Two Missing Igredients for Success

In today’s blog, I’ll be considering two practices followed by professionals that are usually ignored by retail traders.

The first one is the ability to hold, at the same time, two or more competing ideas on the basis that both are equally valid. In my mentor program’s trading training section. I start with a rule-based approach, as mechanical as the student’s personality will allow. The outcome I seek is to ensure the trader learns ‘to see a trade, take a trade’ and to ‘trade what he sees, rather than what he’d like to see’.

As a trader evolves and becomes a more experienced discretionary trader, he understands that at any given moment, the market can do one of three things: move up, move down or move sideways. He takes all competing information, organises it as best he can and concludes if he will or will not take a trade; if the former, at what price to enter, place a stop etc. He does this without falling into cognitive dissonance.

Cognitive Dissonance theory says that we have a tendency to seek consistency among our beliefs and/or our sensory data or other beliefs. In the case of sensory data, we tend to either change the data to suit our beliefs or change the beliefs to suit the data. In trading, I think a better way is to hold the competing ideas as being equally valid and to then to organise the data as one or more of the possible market behaviours: up, down or sideways. Based on this organization, we come to a trading decision.

Let’s use the current ES as an example. I hold the view that the 18-d (monthly trend) and 13-w (quarterly trend) are in a start of a downtrend; and the 12-M (yearly trend) needs to complete an Upthrust Change in Trend pattern by giving a bearish bar close in February. Now, that’s what I call a bearish mindset!

But, here’s the thing. On Friday, the ES had a bearish setup for the 80-min 5-period swing (1d i.e. Daily trend) – see “A Surprise or Unexpected Event“. The Gann idea I call, ‘the 4th Time Thru’, is a very reliable pattern. If the market is as bearish as I believed, then I’d have expected the ES to breakdown on Friday following the breach of 1337 (basis March). While the ES did move lower, it did so sluggishly. When I went to bed, I was expecting to awaken to see new lows made, with a close near the lows – much like the price action yesterday (except yesterday I was looking for an close).

When on Thursday I analysed the ES, I had to be able to hold two conflicting ideas: the market was bearish, and therefore it should break 1337 and close down. If it was bullish, or at least not as bearish as I believed, then the downside breakout would fail and the market would reverse. In that case, I had to consider if I wanted to be long. I decided I did.

I decided this because if the market reversed then:

  • The minimum target would be 1373 to 1378 and there probably would be a retest of the breakdown zone 1397 to 1400. And
  • If the market did fail on the fourth attempt down, the underlying market trend may be up despite my tools. In other words, the market behaviour and my belief that the trend is down are at odds. In that situation, I am better off deciding on a course of action considering the market’s behaviour rather than closing my mind to the contradictory information.
  • I hold this view despite the fact that I believe the Ambac rescue package will not change the bear trend i.e. the news that pushed prices up on Friday are a ‘surprise event, rather than an ‘unexpected event’ (“A Surprise or Unexpected Event“)

Too often the course taken by traders is to block out the information that fails to support their view; in other words to pursue what I call myopia. Unfortunately for us, many times the market rewards myopia until one day… until the day she decides there a lesson to be taught. On that day, the learning is painful.

A good, and tragic, example of this is the ‘High Probability Trader’s’ experience on ‘Soc Gen Day’.

So that’s one trait. The second trait is the unfailing use by professionals of their monthly (or weekly reports or quarterly reports). Certainly one weekend a month I pore over my psychology and equity stats to look for patterns of behaviour that positively or negatively impact my trading. If I see a large loss, or a series of losses, I look seek to identify the events that contributed to the losses. The same for profits.

Of all the ideas I teach, this one is the most honoured by its breach. I thought that perhaps it was because I asked students to do it manually rather than by Excel macro. So I asked someone to do it on the basis I’d sell it at my speaking engagements. He charged S200 (about US$150). Not what I’d call a fortune. Out of 60-odd members, 2 took up the offer. So doing it manually is not the answer.

I don’t know what the answer is, but I do know that your period’s benchmarks are critical to success.

———-

An aside: On Mar 1 & 2, I’ll be speaking at Singapore’s Asian Traders Investment Convention (ATIC) to be held at Suntec City. See
http://www.theatic.net/mailblast/sg_atic_2008.htm

This is a quality event for a very low price. In fact, you can even avoid the entry fee, S$18.00 (to the convention) by filling in the survey in the link above BEFORE February 28. I’ll be presenting new and unique ideas on managing impulse trades and position sizing. Note that for key note speakers there is a fee of S$30.00.

5 thoughts on “Two Missing Igredients for Success”

  1. Ray, you are right on on both accounts. Had someone sat me down and explained the idea of Cognitve Dissonance to me right from the start, perhaps I wouldn’t have lined the pockets of that guy taking the other side of my trade so richly for years! I think most “teachers” out there have a passing understanding of it, but its usually cloaked in statements that are easy to say and repeat – that even sound catchy….. Such as “when the market moves against you just get out… You can always get back in… etc, etc…” Reality is that we are all subject to CD and can only begin to behave differently when we 1) actually become AWARE of it and 2) we begin actively and aggresively taking steps to counter it (which would include just “getting out”).

    On your second point, that was actually one of the last pieces of the puzzle to my becoming a profitable trader. I actually began to face the ugliness of the statements and pinpoint those times when I had a nice run up in the account and what happened psychologically as I gave it all back. Its a hard thing to do… Its the LAST thing you want to do because of CD! We don’t want to seek the data that will show us what a mess we’ve become. CD compels us to seek the data that will conform to our belief that we are GOOD TRADERS!!

  2. Ray

    Just thinking out loud as usual.

    As the market was not making waves in the early session, I decided to turn in early with the intention of having a catnap to catch the market later.

    However, the analgesic I had took me to slumberland. On waking up early this morning my local time, I checked that ES has tried to break the resistance 1340 , and closing at 1382.5 when pit session closed.

    Reading the Market Profile chart points to if it breaks above the resistance 1340, it will set up a long for swing/position trades.

    Before I hit the sack, news broke that gold has the support of the IMF gold sales while crude has no lack of supply; both reversed trends and moving north this morning. Tough to read these instruments which are volatile and hard to trade.

    My forex position on GBPJPY looks like forming a horizontal triangle, which may see it breaking up to 214 at least today. I would take some money off the table and re-enter long upon some retracement.

    The story about the bond insurers is valid and by now probably discounted by the market.

  3. Hi Ana

    Thanks for sharing. Both Crude and Gold have a failed forecasting pattern. If we have a confirmed breakout by close of today, we can expect a sharp move to the upside. Both will need a bar with bullish conviction.

  4. Jeff

    As revision of our trading results is important, I wish to let you know that the template Ray has devised called Excel Macro would do all the calculations for you as long as you have done your inputs whenever you enter and exit your trades.

    It is time saving and is retailing at SGD200 but before end of Feb 08, at a discounted price of SGD150.

    Let me know if you are interested.

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