Practicalities and philosophy of trading from a profitable trader

[Martinghoul]

Boy, and I thought the ppl on FF forums were pushy... It's like watching a gang tackle. Let the guy take his time. It's his thread after all. If you don't like it, then don't follow it anymore. Simple. What's with all the attitude and suspicion? So far I haven't read anything that warrants this kind of behavior. So he's not spilling his exact trading rules, what did you expect? Would you? Go buy Don Miller's new book for $20, and see what kind of "trading insight" you get for your money (hint: not much at all).
Point is, take it easy guys. Let the man speak at his own pace.

I meant no disrespect for the OP... However, too much philosophical musing which precedes the actual discussion of the method's substance is really putting the cart before the horse, IMHO. After all, you really only want to hear someone philosophizing a great deal if that someone has genuinely achieved something and can demonstrate some practical applications of their philosophy. Innit?

 

[Splitlink]

then my mistake, apologies Goldmember...I guess I must have fallen asleep...death by a thousand words.

Fall asleep!

 

[goldmember1]

This might apply to some people who have replied on this thread - if you do not find any use for what I'm writing, then feel free ignore it! Everyone has their own opinion and there are plenty of threads and forums which I do not read/do not find useful as well - this might be one of them for you.

Spending your time wisely

New retail traders work assume that working hard at a trading system is spending 12 hours at live charts working for 3 months as part of the retail cycle which is the most time consuming activity. I have heard people say they want to watch charts until they have seen every market eventuality. In my opinion, this is a waste of time - for instance, someone might not have seen the GBPUSD gap 200 pips at the weekend, or see the RSI 15 minute hit 6 before, but you might have to spend 12 hours a day, for months to actually see it, and if it happens when you are asleep then you missed it. If you are attempting to learn by chart watching ask yourself: what have you learned this week that you did not know last week by watching the chart? If you can write 2 or 3 new points that you did not know the previous week I would be amazed.

There was a trader I spoke to who claimed that he had learned a lot in his first year of non profitable trading by watching charts - I asked him what he learned in ONE YEAR, and his learning consisted of 1) always use a stop loss, 2) don't be emotional, 3) let profits run. Three points that he could have learned in an hour, he took a year - (thats 5 days a week, 50 weeks of the year to learn 3 points).

Once you have a general idea about the charts the most efficient way to spend time learning trading is:

a) backtesting purely technical set ups using forex testing software (V hands is a free one) if you are a technical trader,

b) learning about economic triggers if you want to learn fundamental trading not watching the forex calendar tick away

c) learning how to program if you are an EA trader instead of watching how your EAs perform live.

In my opinion, there comes a time quite quickly that staring at a chart is wasted. If you trade technically on a discretionary basis, you should just be alerting your levels. If you trade fundamentally there should be fundamental news that you look out for and you can have your newsfeeds alert you. If you trade arbitrage or pure technical, then you should have EAs that you audit and update. Chart staring and 'getting a feel' for the markets in my opinion is one of the biggest wastes of time you can do. Trying to watch charts to develop a sixth sense for the markets I believe is like sleeping with a French dictionary under your pillow and hoping to learn French - you have to spend your time learning in the right way to learn anything.

If you can trade with minimizing your chart time then you are spending your time more efficiently. We have all I am sure spent an overnight session battling to get our round figure for the day/week/month. After doing that a few times early on in my trading, I realised that I was spending 4-5 hours earning $40-50 - a minimum wage for an overnight session. I could sign up to the lowest paid overnight job and earn more - you wouldn't accept a $10/hour job under these conditions so don't accept it in trading.

