Monday, August 17, 2009

The Truth About Trading - Part I

Here is an edited version of a post by a fellow named Ziad Masri. It was posted originally on the EminiPlayer blog in July of 2009. Later a guy who goes by the name Gladiator X added some of his own thoughts to Masri's post.

I edited these posts to make them more readable and am posting the result in two parts. While the ideas discussed in Part I come largely from Masri's original post, he didn't want me to attribute them directly to him since the post also contains some of Gladiator X's thoughts and because I had edited a number of details. I really don't know the original source of Part II. It was posted by Gladiator X on Trade2Win .

I think both parts explain the truth about trading and about learning to trade more clearly and accurately than anything I have seen previously.

Part I

Why do most traders fail? Change your ways. Now.

(includes subtantial parts of a post by Ziad Masri)

edited by Carl Futia

I am someone who trades for a living. I have less than 10 years experience but I feel that the mental energy, time, and effort I have put into trading is enormous. I think I have had success because I did the REAL HARD WORK, work that most people want to avoid.

Hard work isn't reading a trading book, applying to a broker, opening a chart and spending hours back testing an EMA crossover. It isn't sitting for 12 hours per day testing the crossover on different markets and then sitting 4 hours waiting for the signal to emerge because in the back test your found it to be 'high probability'. If you are doing this you're wasting your time, spinning your wheels without moving. You are avoiding the truth of trading.

Here is the truth of trading. A trader must learn to identify the direction of the market's trend in the various time frames which are relevant to his trading goals. But the trend direction is often ambiguous. So a trader must learn to face trend ambiguity and thrive in it. Trading is not about clarity. It is not about setups and signals - not about EMA crossovers, three-higher closes for entries, waiting for pin-bars at support.

These sorts of setups and signals may work for a small number of successful traders, but for most aspiring traders they are useless. Why? Because they are NOT the essential part of the trading process. Traders who use setups and signals successfully have already built a mental map of market behavior. Such a map identifies the market's condition and trend in the various time frames which concern him. The current position of the market on this map determines the value of a setup and signal in particular contexts. The way such mental maps are developed is difficult to explain.

Here is what I mean. I could explain a specific setup of mine to you, one that is extremely easy to follow. But I couldn't explain how I interpret the time and sales window and compare it to order flow and market action. And it is this latter interpretation that determines whether or not the trend direction is favorable to the setup. This skill at interpreting time and sales in the context of market action is one I have developed by watching the market carefully and by taking hours and hours of notes on its behavior.

It is this experienced recognition of the direction of the current market trend that gives me an EDGE over other traders. Only after I have made this judgment do I start paying attention to setups and signals.

Knowing the direction of the market's various trends tells me whether my setups are likely to be good ones or bad ones. Most aspiring traders can't make these distinctions. To them all setups and signals look the same. When they take a loss after following one all they simply say "oh it didn't work" and moan about it.

These people have not started the really hard work - the work they need to do to be successful traders. They will have to spend weeks or months watching markets trade. They will have to take notes on what they observe and start building a mental map of market behavior. They will have to learn to exercise judgment is assessing the market's condition and trend - and to have confidence in their judgments and the courage to act upon them.

On these forums hundreds of people talk about how to be a profitable trader. But most of them not profitable themselves, at least not to any significant degree.

Speaking as someone who makes A LOT of money from the markets I say that it was never a specific system or price action setup that finally made me consistently profitable. Rather it was my extensive study of market behavior, of the "tells" it gives that help me identify the market's trend. I had to learn to embrace the inherent ambiguity of all market behavior - to learn that there are no certainties, only probabilities. I had to create my own interpretation of everything, even though I used the knowledge I found in books about the market and trading as a starting point.

I am now able to trade without a system, without a detailed plan but with money management. All the guru's say YOU NEED a specific entry and exit plan but I don't use one.

Believe me, the reason MOST traders lose is because they fail to embrace uncertainty. They try to convert the inherent uncertainty of market behavior into something that is a sure thing in the sense that every trade they make will be dictated by a fixed set of rules. They spend fruitless hours trying to find a system of setups and signals that will make money in the markets. They don't learn the $tick relationship to price themselves but instead look online and see what others have found. They are unwilling to do their own thinking . They don't spend the time needed to develop their own skills of market observation and interpretation.

It took me 4 months to become profitable. Many of you won't believe this. But the reason I was able to do it so fast was because I cut out all the crap. You may believe you are working hard - you may have been up for 8 hours last night testing if the strategy you just read about in a trading book is a good one.

