It Just Doesn't Matter

I've experienced at least a dozen ways in which a trade can go south and I'm sure I'll experience a dozen more I hadn't even thought of.  I've stopped keeping track of the number of times I was top ticked and found it too demoralizing to continue tracking the number of times my stop was bottom ticked only to watch price rebound to new highs.  I was surprised to find out that there are ticks you can get filled at below the low of the day; yes, that's correct, the printed low of the day may not have been the actual low.  I stopped keeping track of the number of times price came within a penny of my exit target alert only to close out at the end of the day below my entry –or worse –stopped out.  But, you know what... It just doesn't matter.

Something I've been working on in my trading lately is taking another shot at a stock that I've exited or been stopped out on.  Usually I'd find a few or more reasons not to reenter such as not wanting to deal with wash rules, or not being able to handle taking a second loss on the same stock so soon afterward.  The problem with this is that it is anathema to the way world class traders think and act.  World class traders will take multiple shots on the same stock if they still define it as a quality set up with an edge and a valid entry signal as defined by their rules.  This is what matters to them, not the emotional attachment to a ticker and the recent experience of taking a loss or two.  It's about the set ups and not the bias to a particular symbol.

Bias to a symbol is a common theme with greater repercussions than one might think.  It is in part why I would not take another shot on the same stock, and it's also why at times I'll have a more favorable view of a set up if I know what the symbol is regardless of how less than stellar the chart may look.  So, in order to think and therefor act like a trader I've made a conscious decision to get over the hump by occasionally taking another entry.  This past week LF was my stock.

One of my rules based upon assessment of my trades is to exit a stock if it closes lower than my entry. Empirically this makes sense because why should I be long something that is not going up?  Emotionally however, this was a difficult hurdle for me to overcome as it forced me into accepting a number of scratch trade which increased my losing percentage and string of losses as well as having the appearance of adding up to a significant amount; however, my statistics don't lie and coming to grips with the simple fact that this is a high probability failure trade on my time frame finally convinced me it's acceptable to take a larger number of small losses and increase the frequency of my trading (I had to spend a lot of time improving trade management, but that's another story). With this in mind I took an entry signal on LF on Monday and closed it at the end of the day and ditto for Tuesday. Come Thursday I witnessed, much to my chagrin, LF bolting out the gate and up nearly 6% before my scan alerted me.

Now I was faced with a dilemma, let it pass and miss out on what's been setting up to be a good trade opportunity or take a third shot and, heaven forbid, watch it reverse hard on me and get stopped out a third time.  I took a few moments to contemplate and noted that it was currently priced at my maximum chase point on a stock at this price level, 6%.  I decided to take the trade, it was still a good set up.

Quickly the entry was confirmed as the price continued higher and I found myself up 5%.  It seems just as quickly maximum adversity kicked in like steel toes to my teeth and the market sent a simple reminder to me that no matter how solid the set up, anything can and will happen, especially when least expected or prepared.  Conveniently the stock was downgraded and after hour news hit the wire that the CFO was resigning and I was quickly preparing myself for the acceptance that the stock would gap down like a stone.  Regardless of how I felt about the downgrade being a bullshit call, particularly since it was done during market hours which is rare, and irrespective that I didn't believe the CFO resignation was an issue, I didn't expect the market reaction to take this view and basically accepted this would be a loss.

The set up was sound, the entry within reason, and the amount risked tolerable.  I took a shot, and then another, and finally one more.  This I can control.  Entering and getting stopped out 30 seconds later I can not.  Entering and having a BS downgrade that could have been done premarket instead of during hours and after an 11% move I can not.   In the end, however, it just doesn't matter.  It just doesn't matter how the trade gets from A-Z as long as it's part of plan.  Yes it may at times be an emotional roller coaster and yes sometimes will be more difficult than others, but in the scheme of things it's just one trade and it just doesn't matter.  Occasionally there will be that isolated trade that stings and hurts so badly it flashes before your eyes before you take a signal, but over time these become fewer and farther between.  As my sample size grows larger these trades shrink, and in the grander scheme of things, it just doesn't matter.  One thing that truly matters is trading with a solid  plan that allows one to get to this point that it just doesn't matter.