 

[goldmember1]

Fooled By Randomness

This is one of the most important concepts that I read in Talebs book. I think that Taleb takes it a bit far by saying that everything is just random, but certainly randomness has a lot to do with performance. For instance, flipping a coin is 50/50. However, 1 person can be expected to guess 5 correct answers/5 wrong answers at random out of 10 coin flips. A person who guesses 10 coin flips correct is awarded the title of master coin flipper, and is given a lucrative job at an investment bank. Given enough people, at least a few out of millions can be expected to be expert coin flippers despite pure luck just playing a part. With 10 game coin flipping, one in 1000 players (roughly) can be expected to be given this award. These expert coin flippers swan around with their 100% win rates and live the high life guessing coin flips for their investment bank, however they are no more talented at guessing coin flips than anyone else.

Myfxbook (before the metaquotes argument) had over 100 000 traders on its books. If they were a site that catered to coin flipping instead of trading, they would have at least 100 expert coin flippers on their books purely out of chance. These people get all the kudos, but eventually they have losing runs, and the more they coin flip (as well as for their investment bank) the more the mythos wears off, and eventually they are sacked from their position as expert coin flipper (except the lucky ones who has guessed another 10 in a row who is awarded the title of master coin flipper and a $10 million bonus).

Trading in the same way has a lot of chance associated with it. However, the more you coin flip, the more you can say that luck has less of an effect, and skill comes into it. Someone asked me whether I thought that a 300% account in a month was impressive - yes, but I stated that I had not seen it being sustainable. ie: A 300% gain in a month might be a master coin flipper, but unless there is performance over time, this might just be due to survivorship bias. I would also like to see several people achieve these gains over a time to consider the gains realistic, otherwise we might just be looking at a master coin flipper, or even a grand master coin flipper.

What I have seen and marked as realistic gains is what a significant cohort of traders can achieve over a long time period. I am less interested in an isolated incident where a single trader makes a significant percentage higher than anyone else - statistically this is known as an outlier. For anyone who is interested in statistics (and they do play an important role in risk management and equity management) I would suggest that they read up on permutations and combinations. I won't post on permutations and combinations further unless requested since it would be considered boring plus there are better mathematical sites where you can learn how to do these maths.

 

[0007]

Fooled By Randomness

I won't post on permutations and combinations further unless requested since it would be considered boring plus there are better mathematical sites where you can learn how to do these maths.

Not at all boring! Yes, there are sites & other sources but based on the quality of your previous postings I think you have something to offer to those willing to listen.

 

[D70]

Eagerly awaiting next installment [thumbsup]

 

[goldmember1]

Introduction to drawdown statistics and maths

I have written this post out of request, and it was one of my most enlightening moments in trading. It will consist of several parts since it is a lengthy topic. If you ask retail traders what statistics they use, the extent of statistics are percentages – pretty much the same level of mathematics as nine to ten year olds are taught at elementary school. They continue to use this level of mathematics into their trading and its not really suitable. I was fortunate enough to study maths up to high school advanced level, although I do not consider myself a patch on anyone who has done a college degree in maths. If you vaguely remember the maths, then you will know that when maths teacher said that maths was useful in every day life she was lying, but it is useful in trading.

Statistics are useful because they can tell you how likely results are due purely to chance. They can also tell you the expectation of drawdowns and losses per 1000 trades or per timeframe. You can then fit a strategy or audit your strategy to ensure that you do not succumb to a margin call. In fact, in 2011 there was a movie released called Margin Call. The premise of that was the risk manager and mathematical whizz kid worked out that the risk/drawdown that the company was taking was beyond the expectation that the maths showed – ie: they were living beyond borrowed time already! This meant that they had to get rid of their positions before they would blow up! It amazes me that a lot of retail traders have seen the movie, but have no real idea what they were talking about, except that the Spock from the New Star Trek was in it, and that it was ‘pretty cool.’

