Efficient Trading

[SOCRATES]

Also note that what Socrates has said is opposite to conventional position sizing theory. All books will tell you that you should first decide how much risk per trade you should take, then decide where your entry point and initial stop will be, all of which will determine your position size.

This means that when your trade doesn't work out and reverses immediately upon entry, you will lose the full 1% or 2% or whatever you have decided you will risk. Imagine you are a new trader who is not yet capable of consistently picking high probability entries, but is keen to place tight stops. You will get blown pretty soon. Keeping tight stops goes hand in hand with high probability entries. You cannot have one without the other.

Back to position sizing: what traders like Socrates do is not to concentrate on a fixed risk (e.g., 1%), but to fix the position size. I.e., they decide that they would trade 50 contracts or 5000 stocks. Then they decide their entry point and their initial stop, and decide if the risk is still acceptable (i.e., tiny). If it's not, they reduce the size to maybe 40 contracts or 3000 stocks.

I should point out here that the other essential element of this type of trading is extremely small costs. You cannot trade like this if you have to pay 0.2% of your position size in commission each turn, like the UK CFD companies charge. High costs will deplete your account very fast during the learning phase.

Very Good Post, and Absolutely Correct.

 

[OpenMind]

Thank you Socrates.

Question for you: High probability entries with tight stops must be used in intra-day trading. But is it actually possible to trade EOD using tight stops? To take the question further, is there such a thing called a high probability entry in EOD trading (in particular, the stock market)? Isn't the overnight risk too high to upset all the probabilistic assessments?

I expect this to be a stupid question, I just haven't been exposed to that kind of trading with end of day data.

 

[SOCRATES]

Thank you Socrates.

Question for you: My understnding is that high probability entries with tight stops can certainly be used in intra-day trading (provided one knows what one is doing of course ;-). But is it actually possible to trade EOD using tight stops? To take the question further, is it at all possible to pick high probability entries in EOD trading? Isn't the overnight risk too high to upset all the probabilistic assessments?

The principle of using tight stops is valid right across the board for all instruments in all timeframes.

With end of day operations there is a caveat.

You have to take into account the trend and at what point in the trend the instrument is at.

You need to be assured that the trend is a strong one and well embedded and that therefore its propensity to continue is nearly almost guaranteed, because if it is, it is very likely (I am not saying certain) that there will be gaps.

There are three types of gaps, breakaway, continuation and exhaustion.

You have to be able to accurately asses which gap in the sequence is most likely to occur next and whether it will most likely be an overnight gap but with the trend continuing from then on.

You have to already be in a strong position by the end of day to even consider such a strategy.

For this you need to have a holistic view of all the factors leading to the price structuring nearing the close, becuse without this, really it is a gamble.

You don't really want to gamble, you want to be reasonably assured that at the open of the following day you are going to continue to be in the money and improving.

 

[SOCRATES]

Agree CC,

The lost half dozen posts from Soc have been extrememly helpful from my point of view and appreciated the effort. They have helped me to save money by carefully analyzing my stops and entries further.

Cheers

There is more, but you have to appreciate that the markets are running and I have to find a lull in the proceedings to find a slot to give the rest the proper attention it merits...later, I promise.

 

[Profitaker]

Openmind

Considering the thread started with an article on cognitive thinking I'm suprised it's moved to stop-losses.

Anyway;

You need to consider the volatility of the underlying when setting a stop. What might be a tight stop in one stock may not be so in another stock, despite them both trading at the same price. BTW, this equally applies to a limit order. Volatility – I’m sure old Soc will fill you in…..LOL

The other factor is time. A tight stop for an intra-day trade is not a tight stop when applied to a weekly trade. This also applies to a limit order. I think this is what you alluded to above. There is a mathematical relationship between volatility and time. Again Soc will fill you in….LOL

 

[tunnel1x1]

Right Sir, on another thread on these boards I made two statements about what in essence are fundamental principles for any stock operator, futures trader or dealer in securities, commmodities or even currencies.

Anyone who is accomplished in the art of trading effectively in any market will recognise the validity of my statements, and I may add, that silence gives consent from the really expert few, but what happens is that when statements of quality are made on these boards they tend to stimulate the rabble to respond unfavourably when in fact they ought to be listening intently and not interrupting with rude and inept comments.

The two statements I made were "Survival of the Fittest" and "Merit, Ability and Conduct".

Let us take the first. The markets are not there for the benefit of individuals who have a gung ho attitude. They, as a by product of the way they are constructed, serve to punish, and I may add, punish severely those who adopt a cavalier attitude to trading, because, contraty to what is popularly disseminated here and elsewhere, it is not some silly little game that anyone can play, it is a profession. For this reason, the market sorts out the cavalier trader from the prudent and skilled. Luck, which may for a time be on the side of the unprepared, is not sustainable. so first of all there is a proper way of going about things and an improper way of going about things with ultimate inexhorable results.