Reality Based Trading- Balancing What You Want with Who You Are

Breaking down some numbers today it's become abundantly clear that the metrics I'd like to achieve and what I've accomplished are night and day. This is a principled example of cognitive dissonance and the resolution to this is not 100% clear, so I thought it in my best interest to externalize the conundrum in an attempt of ascertaining coherence.

Ideally my benchmark to achieve is a risk/reward ratio of 3-1. This number is not something I've simply pulled out of my ass --it is completely rationale and here is why; Cognitively it has been shown that the human brain reacts approximately 2.5x more to losses than gains which means that for each loss the gains to balance the internal state should be 2.5 or more. Given this, my thoughts were that if I could maintain this ratio the internal balance of my mental state would be more harmonious and would lessen the discomforts I have at times being in a trade.

The problem is that I've latched onto this anchor and continue to hold to this metric as a goal to achieve while in turn completely neglecting the information my trades are telling me. Here in lies the crux of the problem; what I'd like to achieve I have thus far been unable to do with consistency.  In turn I  have ignored the profits achieved consistently resulting in sub-par performance. The result is that this has done anything but appease my internal state and in fact it has simply increased frustration and exasperation.

Currently what I have shown myself capable of is a 58% success rate with an average of 1.17 R/R. I have not shown I am capable under the current market conditions to extract 3-1, let alone 2-1 with consistency so it is to my detriment to hold onto this view any longer. In fact, given that my time frame is 5 days I can simply take the max high over this time compared to entry and note that the average has only been 4.8% to begin with. Couple this with my current average profit extraction of 3.93% and I'm really not missing much profit and in fact causing detriment to my productivity in attempting to extract more.

Given this I can only come to the conclusion that it is time to stop fighting the reality of the situation and to accept fully what my personal performance is indicating to me. Which in turn means I will have to modify my plan for the time being. This isn't to say that I'll completely give up on reaching for 2.5+ R/R, it simply means I'll also have to let my metrics show me when I am capable of that. Once my stats begin to show me I am costing myself by not holding on a little bit longer and maximizing potential profit I'll adapt.  

Breaking it all down trading in it's essence is simply a game of numbers and probabilities. Each trade increases our sample size and inches us closer to truths about who we are as traders at any given time. One of my priorities written in my trading plan this year was to become more aware of how my numbers speak to me; and given the number of trades I've taken thus far the outline is starting to become a story and it's time for me to start listening.

In keeping with the theme, here are some key formulas to be aware of for trading:

Risk of Ruin is a gambling concept and an important calculation to understand.  This is the ultimate calculation a trading strategy is measured against for if ruin is reached that's it --no mas.  While a near 0 risk of ruin is not a guarantee that one will not blow up their account, it is important to be aware of as an indication of how well one is trading. If this number begins to increase somewhat significantly it is a good clue that one is not in cadence with the market or that ones strategy is not currently working or worse, one is not trading well at all regardless of the market or the method.

There are two caveats to consider in this calculation.  The first being that it requires gains to be larger than losses.  Obviously a 50% success rate where losses are twice as large as gains will lead to ruin but it is also important to acknowledge that trading is not a zero sum game.  While it is true for every winner there is a loser, it is also true the house wins.  A series of ten flat trades can still burn 1% of an account.

Risk of Ruin

Expected Value is another important concept to understand. If you don't know the expected value of each trade you are doing yourself a disservice.  In conjunction with a near zero risk of ruin this is the second factor that must be taken into consideration: a +EV system.  Knowing these correlations will greatly assist in understanding the risk that is being taken.  If the system is not positive and there is an 8% risk or ruin why is the system being traded at all?  If it is marginally positive, where can things be tweaked to improve performance or reduce risk? 

Expected Value

If the first two are positive, then the tweaking comes in the form of personal performance statistics. Figure out what stats are important. I trade with a 5 day time stop so I keep track of how the trades I take perform on this time frame whether I get stopped out or exit before then. Additionally what has been critical information for me to know is if the days close is higher than entry and if the second day has a follow through. A secondary piece of information I watch is the max high over the 5 day period which further heightens the discrepancy between what the stocks over my time frame were capable of moving from my personal desires. You're numbers won't lie to you so deducing this information is absolute imperative.