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solfest

Whose Game Are You Playing?

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After a few years of trading I have come to the realization that the key to winning is all in my head. This is a psychological battle with myself. The market participants are irrelevant. There is no giant war against the big banks or hedge funds or you my fellow independents. The game (war sounds so nasty) is me against me. Or as I once penned Bad Solfest against Good Solfest.

 

I have an edge and the key to success is to only trade within that edge. Good Solfest follows that plan, Bad Solfest wants to make up new rules every time he has a losing trade. Bad Solfest tries to play everyone’s game, Good Solfest only wants to play his game.

 

Let me put this another way, wander over to your bookshelf and pick up your well thumbed copy of Trading in the Zone, by Mark Douglas. Douglas has a great analogy on page 102 about casinos. He states a casino has a 4.5% edge over all the players in the game of blackjack. A small edge. The casino is very confident in their edge, they don't question it, they don't get concerned if they lose money to some players. They know they have an edge and if the game is played by their rules they will win in the long run. How do they know this? They have stats, millions and millions of games played.

 

They know.

 

If someone comes into their house and tries to change the rules (they call it cheating) they take them into a room with no windows and break their kneecaps. That's how we know if we want to play we have to play by their rules. We also know that if we play enough we will lose and they will win. Why people play a game with that reality is beyond me. Or is it the same reason people keep trading even though they are losing money every month?

 

The successful trader has to be "the house". The game has to be yours not someone else’s. It's your game because you set the rules, your plan is the rule book, and you have set the standards for the game.

 

There are two issues that must be done right in order for your "casino" to be profitable, your plan must have an edge and you must never deviate from the plan.

 

How do you know what your edge is? Stats, stats, and more stats. It's all you have; it's the only way to know. Do you have them? If you don't have the stats to back up your plan and you are trading live you are a dead man. You are not the casino, you are the drunk tourist from Hoboken, and let me repeat, you are a dead man.

 

Get the simulator out of the closet and get yourself a database of trades that means something. If the edge is not there with the current plan you have some work to do.

 

Now let's assume the stats are there, the edge is solid, now all you have to do is execute. Why is that so hard? Recency bias? We humans are stupid? No, no that's a little harsh, we're just emotional, and the emotions that come roaring out when we are dealing with money are ego, fear, and greed.

 

How do we combat these emotions? How do we act like the casino with the small edge? We keep our stats and we measure our success based on something other than money.

 

We know what we have to do, so let's measure our success on how well we do it. It’s our game and we keep the score. The game is not scored by profit or loss but by how many plan certified trades you take. You lose points by missing qualified trades and by taking muts (made up trades).

 

You can figure out the scoreboard any way you want along those lines. Make adherence to the plan the only thing that matters.

 

You are the house, the casino, so when you let the other players into your establishment make sure you only play against them by your rules.

 

If you cheat (don't play by your own rules) I will come to your house, take you into a windowless room and break your kneecaps.

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Let me put this another way, wander over to your bookshelf and pick up your well thumbed copy of Trading in the Zone, by Mark Douglas. Douglas has a great analogy on page 102 about casinos. He states a casino has a 4.5% edge over all the players in the game of blackjack. A small edge. The casino is very confident in their edge, they don't question it, they don't get concerned if they lose money to some players. They know they have an edge and if the game is played by their rules they will win in the long run. How do they know this? They have stats, millions and millions of games played.

 

They know.

 

If someone comes into their house and tries to change the rules (they call it cheating) they take them into a room with no windows and break their kneecaps. That's how we know if we want to play we have to play by their rules. We also know that if we play enough we will lose and they will win. Why people play a game with that reality is beyond me. Or is it the same reason people keep trading even though they are losing money every month?

 

The successful trader has to be "the house". The game has to be yours not someone else’s. It's your game because you set the rules, your plan is the rule book, and you have set the standards for the game.

 

There are two issues that must be done right in order for your "casino" to be profitable, your plan must have an edge and you must never deviate from the plan.

 

How do you know what your edge is? Stats, stats, and more stats. It's all you have; it's the only way to know. Do you have them? If you don't have the stats to back up your plan and you are trading live you are a dead man. You are not the casino, you are the drunk tourist from Hoboken, and let me repeat, you are a dead man.

 

Get the simulator out of the closet and get yourself a database of trades that means something. If the edge is not there with the current plan you have some work to do.

 

Now let's assume the stats are there, the edge is solid, now all you have to do is execute. Why is that so hard? Recency bias? We humans are stupid? No, no that's a little harsh, we're just emotional, and the emotions that come roaring out when we are dealing with money are ego, fear, and greed.

