Black box thinking

We’re excited about the subtle but significant changes that we have implemented.

I think all traders, whether they are proprietary, professional or retail, always struggle to find what works for them. And as you know from these posts, we are no different.

Black box thinking, the surprising truth about success’ by Matthew Syed brings home the idea that learning from our failures is paramount to any chance of eventual success.

The book, in part, draws comparisons between aviation and healthcare. Since the ’70s, and formerly a NASA programme, aviation has, in large part, been such a safety success story by learning from its mistakes. Nothing grander than that.

Aviation insists on an open-loop learning model. Flight crew, for example, operate in an atmosphere of mutual support of cross-referred checks, everyone questioned by anyone no matter what their position and an open-loop reporting facility that shares without vindication errors that have or may occur.

What has this got to do with a traded fund?

Even a highly proficient technical trader is guilty of a multitude of errors creeping into the routine of things. The nature of the game is that such mistakes take away from an account over time significantly more than a corresponding success adds.

Therefore, imagine trading in a similar way to the description above. In which we work within a team, each member graduates to a position that best suits their innate talents.

A position that leaves room for movement and innovation but benefits from an agreed plan or strategy, a shared briefing and approach appropriate to the timescale required, loose but agreeable support during trade time and an all-important regular debrief of lessons learnt.

From the observation of news reports and events, market analytical assessment, timely recognition of value and setup to the execution of the trade, the structure and its subsequent management.

We give ourselves the best chance of success by openly confronting each aspect of our trade model and learning frankly from our failures, no matter how small.

When is a trade an investment?

Our post ‘Early on the DAX and JPY‘ still applies. We entered short the German 30 index (DAX) and shorted both the Australian Dollar and the Euro against the Japanese Yen.

It is arguable that a weekly chart is not trading but investing. These trades have been going for so long (several weeks) that they show best on the higher time frame drawings.

If the S&P 500 index takes a drop, then it is probable that the DAX will follow.

The Economist recently reported that Bridgewater (the world’s most significant hedge fund) had taken a $1.5 billion in derivatives short in the S&P 500.

Al Brooks, a technical trader, forecasted at least a 5% drop in price in the index, a decline, he explains, that eventually could be anything up to 20%.

Having said all that, making independent technical assumptions is vital.

The DAX, despite the convictions of those mentioned, is a low probability endeavour. But we continue to hold.

A trader always considers the probability and reward/risk of a trade. A low probability trade often equals a high reward/risk outcome; and a high probability trade a small reward/risk outcome. That is all part of the ‘traders equation’.

The strengthening of the Japanese Yen, on the other hand, is technically, and on a weekly synopsis, a satisfactory probability endeavour.

We continue to trade the remaining fund margin on the lower timeframe, which last anything between a few hours to no more than a few days. In other words, trading not investing.

The trader and the analyst—different mindsets

We are already moving into our third week back since the seasonal break. We took the time to review our trading plan. It isn’t just in the words we have written but, and probably more importantly, in our approach. The ‘how we do it’ is one thing. Our collaborative methodology is another.

Anchor

Last year we anchored our trade readings around the lower time frame chart analysis. In other words, we day traded. Which, of course, means that a trade entered at any point during the trading period would be exited before the end of the day.

This year we have started to move our anchor period to the one-hour charts; this is a wonderfully flexible timeframe. It is a period that is on the apex of being classified as either a lower or higher timeframe. Many deals finalise in the same session, but a trader may have to be comfortable holding for several days.

Any change in price is relative

Okay, holding for several days to an investor or a higher timeframe swing trader makes them think ‘what is the big deal’? The answer comes down to relative price change. An investor may have judged a trade entry based on a weekly chart and maybe placing high reliance on fundamental rather than technical information. Often, several days, weeks or months down the road and to this individual more than likely nothing has changed. Price is similar or an average weekly bar or so higher or lower in value to where she started.

Meanwhile, if we zoom in to the other extreme of our short-term trader, life has been a perpetual whirlwind of activity all within the same period in which our investor friend has seen little difference.

How many markets?

The various trade levels can be called ‘position’, ‘swing’ or ‘active’. But again, this is relative to a timeframe. An ‘active’ or ‘scalp’ approach on a one-hour bar chart would, over a similarly traded price range, be a ‘swing’ by a lower timeframe day trader.

It is generally best that technical traders select an anchor chart period that best suits their strategy, personality and commitment.

As we have moved to the hourly anchor, we have also significantly increased the number of markets we review. Last year on the lower timeframe, we reviewed no more than three currency pairings. With our change in anchor, we are viewing more than 20 pairings.

