BarroMetrics Views: Ebb and Flow
First off, John Gault sent me a question: “Why are you not adding the profit immediately to your capital”. I’ll answer this question later in the week.
Turning to Ebb and Flow, the last posts in the Success Series.
I subscribe to the view that there is order in the market over the long term, but that it is random on a trade-by-trade basis. As a result, there will be times when we, as traders, can do no wrong – we go short, and the market declines; we go long, and the marker moves up. We feel on top of the world; we’re God’s gift to the trading world. These times I call Flow.
And as is the wont in trading, the reverse also happens: the times when all we do is ‘wrong’. If we go short, the market moves up. If we stop out, the market then reverses and moves, in what would have been, our favour; if we add to losing positions, the market continues against us. The result is a humongous loss. I call this the Ebb Stage.
Ebb and Flow are the outlier zones. Like Black Swans, they occur more frequently than the stats suggest they should. For the trader, both states are dangerous to their wealth.
Flow engenders hubris and we throw caution to the winds – position sizing too large for our capital, no exit strategies in case the trade heads South, entries on a whim, etc.
Ebb engenders unhappiness, perhaps attacks on our self-esteem, anger, etc.
And there is a third state, what I call ‘Normal’ – the ‘win-some, loss-some’ zone where the trading results are line with the stats.
How do we protect ourselves against Ebb and Flow? A better question is how to we take advantage of Ebb and Flow. The tools I use are stats and awareness.
Let’s first take stats first.
I have what I call a normal size position. In an Ebb state, I reduce my normal size to 50% and then 25%. I also look to cut my positions much earlier. The last is a relatively new idea. It came about because, at Sydney presentation, an attendee asked:
“Can’t we just exit earlier?”.
Of course we can! We don’t because we’re afraid that if we exit, the market will move in our favour. So, the next question is: what stops us from re-entering? Answer, nothing except the fear of loss.
I adopted this strategy in March 2015, and I have to say I am impressed.
In the past, an Ebb stage would cost me 8% (+/- 3.23%). In the past 12-months, my largest losing month has been 3%. Most Ebb months showed marginal results i.e. where the losses and profits are so small, I consider the trade breakeven.
In Flow stage, I increase size (maximum of 2.5 x normal) and give the initial exit more latitude. The leads to maximising my returns.
My Equity Journal gives me the Expectancy Returns for both my trade
results (i.e. accepting the results with for size as traded) and on a 1-contract basis. (for FX 1-contract is user-defined). By comparing the two, I know if my position sizing is producing optimal results.
I know what you are thinking….how do I decide that I am in Ebb or Flow? I’ll answer that question next week