But I say you haven't really started doing the hard work yet. Until you do you will remain unprofitable. You won't find the high-probability, profitable setups you seek. To do this you must first study the market's behavior and understand it - learn how to identify the market's condition and trend. Only after you have mastered this aspect of market interpretation that you can you work with setups and signals.

It will be your understanding of the market's trend that turns your setups and signals into high probability, profitable ones. Setups and signals by themselves cannot do the trick - they cannot turn you into a successful trader. They do not incorporate and understanding of the market's trend and condition. They miss something that only your personal judgment can provide.

Let me give you an example that might open your eyes. Have you ever played a shooting game like Call of Duty 4 or Halo 3? The players who are very good at these games haven't got a system, they don't spend up at night thinking about the best place to camp with a shotgun. They practice playing the game. They master it.

The difference between a winner and loser isn't that the winner knows a secret, or paid someone to teach them the secrets, or have a system of using power-ups to beat people. The winners win because they are more skillful, they have learned how to play, they have mastered the game. How did they do this? By playing the game, by being continuously involved in real time competition. 

The same is true of good athletes in any competitive sport. They don't plan their moves against their opponents in advance. Instead they play by following general principles they know work most of the time, and they rely on their game experience to make the right play in response to their opponent's action in the context of the specific game situation. Yet despite their skill and experience every great athlete will tell you that he/she fails frequently.

Try hard to think about what this means. I think it demonstrates my point quite clearly. The good players are genuinely skilled. They do not follow mechanical rules in their play, rules that anyone could learn by reading a book. Whoever heard of a football player becoming great by reading a book on football?!! But aspiring traders seem to believe they can become good traders, make good profits, by reading books on trading and checking out the statistics of every setup and signal under the sun! What's wrong with this picture?

A genuinely skillful trader is someone who can apply his knowledge of market behavior in any context, in any environment. In some situations he knows that certain setups and signals are genuinely useful, but in other situation he avoids those same setups and signals like the plague.

CONTEXT! It's all about context. Stop trying to trade on signals and setups that pretend that the market context is always the same. You must instead focus your efforts on identifying the direction of trends. This is inherently an ambiguous and uncertain process. So you must embrace uncertainty! Embrace ambiguity! Accept the fact that you won't get things right every time.  But at the same time learn to trust your judgements without the support of a rigid framework of mechanical rules.

Here's the situation as I see it for most users on the forum. You've have been spinning your wheels while thinking that you are getting somewhere. You are trying to learn how to trade in the wrong way.

I see that most aspiring traders focus all their attention on "set-ups" and on finding out which combinations of indicators work. But these people are never going to become profitable. Why? They are following the advice of trading books that say trading is simple and psychology is everything. So they search for set-ups that 'work', and they hope that these setups can take the guess work out of trading. They want to be "disciplined" and have simple rules that guide all their actions in all contexts. But I have got news for you: you CANNOT take the guesswork out of trading!!!

I offer this opinion as someone who started last year with $30,000 and ended with $150,000 without a single losing month. I think I was successful because of the way I went about learning and what I focused on. My learning process was very different from the ones suggested on this forum. I learned that while psychology is huge it is not everything. And while trading is all about simple principles, actually having an edge is NOT simple. It's a myth that you can have a couple simple price or indicator set-ups and make money consistently if only you are disciplined. That's a load of crap. It keeps the dream alive for wannabe traders who never realize what trading is truly about. 

Trading is about being okay with ambiguity. It's about tolerating confusion. It's about sitting with discomfort and being at peace with it. It's about not having an exact script of when to trade or not to trade, or what's really a high odds trade, and being okay with that. It's about exceptions to the rules. It's about contradiction. It's about uncertainty.
And yet traders left and right want to make it simple and certain. They want to reduce it to a few simple set-ups to trade with discipline. But the market is not simple. The market is all about uncertainty, and complexity, and ambiguity. Simple set-ups could never capture that, and they can never give you a true lasting edge.

So what's the solution? Is the problem in the simple set-ups themselves? No, it's how they're being used.

The bottom line is that every trader needs to learn to READ the market, identify the direction of the trend which concerns you. This means that simple rules will not do. There has to be a synthesis of different elements (whether they be price action, indicators, inter-market themes or whatever), and real-time interpretation must take place. It has to be all about CONTEXT.

