Professional poker players know (as best they can) the expected values of every hand they play. The best of them know what hands to play from what position. Like traders, poker players have to make decisions under uncertain conditions with imperfect information. That means they are mucking or folding the majority of their hands before they see the flop (in NL Texas Hold ‘Em).
They know what the percentages are of their hands improving. For example, if they are dealt a pair of Kings, they know the probability of getting another King to make 3 of a kind (a set of Kings), or quads – four of a kind.Those estimates get them as close to the best information they’ll get in order to know if and when to bet and how much.
They know what the probability of making a straight if they have two connectors (two cards in numerical order) or making a flush if they have two cards of the same suit.
This allows them to the knowledge to know how to bet given the odds and the size of the pot. Yet it’s still possible that they can do everything correctly and still lose the hand. That’s going to happen quite a bit if you play a lot of poker. It’s going to happen a lot in trading as well.
Simple Trend Following System
Let’s assume that you buy 55-Day Highs as part of your Trading Entry Rules as part of a simplified trend following system. You enter a Buy Stop order 1-tick beyond the previous 55-Day High and you get filled as expected. However, for the next three trading sessions you notice that your marked-to-the-market equity on the position has not changed. Momentum has stalled although this might be a trade that you can normally count on. This would be the equivalent of folding Ace-King Suited. Sometimes this isn’t the best hand and you’ll get beat by a pair of Aces, Kings, or even Twos…
It’s possible that your trend following entry was executed properly, but the instrument itself has traded sideways. Not your fault at all – all you can do is enter your orders and let the market come to you, then enter your protective stop order. You are powerless over what happens as far as follow through.
Trading with Time Stops
There are only three things that can happen when you trade: the trade goes with you, it trades flat, or it trades against you. In two of the three scenarios, you are wrong. In one you are losing money, in another you have opportunity cost and the chance the lose big (especially if you are trading commodities).
Professional traders deploy what’s called a “time stop” after N-days to offset positions that have stalled. When you trade commodities, you have unlimited loss potential regardless if you are long or short, so you need to see trades follow through in the intended direction right away, else you might be stuck in reversal going against you. In this case, you are folding your cards so to speak before you lose money.
In my experience, deploying a time stop under these circumstances saves me from losing money on trades about 70% of the time than if I’d stayed in, and it’s a tool I use regularly. Profitable trades typically start making me money right away. If not, I know when to fold ’em.
Dealing with Emotions in Your Trading
Like in trading, you can become emotionally invested in the outcome of a hand. If you have a pair of Aces, you can get beat from time to time despite Aces being a strong pair.
Professional traders can learn a lot from this type of knowledge. If you trade long enough, you will get beat when everything looks to be in your favor.
I’ve been long stock that beat earnings estimates, but was greeted with a down market because of some external factor that took everything down with it – including my stock. Not fair you say? No one cares what my definition of “fair” is when trading. Nothing is fair.
A good way to become mindful of what you could be in for is to study the winning and losing streaks from your backtested results. Most of them will tell you what you longest losing streak is (duration) and how bad it effected your equity (magnitude).
I think this will help you learn to build your confidence and put things into perspective. This is likely going to happen to you if you trade long enough. You don’t have to like it, but knowing that it’s possible can save you from going on tilt.
Trading Systems Have Losing Streaks Built Into Them
The losing streaks that you’ll have by trading a system will pale in comparison to those that you’ll need to endure if you are day trading or trying to ready charts or “set-ups.” Those are a thing of the past.
The modern trader – the trader who is setting himself up to win for the rest of this decade and into the 2020s will have 100% of his trading rules backtested, know the expected values, and have rules to eliminate sub-optimal trades, and have rules built-in to trade for the marathon of the next 20 years. That does not now nor will include trading based upon charts nor intraday data.
Firms are investing tens of millions of dollars to trade against daytraders and short term traders as they are easy to pick off and bully. Plus, in that space, there are a million suckers born every minute so you’ve been warned: don’t be one of them. You want to trade low-hanging fruit, not be the low-hanging fruit.
Trading simulation software will allow you to vary start dates, the instruments that you are trading at any given time, how to measure volatility, and how to cut risk during losing streaks.
Your New Trading System
1. Learn to love stopping out of trades – it protects your equity
2. Play high-expected value systematized trades (not chart reading or set-ups)
3. If Momentum stalls, offset the position after the third day of flat trading
A great book on how to understand what a poker player learns to contend with is Getting the Best of It by David Sklansky.
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