BarroMetrics Views: Uncertainty and Trading

Humans crave certainty and when the activities we engage in fail to provide it, we go out of our way to seek and/or create it.  This I believe is the main reason why patently absurd ads in the trading game are so successful.

Not too long ago, I was at a dinner. Seated next to me was a budding trader who had just started trading. He had attended a local guru’s seminar and had  three or four consecutive wins. When he found that I also was a trader, he asked me for some tips on how to succeed. I started to tell him that trading is a probability game and that each approach had its own rate of success. For end-of-day trading, you could expect an average win rate from 30% to 55%. To succeed he had to manage his Expectancy Return (see below), rather than focus on the win rate.

He took exception to the comment, after all hadn’t he just had consecutive wins thus ‘proving’ the guru claims of over 90% winners? I have learned not to engage in debate and moved on to another topic of conversation. I met him again the other day. He was still looking for that elusive certainty that would make him a success.

This need for certainty affects us in other ways.  I am a discretionary trader who mainly uses pattern recognition for my trading. I consciously seek information that runs contrary to my conclusions to avoid myopia. For example in the current EURUSD short position, I have determined that the EURUSD is in the process of completing a ‘6-wave Running Correction’ continuation pattern. If this proves valid, the pattern projects a target to the 1.27 to 1.24 area.

On the other hand, if my interpretation of the pattern proves  incorrect, we may be seeing the ‘3 Drives to a Low’ which projects a target to the 1.3900 to 1.4100 zone.

I formed a conclusion about which pattern was the most probable and acted on that information. But I need to bear in mind that the pattern is an opinion about future direction. It’s not a hard probability, only a subjective assessment which may need revision as new information comes to hand.

This is the source of the difficulty with trading. To trade well, we need to accept that our judgment is constantly being called into question and we need to keep ourselves open to all information not just the items of data that favour our conclusions.

EXPECTANCY RETURN FORMULA

(Average $ Win x Win Rate) - (Average $ Loss x Loss Rate)  = +$

The formula must result in a positive number for long-term success.

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