Once you can read markets in an unbiased way you can then choose to employ "simple" set-ups to enter and exit. But the real work will be in learning to READ THE MARKET to see when you should use which kind of set-up. Seeing a hammer or whatever near a support means nothing unless you've identified the broader picture and gotten a sense of the kind of tactics you should be using, and what the odds are for different scenarios unfolding.

Now I know most traders try do this to some extent, but their main focus is on the set-ups. It's not on reading the market from minute to minute, hour to hour, figuring out the odds of it doing this or doing that, adapting dynamically, and thinking of trade ideas from all your observation as the day unfolds. Rather, it's waiting for some simple set-up to pop up and then taking it.

Is it easier emotionally to have clear set-ups to wait for and trade in this simple manner? Absolutely. But who said 'easy' would make you money? If I've learned anything, it's that the market rewards what is hard to do.

It's hard to have ambiguity surrounding your market reads. It's hard being uncertain. It's hard dealing with competing and sometimes conflicting signs. But this is an inevitable part of the trading process. You must stop trying to avoid it by demanding that things to be clear cut.

Yes, I know, it is hard to be disciplined when there's so much ambiguity, so much uncertainty about just what trade to make.

But as a trader it is impossible to eliminate uncertainty. Don't try to avoid it by looking for simple set-ups or some straight-forward, simple, always- right method. Instead, train your mind to deal with the uncertainty.

How can you learn to do this? You must be constantly engaged with the market, always trying (and often failing) to figure out what the market is trying to do (go up or down). You must learn from experience.

In my own case each and every day I would take notes in a journal. I would try to interpret the market's action and try to figure out trades that would take advantage of my analysis. I took note of the ideas that seemed to work and those that did not. I wasn't focused on paper trading, or on recording my emotions, or anything of that sort. Instead I paid strict attention to the market's action and to the information I thought it was giving me about its condition and trend.

Everything in my journal was about my own perception and interpretation of the market's action and what it was telling me about its trend direction. 

Day after day, week after week, I kept on making mistakes, wrong calls, being clueless about what was going on, not knowing how I should trade, and not knowing if my views made sense or not. Yet I refused to be discouraged and I continued taking notes and learning.

I would view charts and combinations of historical intraday charts, and I'd note certain behavior. For example, I'd study trend day after trend day and try to notice what they had in common and how I could have picked up on it in real time. Then I'd study range days. Then I'd study a price chart of the ES versus the Advance decline line and see what the relationship was across many different days. Then I'd do the same with the ES and TICK chart. And on and on. Over time, this gave me a feel for the markets, and a certain understanding of how certain days differ and many subtle signs and tells for each type of environment and context.

As for set-ups, I didn't use any predefined ones. I just formed trading ideas and then tried to get in at good trade locations. Even this, which is the art of execution, can be quite complicated. I started realizing that in some environments it's best to wait for pullbacks, in others I need to get in at market or I'll be left in the dust. In some contexts I can buy low and sell high. In others I have to buy high and sell higher.. And so on.

I became consistently profitable in a timeframe of a few months by doing this. But of course before that I had read 30 or 40 books and so I had a lot of background in technical analysis. I had also worked a lot on my psychology and personal issues. But all of this was in conjunction with a method of learning and trading the markets that was contrary to what the general wisdom says about simple set-ups and exact rules.

In the end you have come to a personal realization. Take a look at your trading career thus far. Do you truly believe that if you just learn to focus and take all of your set-ups then your equity curve will reverse and you'll be a consistently profitable trader? Do you think a few simple set-ups could make you rich?

I don't mean to imply that you need complex mathematical models. Far from it. What I do mean is that you must develop a mental map of market contexts and the experience and skill to tell where the market currently is on that map. This will take time, effort, and lot's of frustration to develop. And you won't be able to do this if you spend the whole trading day simply waiting for set-ups to materialize. That just won't cut it.

Right now your learning curve is stagnant because you're not truly involved with the markets and their behavior. You are acting like a statistician who is separate from the market. Your day is wasted in waiting mode. You are not in the observing and absorbing mode. Because you fear loss you aren't willing to experiment. This means that you aren't making mistakes and failing regularly, which is what you need to do to learn quickly.

So I think you need to make a mental shift. If the path you have followed hasn't brought you to your goal, try my path instead! Prepare to face uncertainty and ambiguity, the essence of financial markets. But don't be afraid. The market isn't out to hurt you. Success in trading requires the ability to be at home with ambiguity and uncertainty, to be able to take a market stance while accepting the fact that you cannot predict the future with any degree of certainty. This is what trading is about. This is why it is an ART. Once you change your focus and your learning process everything, including success, becomes possible. Until then it'll be a distant dream that keeps appearing to be so close and yet stays so far away.

