The Three Best Poker Rules You can Incorporate into Your New Trading System

Learn to muck your cards - amateurs play every hand

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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

 

Great Trading Articles

Three Clever Ways the Best Traders Make Money

Why Fear Should Not Dominate Your Trading

Trading Systems Do Not Remove Emotion from Trading
 

 
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The Clever Way to Decode Market Data to Win Like a Casino

Professional traders use weekly and monthly charts to confirm trades

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Go check out The Imitation Game on Netflix if you haven’t seen it yet. It has many analogies to trading that I think will resonate with you.

Good trading is about being able to distinguish signals from noise. In the short term, everything is noise though – even potential signals. 

When you don’t have a plan, everything looks appealing. Any big move that you’re not in gives you the emotional feedback that you’ve missed the move and that you should have. 

The Enigma code breakers had great motivation to crack the code: save English lives and end the war. Our motivation is to limit risk and be in high expected value trades. 

You can use price as your main signal, but admittedly, in the short run, it looks like noise. It’s not until you look back to see the statistical significance of today’s closing price to the past that you can begin to ascertain whether it’s signal or noise.

Your trading system is what you can rely on to decipher the data and create trading signals that you can rely on. Without a system, much of what you see can be construed as disinformation – even the price. This is especially true for short-term, intraday traders. 

This is why I think you’re in for a life of frustration if you’re trying to day trade: all the intraday data are random. If you’re lucky enough that today’s intraday data is aligned with significant weekly or monthly time frames, you might have a good trade. If that’s the case, keep the trade though and let the momentum follow through overnight and over the weekend. That is the only way you can fight the manipulation that you’ll otherwise suffer from the hands of the HFTs and their criminal counterparts – the exchanges.

Keep in mind that most indicators only confirm what you already know the price is telling you. You can probably simplify your trading by removing all the overlays and indicators from your charts. 

Compare your daily data with weekly and monthly data levels to confirm your signals, not trading indicators, overlays, or lines that you feel compelled to draw on your charts. If you find yourself needing to do that emotionally, you’re grasping for something that’s not there. 

You can also test your models and from the ones that I’ve done, the tests that I’ve run without the technical indicators versus the ones that included them, the results weren’t improved by having the indicators included. 

I wrote in The Inner Voice of Trading that I felt (and still do) that they are for the most part “emotional band aids.” Indicators won’t help you “not” feel the feelings that are trying to teach you something. They will also add another layer of frustration to the mix and I’ve yet to see one that is foolproof. 

The best thing you can do is simulate your trading ideas over 10 to 20 years of data to see if they have any “rich” history. I’ve never met a daytrader who can tell me the the expected value of a trade he’s made nor that of his favorite pattern.

More Great Trading Articles

The Remarkable Risk Manager You’ll Never Have to Pay

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How to Live with Uncertainty and Imperfect Information

 

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Tony Saliba’s Options Playbook

Inner Voice of Trading Audiobook

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Why it’s Important to Remain Emotionally Balanced for Superior Risk Adjusted Returns

You will always lose more if you go on tilt

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Calibrate the risk that’s appropriate for your account and your emotional constitution. If you are trading too big, sooner or later you’ll find yourself in a situation that you wish you weren’t in.

Risk Management & Position Sizing

Normalize risk across all instruments so that you can create risk units. This way, every instrument will be the same in terms of the risk that you’ll represent in your portfolio.

Many commodity traders use the 20-Day ATR (Average True Range) in order to calculate the daily dollar-volatility per instrument. Then, they divide that into the percentage of capital that they are willing to lose per trade.

Example:

If the Gold ATR is $2.50 (it’s not) then the daily dollar vol is $250 since the gold contract is 100 troy ounces. If you have a $100,000 account and you only want to risk 1% per trade, you can figure out the maximum number of contracts to trade.

$100,000 x 1% = $1,000

Daily Dollar-Vol on Gold = $250 ($2.50 x 100 oz)

Therefore, you can only trade 4 Gold Contracts since $1,000 / $250 = 4 contracts

You can also trade only 2 contracts and give them $5 of risk between your entry and exit. The risk to your portfolio will work out to be the same.

Then to manage the risk, if you enter the gold market long per your entry signal at X Price and place your protective sell stop $2.50 (the Gold ATR value) below the entry price. 

Sometimes, the ATR-based risk on a particular instrument will be too big for you to trade given the risk amount of your overall portfolio that you are willing to take.