The analyst and the trader mindset

Such a change presents an analytical challenge. There is a clear demarcation between the roles of an analyst and a trade setter. The former requires clear ‘what if’ conscious brain thinking. The latter is very much a subconscious endeavour. To mix the two asks for doubt and therefore for unwarranted hesitation, which in turn leads to confidence issues and the introduction of the primal instincts of fear and greed.

A consideration with the lower timeframe day traders too, but the good ones teach themselves to stay in the moment (the subconscious) confident in their backtesting (the conscious) preparation and practise. Higher timeframe traders often move their analysis to the weekend.

The hourly anchored trader (30 minutes to 4-hourly also) have, in this regard, a more difficult proposition. On these anchor levels, the market moves too quickly for the benefit from weekend analysis and unlike our true day trading friend over too many demands to not require constant switching from analyst to the trader. In other words, it is a two-person role.

The colour codes help

We have trialled this two-person approach with pleasing results since our return to work. Through our Trading View software, the analyst will categorise a market using the colder colours of blue, purple and then to green to indicate to the trader where we are relative to each chart. Once the analyst nominates a green (usually with a chart explanation via Skype), the trader is clear to trade. The trader will designate orange as an order placed (again, with a transmitted chart but this time from the trader to the analyst) and red when a trade activates.

This approach, simple in concept, has the advantage of maintaining a clear demarcation of roles and therefore, appropriate brain activity. ‘How champions think’ by Dr Bob Rotella explains the concept marvellously.

Early on the DAX and JPY

Trading in the daily timeframe can result in a seemingly overly extended hold.
We took the German 30 (DAX) short some weeks ago anticipating a decrease in price.
We were very early. The index has hovered at its current value since the 7th of November.

At the start of this month, the value dropped (encouragingly for us) but has gradually ascended.
With yesterdays positive employment results in the USA, the S&P 500 recovered well but closed below last months high.
A weakening of the S&P often has a direct correlation in the movement of the DAX.
We are anticipating that this trade may not play out until the New Year.


We were also early on the daily chart with shorts on each of USD/JPY, EUR/JPY and AUD/JPY.
However, last week each of these pairings moved our way encouragingly.

We continue proactively with intraday trades too — these days more routinely with the 30-minute to four-hour charts.
Such charts keep our stops out of much of the daily noise of news events and on average takes several days to complete.

You will recall that the 5-minute chart was our big favourite for some time. A great daytraders instrument, but the results (for me anyway) were not as significant as what we seem to be able to achieve using a 30 minute, one and four hour and daily approach.

For next year we plan to expand into stocks and shares with part of the portfolio and a weekly technical and annual fundamental mix. More of that later.

As the Xmas break rushes towards us, may we wish you all a wonderful time and, for each of us, a prosperous New Year.

A move to TradingView

Our charting software is in the process of moving from ProRealTime to TradingView.

We have also changed our broker.

Such a move sounds simple. But like moving house, it is more time consuming than first imagined.

In the world of currency pairings (or FX markets) there is no central governing body. Instead, each financial institution provides its price feed to the trader. Whether institutional or private.

Bewildering, but in practice, it works.

What is essential to a trader is that the currency pairing price they observe on a chart is identical to that of the broker.

In the FX market prices are quoted to the fourth decimal point, so the decimal points (1/100th of 1%) must match up on the chart and with the broker.

Right, with that out of the way, why have I moved charts?

Previously browser-based charts were a bit clunky. Slow internet feeds and software that was not up to the job. The way around this was to use software downloaded to the computer.

As you can imagine, things have moved on recently in this area. Of all the charts considered we found TradingView to be the best for our needs.

I won’t list all the advantages that we found only to mention what to us is most significant, and that is the backtesting facility that comes with TradingView.

We would have moved for this alone. To us, backtesting provides an edge. “Repetition is the mother of wisdom” David H. Weis

But as an experienced retail trader, why take so long to move software and broker? It took me by surprise too. Researching, transferring, and practising was more involved than I thought. I guess Lewis Hamilton wouldn’t change cars halfway through the season if he could help it.

The change for us is so profound that it also got me to rewrite my personal trading plan, which is in progress on this site.

We will keep you posted over the next few weeks as our full trading comes online again.

Context price action

Trade opportunities have been in earnest so far in September. Somewhat odd to those trading the higher timeframes such as the daily or weekly scale of things. Where nothing much has occurred, but dig under the surface to the 4 hours, one hour and maybe occasionally the 5 minute and price movement has been identifiable.