So you need to re-align your thinking and get involved with the markets. Get a trading simulator and trade. Take losses. Make mistakes. Be clueless. Don't be afraid of it. It's okay, that's the only way you'll progress. And trust me, you will progress.

Face these challenges. The stuff you have heard about learning setups and applying discipline comes from gurus who cannot trade, who give advice based on their failed ventures.

These challenges most people find difficult to face. This is why most are not successful. If you can't do this profitable trading will remain a forlorn hope of yours.

I wish you all good luck and I hope some of you find this helpful. This is what I am giving back to the trading community, I hope someone of you have an epiphany over what I have said.

When I was in the 'holy-grail' search mentality, a friend explained all this to me. I took what he said to heart, and I believe this is why I am consistently profitable today. This the only real secret I can pass along to you as traders.
Good luck!

The Truth About Trading - Part II

How Amateurs Approach the Market.

edited by Carl Futia

(original source unknown)

This post is for people who are struggling with their trading, not being profitable and finding themselves working extremely hard to no effect.

I found very interesting a recent post 'Who uses stop losses?' and the various replies about how stops are necessary, professional, business-like, etc. That post and the ensuing comments confirmed what I already knew: the retail trading crowd thinks and acts like a flock of sheep.

Books and information about trading all say the same things. They emphasize money management, tell you that it is stupid to average down, tell you to use stop losses, risk 1% of your account, and other common propaganda.

The interesting thing is that people who talk about the value of stops, money management, etc. appear to have gotten their ideas from a book. This include the authors of those same books! It is a never ending process, a constant recycling of bad ideas. I think that those who write trading books that explain how to trade aren't particularly good traders themselves. Why?

I think you must embrace uncertainty to succeed as a trader. Those who write books, teach seminars and so forth are just trying to find a way to make money with certainty because they can't trust their own trading to do it or because they cannot live with the ambiguity and uncertainty of constant involvement with the market.

These ideologies that trading books offer are accepted as trading wisdom in the community of amateur traders. I was fed all this when I was learning to trade.

But I got lucky. A very successful trader told me early on in my career that 95% of traders fail. Therefore, to succeed he said that you have to do the opposite of what they do, you have to think outside of the box. I've always tried to think in a unique and different way from other traders and I believe this is in large part responsible for my success.

All across the internet and in all books about trading you will find the following assertions:

§  High probability setups + Discipline = Success

§  Always use stop loss orders. Have a specific risk-reward ratio in mind. Know exactly what you will risk in every trade

§  It is stupid to have a risk-reward ratio of less than 1:1

§  It is stupid to aim for very high win percentages

§  The entry price is the most important detail.

Almost all amateur traders buy into this ideology. Why? These rules produce the illusion of certainty in the market place. You know your risk and that's it. There is no chance of becoming emotional because you failed to use a stop and therefore busted out you brokerage account. You don't have to worry about having to explain to your husband, wife, or friends that you are not as big an idiot as you seem to be, that trading is still something worth doing.

But in the market certainty doesn't existAny rule that produces the illusion of certainty just makes it easier to fail as a trader.

Admittedly I went through a phase of having a set risk-reward ratio (1:2) and risking 1% of my account, thus calculating my position size must be (x). My stop loss was frequently hit. I was going nowhere fast.

I printed off all the trades I ever did and analyzed them in detail, trying to find what went wrong. I came to some conclusions.

1. I'm buying high, I'm buying on a higher close, buying in a late signaled uptrend rather than buying on falling price.

2. Price is volatile. My stop is getting hit. I can't forecast price fluctuations with enough precision to be able to place a 5 pip stop loss.

I concluded that using a stop loss represented my effort to predict the market's short run fluctuations, to treat the market as if its movements were certain. But I couldn't do it.

I tried to move away from this idea and explore how I could trade without a stop loss.

During this learning process the fact 95% lose was a uppermost in my mind. Whatever traders who were losers wrote I would turn on its head and try to do the opposite. This was my way of thinking outside the box. And I believe that you shouldn't follow the flock.

I began to see trading as an art instead of as pure calculation. It is less about certain maths and more about movement.

It's about watching the market dance, letting it move up and down without placing too much significance on any particular jiggle.

I decided that I just wanted to take a piece of these constant fluctuations and not try to predict them.