This brings me to the second statement "Merit, Ability and Conduct"
We are going to concentrate for the purpose of this illustration to follow, on the question of Ability.

Because this is a profession and not a pastime, it requires the development of skill. This skill has to be underpinned by knowledge. And this knowledge has to be a vast pool from which to draw, because at any given moment any component of this pool has to be accessible in an instant, without hesitation of any sort, to be able to properly identify what is a real opportunit;y, against a very convinving mirage to be avoided by abstention, or by opposite response, as appropriate.

Now in simple terms, what happens is that none of us are born knowing. If we were, everyone could and would succeed immediately, which is not the case. In consequence of this obstacle, we have to undergo a process of learning to teach ourselves. This is a gradient which can take a very long time to climb, but I promise you, there is an ultimate end to it. It feels like climbing a mountain and finally getting to the summit, where there is no more mountain to climb but the reward is a sort of anticlimax, like the view the climber is entitled to enjoy.

Throughout this long climb, the act itself of climbing causes the climber to teach himself to climb more effectively. A seasoned climber who has climbed many mountains will climb more effectively than a new climber. Let us transpose this idea to trading. What I am imparting to you is that persistent attempts lead to improvement in ability.

Commensurate with the level of ability is the capacity to undertake what we shall call missions. Fortunately there are only three, Long, Short and Abstention. It could be worse, so we must be grateful there are only three possibilities, three options in this regard.

As the level of ability rises, together with the rising of this level and harmonious with it also three things develop. These are choices. Because they are choices they cannot be mechanised, they cannot be fudged, and they cannot be altered, because they are the expression of will. They constitute committment. As they constitute committment, once committed they cannot be undone, which is what makes this profession unique.

But what happens is that through the gaining of proficiency, these three choices do not exactly take on a life of their own, but evolve and become more and more accurate, and more and more refined.

I am specifically referring to Timing, the Point of Entry and the Point of Exit.

When the market begins to "talk to you" instead of just baffling you, the Point of Entry selects itself for you and the Timing is the right one. In consequence of this, you repeatedly and confidently experience the position going in your favour immediately. The stop, which is a crucial safeguard for everybody, is now quickly left behind. With progressive increases in proficiency leading to accurate entry and perfect or near perfect timing, the stop can now be narrowed and squeezed to the limit, taking into account the spread. The other thing that happens is that the exit point becomes clearer and clearer, as you begin to detect exhaustion or imminent reversal.

One percent of capital employed is a vast amount to risk. One fifth of this figure is what you should ultimately aim for or thereabouts.

But in the very early stages in your development as a trader you should begin to cultivate the use of tighter and tighter stops as you progress, because not to do so constitutes dereliction of control. Ultimately risk is about being able to control unforseen losses.

Nearly all of trading is about control. The most important aspect is the control the trader places upon himself to start with. With attainment of progressive proficiency over time, you will see and experience that everything else takes care of itself and falls into place neatly.

The price you have to pay is self governance of absolutely the highest order, and nothing else.

I therefore do not agree with theories involving wide stops or stops placed under the last reversal and such other tripe, I maintain that the trader has to assume complete and utter responsibility for his decision, all else is an excuse.

This attainment of self governance of the highest order is the single most difficult discipline most people have difficulty in mastering. You must take steps to master it, otherwise it will master you, with dire results.

I hope and expect that this comprehensive explanation serves to satisfy your query.

Socrates,

Thank you for taking the time to reply. Your response was comprehensive and valuable, and it did answer my questions.

At one time in my trading, I did experience what you reference by entering at just the right time and the right price. The market would invariably proceed in my favor and continue in my favor over several days. The stop was there but was not really an issue. Over a period of 4 months, I increase my account by 100%. Now that was probably partly luck and partly being in sync with the market. However, because I was sufficiently inexperienced, I had not developed the right mind set which you speak of. I had too much of that cavalier attitude so the market proceeded to sort me out as you say by forcing me to give it all back. So, after slipping down the mountain abit, I am walking back up the gradient.

Thanks for the valuable insight into mindset, stops, and timing.

tunnel

 

[dbphoenix]

You need to consider the volatility of the underlying when setting a stop. What might be a tight stop in one stock may not be so in another stock, despite them both trading at the same price.

True. Futures, too, depending on the daily or weekly context.

It'll be interesting to see how many of those who buy into the tight stop thing without qualification will be around in a year.

 

[charliechan]

Thank you Socrates.

Question for you: High probability entries with tight stops must be used in intra-day trading. But is it actually possible to trade EOD using tight stops? To take the question further, is there such a thing called a high probability entry in EOD trading (in particular, the stock market)? Isn't the overnight risk too high to upset all the probabilistic assessments?