 

How do we combat these emotions? How do we act like the casino with the small edge? We keep our stats and we measure our success based on something other than money.

 

We know what we have to do, so let's measure our success on how well we do it. It’s our game and we keep the score. The game is not scored by profit or loss but by how many plan certified trades you take. You lose points by missing qualified trades and by taking muts (made up trades).

 

You can figure out the scoreboard any way you want along those lines. Make adherence to the plan the only thing that matters.

 

You are the house, the casino, so when you let the other players into your establishment make sure you only play against them by your rules.

 

If you cheat (don't play by your own rules) I will come to your house, take you into a windowless room and break your kneecaps.

 

Casinos have a statistical edge which is permanent and can be tweaked up or down by changing the rules that you have to play by.Very, very different from a trading edge.

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Casinos have a statistical edge which is permanent and can be tweaked up or down by changing the rules that you have to play by.Very, very different from a trading edge.

 

An edge is an edge. You either have one or you don't. If you do then all you have to do is stick to the plan.

 

I do realize there are a myriad of reasons why doing that is so hard.

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Alright then you are almost there....now just remove the dramatic verbage and you've got it

 

First of all, the general concept you outline is correct....after you get the technical issues out of the way, the last real obstacles are psychological in nature....and they are (in order of importance) focus, discipline, execution and risk management....

 

FOCUS

 

There are plenty of smart people in the profession.....they are like high wattage light bulbs...extremely bright, but the light shines in all directions....to be successful in this profession "once the bell rings" you need to focus like a laser on the data that really matters......In terms of finding an edge...there are valid, viable behavior-based edges all around us....in my office we (I) find them the way I was trained to...by observing the way my target market trades and finding little niches that repeat...thats step 1....then you have to understand why (step 2) and finally you have to confirm the behavior (data collection and analysis) which is step 3.....and for those interested, for this last step I go back manaually to locate 400 data points (my estimate of a "statistically significant" sample size).

 

DISCIPLINE

 

Once you have verified that your "behavior" can be traded....you have to be disciplined (in a way that you already seem to understand)....you only trade that behavior or (assuming you have more than one setup) those that conform to your "rules"

 

EXECUTION

 

This is all about desire to succeed....for the "behaviors" that I trade, I have to get up very early or stay up late (depending on the day of the month). In other words I have to be willing to do what others won't....and finally I have to be willing to "take every trade"....because if you don't...you are "randomizing" your results....(you refer to Mark Douglas...he would understand exactly what I am saying)....the bottom line is that you show up every day...you take all the trades, you manage risk exactly as your plan outlines, and you take profits exactly as you planned....otherwise at the end of the year, the result you get is going to be a function of random chance, instead of your edge.

 

RISK MANAGEMENT

 

This last part is at least as important as any of the others. If you don't understand risk management including proper position sizing, even with a great edge, you aren't going to be able to grow your account efficiently....why does that matter? Because markets change and when you have an edge, you had better take advantage of it while you can...anything can happen, you can get sick, family obligations can get in the way, you can experience "technical difficulties"....etc...so you make the most it while you can...I like "fixed fractional" for position sizing.

 

Sounds like you have a decent understanding

 

Good luck getting to the finish line...

 

Steve

Edited by steve46

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Good post Solfest. Steve's was even better but you get the credit for spurring him on anyway. :)

 

The three steps to an edge are very important with step two an important way of minimizing data mining errors. I don't get quite as many data points as Steve but have always put any new idea through the back test then forward test (paper). Its surprising how often the forward test reveals issues that need to be resolved for a really effective edge.

 

Finally the points about discipline and taking each trade are absolutely critical - without them your edge is grass. A couple of useful books that aren't in the normal trader's set for anyone wanting to deal with discipline issues are:

 

- The Practicing Mind Bringing Discipline and Focus into Your Life by Thomas Sterner. Its surprising how a book by a musician / piano tuner can relate to the processes and practice that is trading.

 

- You Are Not Your Brain by Jeffrey Schwartz generalizes the treatment of OCD to face up to the problems that traders seem to experience turning Mark Douglas's (yes read his books too) prescription into reality.

 

and

- Your Brain at Work by David Rock which overlaps elements of You Are Not Your Brain in a way that is very relevant to the design and execution of good trading processes.

 

The second and third books deal with learning and neuroplasticity without the new agey psychobabble pseudoscience that seems to be adopted by some of the people bringing it to the trading community.

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Hi,

 

The article is very useful. I am a new trader. How can I backtest a system? Also, is there a template for creating the plan.

 

Read Trading in the Zone, Enhancing Trader Performance, Trade Your Way to Financial Freedom, and Way of the Turtle.

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