I concluded that trading is not about having a certain risk-reward, not about applying the same risk to every opportunity, not about exiting at a pre-determined level. It is about making adjustments as the market produces new information, as it moves move around on your mental map of its behavior.

It's extremely hard to make money from the common wisdom you find in trading books. But if you look past such "wisdom" you can see trading doesn't have to be so complicated and time-consuming.  

Volatility can produce profits for you without you having to be a prophet! All the prop firm traders I know who are successful understand and base their methods on this insight. All the successes I have had in trading arise from this observation.

Professional traders win by applying their own judgment and experience to judge the market's position on their personal market maps and then letting the market's natural volatility work for them. They don't waste their time back testing strategies.

So how can you change your current quest to trade for a living?

1. Read my previous post about how to learn to trade, I seriously think if traders learn to read the markets, they will be successful. Read the market, take in the new information is gives you each hour and each day.

2. Try to escape from common wisdom and general public beliefs. Start thinking outside the box, Start looking into volatility, high win percents and try get past your human fears and uneasiness with ambiguity. Don't use hard stops.

3. Average down and pyramid as a planned tactic with risk management.

4. Enter when price is falling.... In an uptrend.

I strongly believe averaging down if done as a planned strategy and not as an effort to deal with a loss is an easy way to profit... That is from personal experience and it is expressed in my account balance.

Thanks for reading. Hope this helps.


JM said...

A tremendous public service, Carl. Very interesting and, when you think about it, it makes perfect sense.

Unknown said...

Great post! Full of insight.

Unknown said...

Mr Futia!

You should know the math a bit, having a doctorate degree.
Anyone, risking 1% on any trade maximum trading for a year can get 6000% profit in any market?

That is a Bulsshit nonsense, it is almost impossible mathematically.
I am not questioning that this writer might be profitable, only his real results is a true lie.


Happy Misanthrope said...

Mr. Futia,
There are very few people that can
trade with no hard stops. Soft stops are an oxymoron. One can have wide stops but one must always have a stop. Extremely rare is the person who can think clearly in the heat of battle. Most traders fail because they blow through their stops.

Ed said...

Joe, not necessarily a lie, I crunched some numbers and I think with 75% win rate at a 1%/1% risk/reward ratio, then out of about 1000 trades it is possible. So about 4 trades a day for 250 days. But yeah, need major skills for a 75% win rate at 1:1.

Unknown said...

Hi Speculator!

There was a nice Word Trading Championship in FX mnarkets, any pair could be traded in any time frame for one Year.

The World Champion, who was a Chinese guy win the race, by a huge margin, and he had about 850% profit during that period.

Now making 7 times that amount in the same year is almost impossible, and I have never seeen any trader come even close to that.

Having 4 - 800% in a Year I would say possible but even those winners have much bigger than 1% risk on their positions.


TraderO7 said...

Nice comment! Thanks for posting, very helpful for my self-education in trading.

Unknown said...

I've come across this just recently. I realise that most comments on this are over 3 years old, but I think this post is valid for any trader at any time.
I'm a serious individual trader and I've been doing it for nearly 20 years. At first I was quite impressed by the ideas expressed here, but something about the views expressed niggled away at the back of my mind. I realised that all the author is saying is keep following the markets, keep trading, keep thinking about this stuff until it becomes instinctive, as in the example of great sportsmen playing instinctively. I agree with that. It's what I call 'trading in the zone' (title of a good book on trading psychology by Mark Douglas.). But I disagree with the writer when he disparages the need for rules, mental discipline, emotional discipline. My view is that one's trading rules and discipline itself should become second nature, instinctive.

IRSHELP said...

1/1 r and r ratio with 75% accuracy, cmon, cmon, the expectancy or edge of a trader with these stats, far exceeds the edge las vegas has over its lemmings that results in massive profits for the casinos. if a trader shows you stats like, that, make sure it is real time not on paper, and the number of trades exceeds 500. there is no such animal!!

broken arrow said...

I don't thinks so !
I disagree with the writer !
He compares trading to other human skills than can only achieved by practice and experience and not by
per-determined specific rules and guidelines
this comparison is only valid if trading is like any other normal skill human can develop
but Trading is never like that , trading will never fit human normal nature
trading is against our very nature and if you are trying to approach it as a normal skill you will never make it !
trading will never become as " a second nature " for most of us !
the only way to make it in this dirty business is to know the reality of trading and it's major conflict with our very nature !