I expect this to be a stupid question, I just haven't been exposed to that kind of trading with end of day data.

you may also want to consider the time of week. if a good trend has been developing from say monday onwards, there may be a correction on the friday.

some people like to build a position gradually. some are forced to do so because they cant get all their business done in one go.

holding overnight is not necessarily as risky as some may think if they know wjats what, but holding over the weekend could be. so they unwind on the last day of the week - and fewer people are adding thus the correction.

 

[Profitaker]

True. Futures, too, depending on the daily or weekly context.

Indeed, any asset or option thereof.

It'll be interesting to see how many of those who buy into the tight stop thing without qualification will be around in a year

Not many I suggest. Your phrase “without qualification” is key here.

I know old Soc will want to cover these aspects of practical stop-loss application himself, so I won’t steal his thunder. He’s probably whipped himself up into a frenzy as I type LOL.

 

[SOCRATES]

True. Futures, too, depending on the daily or weekly context.

It'll be interesting to see how many of those who buy into the tight stop thing without qualification will be around in a year.

Here we go again....

No, it is not true and you ought to know by now that it is not true.

It is dependent on the skill level of the trader and not dependent on market gyrations.

As for your second comment, the outcome of persisting with wide stops is a forgone conclusion, dire it is, I don't understand why you persist in contradicting, I really don't.

 

[Profitaker]

You mean a skilled trader can stop the market gyrating ?

Priceless !

 

[SOCRATES]

you may also want to consider the time of week. if a good trend has been developing from say monday onwards, there may be a correction on the friday.

some people like to build a position gradually. some are forced to do so because they cant get all their business done in one go.

holding overnight is not necessarily as risky as some may think if they know wjats what, but holding over the weekend could be. so they unwind on the last day of the week - and fewer people are adding thus the correction.

Yes indeed, also a very valid point and one to carefully consider.

 

[SOCRATES]

You mean a skilled trader can stop the market gyrating ?

Priceless !

Read what I say properly before you pounce with your usual inept comments, once again.

A skilled trader cannot stop a market gyrating, but instead take advantage of a market that is gyrating, obvious is it not ?

That is what is really priceless.

 

[Profitaker]

Soc me old mucker...

If one can't stop the market gyrating one has to live with it, once in a trade. The "gyrating" as you call it is actually refered to as volatility, at least by skilled traders.

Volatility of the stock / commodity / FX that you're trading is a major factor in deciding where to place a stop-loss order. Yet you've not mentioned it to your students here - why not ?

 

[SOCRATES]

Now in the next post I am going to reply to the post by ChrisW and we are going to constructively explore how individuals develop emotional spirals.

These emotional spirals are directly linked to dereliction of control, so the topic of stops is very relevant and at the root of all the problems.

Also I am going to explain the other emotional and psychological impediments that are caused as by products together with the trading implications of such deleliction, in detail.

I am certain it will be of benefit and interest to many members and visitors.

 

[FXSCALPER2]

So the secret of out dear Socrates is

1- knowing what the price will do next (almost) and;

2- using tight stops

That was worth all the suspense! Also, what is up with risking a 5th of 1% if you win 90% of the time? Given that you are almost infallible, you are being a wee bit, er...., what is the word?

 

[Profitaker]

Why are my post being selectively deleted ?

 

[frugi]

As usual an interesting discussion is is danger of being derailed by the odd sarcastic naysayer and the consequences of this are also the usual unwelcome ones, namely a bunfight. Please keep the thread on topic and let Socrates expand on his recent posts, if he so wishes, and indeed all the others who are sensibly contributing. Those who believe that any trader's skill is limited according to their own frame of reference are welcome to stop reading the thread, but not welcome to spoil it. Thanks. Profitaker please note I have not deleted your posts concerning volatility etc. merely the inflammtory and off-topic ones (as I have those of others too).

 

[Profitaker]

frugi

Did you know the stockmarkets are one MASSIVE bun fight ? It's precisely disagreement that causes stock prices to change. What's wrong with disagreement and a healthy dose of sarcasm here ?

You tell me what I can and can't say, in public, how's that ?

 

[jimbo57]

As usual an interesting discussion is is danger of being derailed by the odd sarcastic naysayer and the consequences of this are also the usual unwelcome ones, namely a bunfight. Please keep the thread on topic and let Socrates expand on his recent posts, if he so wishes, and indeed all the others who are sensibly contributing. Those who believe that any trader's skill is limited according to their own frame of reference are welcome to stop reading the thread, but not welcome to spoil it. Thanks. Profitaker please note I have not deleted your posts concerning volatility etc. merely the inflammtory and off-topic ones (as I have those of others too).

And as usual special treatment is metered out.