Q&A The Thin Line

BarroMetrics Views: Q&A The Thin Line

Most of the questions can be classified under four headings:

Q1: What is the difference between a discretionary rule-based method and a rule-based method (mechanical system)?

A1: At the most basic level, the difference lies in the addition of one rule for the discretionary rule-based: “follow your trading rules but there will be times when you need not”.

This addition allows for intuition to play a role. The problem is, for novice traders, this additional rule allows not for intuition but for ‘into  wishing’ – they hang on to losing trades long after the used-by date. 

But, the difference can be much greater than merely adding one rule. To understand this difference, we need to be aware that technical analysis can be split broadly into two main camps:

  1. Richard Schabacker. Robert Edwards’ Uncle (Edwards was the co-author of Technical Analysis of Stock Trends). His approach was to categorise patterns and trade the patterns. Thomas Bulkowski has a site that tests the efficacy of patterns, Bulkowski’s Pattern Index.
  2. Richard Wyckoff. For Wyckoff, the principles of how markets operated came first. The model was an extension of the principles. If a model stopped working, the principles provided the answer to the question ‘why’. (NB: although I have used Dr. Gary Drayton’s introduction to Wyckoff, I rate the Wyckoff Stock Market Institute as the best source to secure a Wyckoff Education. Dr Drayton is the next choice).

Most Rule-based systems adopt Schabacker’s approach, very few adopt Wyckoff’s. As a result, most Rule-Based systems lack context, and do run into periods of lon drawdowns. Long drawdowns is one of the reasons I have preferred the Discretionary Rule-Based approach. Now thanks to my friends, Mic Lim and Joshua Fong, I have been able to develop a contextual Rule-based approach.

Q2: Since Discretionary Rule-Based trades are trader-dependent for their results, shouldn’t we expect to see different results for different traders, even if they trade the same instruments and use the same method?

I alluded to the answer in yesterday’s blog.

The question confuses ‘results’ with ”positive-expectancy’. ‘Results’ are the magnitude of the return; ‘positive-expectancy’ defines the robustness of the method.

Results will differ, of course. This is true of even Rule-Based (let’s call them mechanical) systems. The famed Turtle experiment produced a wide divergence of results among the traders. However, if a group of traders execute, with consistency, the rules of a robust method , the ‘expectancy return’ ought to be positive among all the members of the group. 

Q3: Why use stops?

A3: I am not sure how this question arose in the context of the discussion; but, since quite a few asked, I’ll answer it.

Long-time readers know that this issue has popped up from time to time in the blog. Some readers take the view that trading without stops is best. And they tend to equate ‘stops’ with exit strategy.

I take the opposite view.

I believe that you must always have an exit strategy – otherwise, one trade is may wipe you out. (For a more detailed view of my risk management principles see “Routines and Habits IV (B))”.  Figure 1 shows what I mean. The pair happens to be the AUDUSD, it could have been any instrument; it’s a daily chart, but it could have been any timeframe. Position sizes tend to be larger when traders day-trade. Depending on his size, a trader could have wiped out his profits and even his account on just one trade.

I use two types of exits:

  1. A hard stop i.e. a fixed price to exit – once the market hits the price, I exit and 
  2. A soft exit i.e. should certain conditions occur, I exit even if the hard stop is not hit. 

Q4: Would I be willing to make available an introduction to Ultimate?

A1: Not as a blog. But, I am considering a two or three video series. Let me see if I can organise that. I’ll let you know by Thursday or Friday.


FIGURE 1 Exit Strategy

11 thoughts on “Q&A The Thin Line”

  1. Do Ultimate graduates possess the 15 Biases that make them make dumb discretionary trading decisions?

    15 Biases That Make You Do Dumb Things With Your Monhttp://www.fool.com/investing/general/2013/08/30/15-biases-that-make-you-do-dumb-things-with-your-m.aspxey

  2. Hi Paul

    Do I know if they all have the 15 biases? No I don’t.

    Are they aware of the biases and what to do about them? Yes they do.

  3. Hi Wenda

    You have registered for Ultimate 2016, March.

    I would wait to complete that before investing in the Wyckoff Course – because not all of Wyckoff is relevant to futures. Taking the Wyckoff course before Ultimate may cause confusion.

    I would not purchase the tape reading course. Much has changed in tape reading from Wyckoff’s day.

  4. I understand now, discretionary trading is that kind of trading that is not completely mechanical.

    I’m thinking the “problems” of discetionary trading that arise in some traders can be alleviated by:
    1) moving up higher in the timeframes, this allows more room for proper decision making and reversal of impuslive decisions before the damage is done.
    2) as you said, a checklist for decision making (entry, exit)
    3) gain quickly more experience in asserting the proper market context by using a simulation platform.

    Makes any sense?

    Please put a note on the blog when you release the Ultimate intro videos. 🙂

  5. Hi Sorin

    Yes, your suggestions have merit – at least as far as their influence on the discretionary decision-making process.

    But, what I was alluding to in these series of posts is the fact that some traders are unable to handle the number of inputs used in discretionary trading.

    If I do make available intro videos to Ultimate, I’ll note that in the blog.

    And if I do, take a moment to compare the number of variables I look at to answer the first two questions in the decision-making model that I use:

    1) What is the trend of the trader’s timeframe?
    2) Is it likely to continue or change?

    There are about 7 variable in the discretionary approach as compared with two in the mechanical. The two also serve as the setups. Quite a difference.

    There is of course a price for the simplification but that’s a story for another day.

  6. Only those Ultimate course graduates who have Ray’s signature trading discretionaty ability, using what was taught (discretionary rule-based method) to do trading could have the same positive and robust Expectancy as Ray
    – regardless of their trading personlity/preference?

  7. Hi Paul

    Ha-ha. That’s quite a cap!

    Unfortunately, probably not true.

    If it were true, how would would we account for the positive expectancy return we see with the first batch of beta testers of the mechanical method?

    Let’s see how the second batch do. Will keep you posted. For the moment, I’ll stay with my hypothesis.

    What is established though: anyone who wants to succeed needs to put in the right sort of hard work. By that I mean they need to put in the hours using Deliberative Practice.

  8. hi Ray,
    The mere fact that
    “Are they aware of the biases and what to do about them? Yes they do.”
    – makes Ultimate course value for money! 🙂

    For mechanical method, it can be traded by EA with zero human input, no discretionary judgement/skills/ability required.

    Deliberative Practice
    – Brett Steenbarger has emphasised that in his blogs

    Great minds think alike!


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