A couple of examples from my recent trading log:

The setup above is a short entry in AUD/JPY using the 5-minute chart. A live screenshot with the left-hand edge of the blue line depicting my entry position. My target is the lower red horizontal line, a goal that is reached later that day.

The entry and exit on the trade above started on the 12th September and concluded four days later. A double-entry with each short shown by the red arrow at the top of the chart. Exit for both entries was at the green diamond and slightly before my target depicted by the lower red horizontal line. Holding to the goal would have been a good thing to do, but we achieved a trade that provided nearly six times of reward to risk (6R).

Price action and the context of multiple timeframe charts gives me an early insight into the sentiment of the market and, importantly, the probable market flow of the big players. Technically the trade has to make sense and has to be incorporated with a setup that provides me with a clear reward to risk calculation. The deal has to make sense also on a reasonable timeframe above my entry chart, which provides the essential strategic or fundamental agreement (the macro).

When you explain what type of financial trader you are, it will often fit into one of the following broad explanations:

Sentiment
Flow
Technical
Macro

As a context, price action trader who reviews multiple time frames, I consider that in one way or another, I have a preview into all four disciplines.

Here’s a trade that I exited almost on the bell of the weekend market close last night at 20:59.

The above setup started at the higher horizontal black arrow and concluded successfully at the lower similar mark. Fortunately, the price reached the target as the market was closing for the weekend.

The entry was over two days and as you can see from the picture price took its time to move determinedly lower. When it did, it made the hold all worthwhile.

Below is a sentiment notice that the dollar was likely to weaken. Interesting how context price action identified this sentiment some 24 hours earlier!

Media sentiment regarding USD/PY.

August is more active than usual.

So far, the currency and index markets have been more active than traditionally so in August. 

My anchor or intraday timeframe has moved out to the hourly chart. I still, however, for context, frequently view the 4 hour and daily charts. The weekly also but only to reaffirm a previously drawn crucial weekly support or resistance line, otherwise the weekly chart not so much. 

With the higher timeframe, I’m able to consider many more currency pairings. More than a dozen together with the DAX, S&P 500 and gold. You will know from the news that the indices mentioned have been negatively volatile recently. Unlike your typical investment vehicle, we can benefit equally from the negative or positive price movement of all of these instruments.

Within the currency pairings, the British Pound has spent much of its time in a reasonably tight range against the US Dollar and other pairings. The Japanese Yen, however, has generally trended positively very well against many of the major players. 

We discussed in the last post the importance of measuring specific criteria. Probably the most important of which, together with the per cent amount risked on each trade, is the reward to risk result (R). For example, an exit position that has a 50 pip risk, but a 100 pip reward is a positive 2R trade. 

For a consistent trader, this is also a reasonable indication of market movement. August is littered usually with 1R (or less) trades. However, this week, I’ve taken a few higher trades, one of which at over 5R. 

I look forward to what next week might bring.

Of note, the fund will not be traded from the close of the market on 23rd August until 12th September.  Happy holidays everyone.

What a trader needs to know to improve profitability

What am I working on the most to improve my trading profitability? 

A question, some would think, answered with reference to strategy or method, but it is not that, as significant as it is.

It is regardless of a traders methodology.

What makes a massive difference to profitability is knowing these three inputs: R, win/loss percentage and per cent of account balance risked per trade.

Professional poker players calculate ‘risk of ruin’ (ROR) as a measure of probability, and it applies equally to financial trading.

To calculate our ROR, we need all three inputs, and the smallest of tweaks can make a significant difference.

It applies equally to financial trading.

The measurement of R 

What is R? This refers to reward/risk.

When entering a trade, a professional trader will immediately place a stop loss position coincidental with the trade position.

In the above instance, if our stop is activated, that would be recorded as a -1R trade. (As long as each entry has the same risk amount). If, however, our deal is profitable and we exit at a regular price equal to our stop price position, then we achieve a +1R. On the other hand, if we deliver twice the target distance as compared to the stop position than we would record a +2R, and so on.

Knowledge of the R achieved is essential as a measure towards determining ROR. 

Win/loss percentage.

Win/loss shown as a difference in wins compared to losses shown as a percentage. 

In ‘Market Wizards’ (where Jack Schwager interviews top traders) Schwager gives the ‘wizards’ two choices. A strategy with a high win/loss ratio and a low R, or a small win/loss strategy with a high R. 

I forget the exact wording as it’s a while since I read the book; however, I do recall that all ‘wizards’ took the latter and without hesitation. Most retail traders would probably plump for the former. (If nothing else this indicates the power of R).

Win/loss is better if expressed as a percentage of each strategy traded to provide a complete understanding of the underlying ROR.

