and now you are too afraid to take the next trade. You are now waiting for double confirmation You take a loss and you fight back to make Mr. Market pay for what he did to you. You are now revenge trading You know what you have to do but are frozen by fear while you watch as someone else takes the trade you passed on and feel sick to your stomach as it gets to its targets Monkey Acting Out or Culprit Risk-Averse Monkey; Low emotional capital; Non-belief in random effect Risk-Averse Monkey; Low emotional capital; Non-belief in probability of setup Risk-Averse Monkey; Low emotional capital; Non-belief in random effect Risk-Seeking Monkey; Ok emotional capital and about to debit; Non-belief in random effect Risk-Averse Monkey; Low emotional capital, non belief in anything at all You have been doing this for years and keep repeating the cycle of making one or more of these mistakes and then starting over Risk-Seeking Monkey; Low emotional capital; non-belief in probability of setup 40

41 WHERE ARE YOU NOW? Please take a moment to answer the following poll question again: (poll) 41

42 NEXT STEPS Practice trading more mechanically. Know that you do not know. How do you achieve this? I have given you the tools you need to form your hypothesis Switch to a sim account for a few days and take every trade of a specific setup that shows up without fail and while knowing that the outcome of any trade is unknowable Define and accept either a fixed or dynamic stop-loss for every trade before taking it Trade a sample of at least 30 trades and then compute expectancy. Give your execution of every trade a grade of your choosing Keep a journal or log of your trades. Do something as simple as plotting or marking trades on a 3-minute chart at the end of each day for a couple of weeks. You will recognize a pattern Clear your screens of everything er except what you use. My screens have only what I need to support my trade decisions. This is a key step Your ultimate goal is to become ONE with the fact that every trade has an unknown outcome for EVERY market participant Never think in terms of should, will and must. Keep a flexible mind Don t listen to the idea of controlling emotions. Don t control them, use them to identify issues Never trade to make money. Trade to be a superior trader. 42

43 THE ROLE OF INTUITION Left half of our brain is rational. It operates from prior information Right half of our brain is intuitive. It operates from our creative self. Because the right half is creative, it essentially goes beyond the rational mind and taps into a belief system and the flow of the subject which you are focused on Once we have practiced our approach to trading enough (i.e. Malcolm Gladwell s Outliers of 10,000 hours of practice), then the intuitive mind begins to take over and to help us make decisions without the rational half being involved Achieving this state of being is what one sees when watching a great tennis player, golfer or artist perform his or her craft. The same can be achieved in trading How does it work? Nobody knows, but it essentially is caused by unleashing the full capacity of our mind to see things that are too subtle for our rational mind to describe When someone is trading from this place, it is known as trading in the zone or trading with the flow 43

44 FINAL WORDS 1. We have looked at a small portion of the mental aspect of a consistent trader 2. We have looked at the nature of the unknown aspect of trading 3. We have looked at the nature of our mind as affected by our natural aversion to risk as well as the effect of our education and programming 4. We have looked at the nature of losing and losses on our decisions and emotional capital 5. We have looked at the relative unimportance of trade entry when compared to trade management and risk management 6. We have discussed the random effect on your very next trade 7. We have discussed some basic steps that can be taken to improve your mental readiness to take on the next trade and to accept the wins or losses 8. We have looked at the role of intuition You control how you trade; the market controls how or when you will get paid Brett Steenbarger, The Daily Trading Coach 44

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