Say the 20-Day ATR on the ES (E-mini S&P) is 30 and each full point is $50, then the dollar-vol is $1,500. If you only want to risk 1% of your $100,000 per trade, the ES is too volatile for you at this point since $1,500 > $1,000.

This rule can help keep you out of trouble by keeping you out of trades that can might hurt you financially. Like in surfing, once you catch a wave that’s too big and powerful for your level of surfing ability, it’s too late to call time-out…you can’t just surf the small part of the wave.

Likewise, If you try to trade with a stop that is a fraction of the 20-Day ATR, you are highly likely to get stopped out for losses regularly. You can’t change the nature of the instrument. Think of the ATR like a personality gauge that will reveal the true identity of what you’re dealing with.

If you know someone who is a mean and nasty drunk, you can’t typically deal with them on only the good days. That’s why you have to avoid them altogether – just like instruments that have dollar-vol values that are too high for your capital. This is most important risk management concept to manifest in your trading DNA.

Trader Psychology

Keep in mind that measuring ATR can be done with a computer and you can backtest all your entry and exit rules with the risk across all instruments normalized. That is how you stay emotionally balanced

In doing so, you remove all the guesswork. You have the added benefit of not falling in love with any one instrument risk management wise since each trade will be the same percentage risk in your portfolio (at first, if you don’t add to your winners).

More importantly, you won’t become despondent when you lose money on any one particular trade since they all represent the same risk and therefore you’ll not be married to the outcome of any one trade.

It’s hard to remain objective, especially if you are looking at the headlines of the day for your trades. Trading a system can remove all of that for you, but you’ll still have to a) put on the trades and the protective stops; b) not over-ride the system and “not” take the signals; and c) not over-ride the system and put on trades that were not system generated. 

Trading Commodity Spreads

If the volatility in the commodities markets are too great for outright trading, you can consider trading intra-commodity spreads. In a spread, you are simultaneously long and short two contracts of the same underlying but of different expiration months.

Instead of trading for an up or down directional trade, you trade the relationship between the two contracts for them to narrow or widen. 

You are afforded lower margin with spreads, so if your account is smaller, it might be a good fit for you to get going in commodities. The good news is that most professional traders know the spread markets very well so it’s a good idea to learn them anyway at one time or another.

You typically have lower risk since you are long and short at the time time and the seasonality of physical commodities tends to be very reliable. 

We have some free educational training videos for you on this topic.

Go to MartinKronicle and set up your Free Account to get access. 

Your login credentials will be emailed to you.

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Two Essential Things Necessary to Achieve 10-Baggers in Your Portfolio

One of them is not what you'd expect

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You have to plan for 10-baggers in your portfolio and position yourself tactically and psychologically. 

Two things need to occur regularly:

1) big moves don’t typically happen intraday

2) you have to believe that you are capable of doing it emotionally and psychologically

Tactically speaking, you need to let time and money work for you for best results. A 10-bagger has to have been a 4-bagger first. Don’t cut the 4-baggers at the knees. Place a trailing sell stop order and let the trend continue (if long). Don’t impose your will on the trend. 

Sit on your hands and let the market forces work for you.

Think in terms of percentages and not dollars. If you risk 0.50% per trade and it’s a 10-bagger, you’ll add 5% to your overall portfolio. What will that do to your Incentive Fees? 

If you’re smartly abandoning day trading (smart move), you need to find a better way to deal with the discomfort that you feel when you don’t take short-term winners at the end of the day or before the weekend.

What is the discomfort trying to teach you? For each of us it’s different. 

The unwillingness to feel the discomfort in your trading is also denying you the feeling of what you’d feel by having a 10-bagger in your portfolio. 

In other words, the feeling of having a 10-bagger is on THE OTHER SIDE of the feeling of taking short-term profits. You must be able to walk through the feeling and be with it.

Why don’t you want to feel the feelings around getting a 10-bagger? Aren’t you worth it? I think you are…you are willing to do the work – you might as well get paid as much as you can for it.

You can release that discomfort in yoga class or in your Trading Tribe – and replace the satisfaction you get and not sabotage your trading and still get to feel the feeling that you seem to want to have (because you’re seeking it everyday – you’re a pleasure seeker, just like me).

Great Trading Articles & Podcasts

2 Ways to Add to Your Winner for Huge Gains

Building Pyramids for Asymmetric Trading Gains Part 1

Building Pyramids for Asymmetric Trading Gains Part 2

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