How many trades are needed to give a measurable win/loss? There is no exact answer, but my guess would be at least 100 and somewhere between 500 and 1000 measured trades would be better. Of course, these can be a demo or simulated trades; however, ‘live’ trades are always going to be a truer confirmation of a traders skill level. 

Account balance risked per trade.

Getting account balance percentage wrong is probably why most traders burn their accounts at some point (often early) in their trading careers. I was no different. 

In almost all books or trading courses, the explanation of ‘per cent of account balance risked per trade’ is weak. Thus leaving it open to individuals own interpretation resulting not infrequently to a ruinous outcome.

Yes, trading courses point out the need to trade as a percentage of the account. Maybe one or two per cent is provided as a loose example. In reality, it is much more exact than this.

Without having each of these measures of R, win/loss and per cent of account balance risked per trade, it is not possible to calculate the all-important ROR.

Only when we have all three accurately available can we know what we need to tweak to improve our profitability.  

Fund update

The list below shows how we are doing so far and a simple explanation of what we’re doing to improve things further.

Slowtrader fund as of 5/7/2019

Trading the lower timeframe intraday charts have been a necessary route for us. It has provided lots of chart time and many trade opportunities on an almost daily basis.

However, it is time now to increase the fund at a higher rate by taking the significant lessons learnt from day trading and move to the higher inter-day chart levels. (Rather than trades being open for a few minutes to a few hours, with the necessary stops and targets that represent that timeframe, we will be trading wider, and therefore a trade could be open from an hour up to a few days).

Most traders cannot trade lower timeframe charts successfully. Very few that I can see make it into a highly profitable enterprise. Why is this?

There are several reasons. The obvious is that with such charts a trader is more vulnerable to short term, and occasionally unexpected, news releases.

Secondly, markets spread can have an inordinate effect on a traders account when trading in the lower dimension.

Thirdly, and a reason that is not immediately obvious to most day traders is that the size of individual bars relative to spread invalidates many opportunities to use measured move targets.

As a discretionary swing trader, that final reason is more significant than I could have envisioned.

To try to illustrate the point the following is an excerpt from a trade taken yesterday and published as it occurs on Skype.

“The 4 hr and even the 1 hr allow measured move trades of a single bar.

A live example (not crucial if you like the price action or not at this stage).
Using the ruler or the fib tool, we have a potential stop and target.

However, if we copy the fib and move it up to match an improved stop position, we get our revised entry point. The stop in this example is just slightly above the high of the relevant range; this works even better on the 4 hr, but I have the 1 hr as a template too.

I would trade the 1 hr on the same markets as the 5 min. I am expanding the possible range of markets only on the 4 hr.

There are many ways to approach the measured move; this is simply how I went about trading this one.

To complete this train of thought. On the 4 hr and often the 1 hr a measured move can be a single bar or multiple bars. It can be a measure of the wick to wick, wick to close or close to close. With enough practise the best solution becomes apparent with a reasonable degree of confidence.

Of course, a measured move relies on the set-up.”

Target reached for a 1.3R. (R means reward/risk, and in this case, the target was 1.3 times the stop position)

Trading principles, are they important?

In the previous three posts, I talked about distinct characteristics (principles) that may be necessary to help make us consistently profitable in technical, financial trading.

A process or a way that we can apply to any methodology, within reason. So, am I saying that the method or system by which we trade is secondary to some overarching principles? Yes, I am. The most significant of them being the trader’s psychology for which I’d highly recommend ‘Trading in the zone by Mark Douglas’.

I have chosen discipline, quantitative and discretionary as my trading hooks, my principles (and combined them with trading psychology). In other words, they are the platform to which I link my trading system.

Is a trading system not as important? When we start, we all look for a method first and are ignorant of the more critical needs of principles. I guess it would be like an athlete working tirelessly on technique but ignoring fitness.

Once I have my underlying principles sorted (my fitness), I can then more easily add systems as I need (technique).

More importantly, trading principles force us to be more selective about our system. The strict criteria of trading laws act as a standard for system selection and amendment; this is the same if we traded in price action, intraday currency pairings or was a gap trader of a daily equity chart.

P.S. For next month I’d like to discuss something that I’m working on at the moment, the need to combine both intuitive and systematic.

Instinctive is how most traders start and how we lose our money, often all of it! We learn that lesson and try again, but this time with a systematic approach, and if we do this well, we might not lose as much.

As a discretionary trader (i.e. not simply a systems trader) what I believe is necessary to tip the balance and propel us into creating a real trading account is a finely tuned and disciplined balance of both aspects. How to go about achieving this is something we’ll explore.