Using the correct statistics you can take your strategy, or your results and apply the worst possible scenario to it (most losses/biggest drawdown etc). You can find out how many trades it will take for you to encounter a certain drawdown. Given infinite time of course, all systems will fail. Given 1000 years, the most robust systems will fail. Statistics will tell you how many trades you can expect to trade before you drawdown 20%, 40%, 60%, 80% (margin call). For example, the statistics can show you that you require 20 000 trades before you can expect an 80% drawdown. In the movie margin call (2011), the statistics already showed that they were way beyond the number of trades required to get a margin call at their current risk (which is why they dumped positions). You can apply this to your own trading. In reference to the points I made before, people who trade 20% per month, a significantly higher risk of the margin call than a 5% per month trader. The risk is NOT just 4 x as high (this is elementary school maths if you think this) – the risk is much higher, and in another post I will discuss it. Again, if this post makes you yawn or fall asleep, do let me know and I will change topic.

 

[A Dashing Blade]

You can quibble around the edges, and there are a few things I disagree with but all in all this is very good stuff imo.

 

[Shakone]

What do you mean by "people who trade 20% per month"?

 

[Fuzzbuggy]

Goldenmember, this is great stuff thank you very much. I'm almost done reading Nassim Taleb's "Black Swan" and he discusses the concept of how doubling your % return is not correlated as simply as doubling your risk, but much larger. Please continue on your risk management discussion thank you.

 

[cablemonster]

Goldenmember, this is great stuff thank you very much. I'm almost done reading Nassim Taleb's "Black Swan" and he discusses the concept of how doubling your % return is not correlated as simply as doubling your risk, but much larger. Please continue on your risk management discussion thank you.

dont be shilly

 

[rathcoole_exile]

It amazes me that a lot of retail traders have seen the movie, but have no real idea what they were talking about

you seem to know an awful lot of retail traders, and seem to have their authority to speak on their behalf ?
personally I know only one other guy, up the road in Bangkok, who trades, but I would never presume to speak on his behalf.
Kudos to you for being so well-connected and representational.

 

[browser]

Very good so far, but have you consistently traded real for 3 full years in and profited every quarter at least. In my view that person is a consistent trader and deserves to show his strategy. Everything you mention so far though is very good grounding for the beginner and helps to remind experienced traders of some of the fundamental keys to successful trading. But there is only one winning formula. Know when to exit a trade.

 

[goldmember1]

you seem to know an awful lot of retail traders, and seem to have their authority to speak on their behalf ?
personally I know only one other guy, up the road in Bangkok, who trades, but I would never presume to speak on his behalf.
Kudos to you for being so well-connected and representational.

I mainly have contacted English speaking retail traders in the UK, USA, Canada and Australia, with a few English speaking Europeans over the years. The majority of those have seen Trading Places, Margin Call, Boiler room. I am sorry if I misled you to believe that I had spoken more than you had though.

Very good so far, but have you consistently traded real for 3 full years in and profited every quarter at least. In my view that person is a consistent trader and deserves to show his strategy. Everything you mention so far though is very good grounding for the beginner and helps to remind experienced traders of some of the fundamental keys to successful trading. But there is only one winning formula. Know when to exit a trade.

Thanks for the encouragement! I can only show the 18 months that I have forex traded profitably, before that I traded/and still do - individual shares but there is no way to prove that it was profitable to others apart from showing statements (which can be easily faked or doctored so there is no point).

Part 2 of drawdown statistics – a brief look at permutations

There are many ways to work out drawdown statistics and I shall just list a few of them, as well as what NOT to do. The most common error that I have seen (I have to clarify that I do not mean everyone does this as some people assume I mean when I mention examples) is where people trade for a month to 3 months, assume that drawdown is the maximal drawdown and adjust expect to continue. One example of taking this to an extreme is where a trader I spoke to was trialing a system which had live tested for 2 months. He then increased his lot size based on those 2 months to maximise his gains assuming the biggest loss in those 2 months would be the biggest loss he would ever had. That did not turn out well as you would imagine.

Myfxbook has a statistic called ‘risk of ruin’ which is based on your win rate but it is flawed since it assumes that all your losers will come in a row. This is actually uncommon. lets go back to the coin flippers working for the investment bank as an example. They each are given $5 million accounts, and bet 20% or $1 million on each coin flip since that is the minimum bet. Guess wrong and they lose $1 million. Guess correctly, and they gain $1 million. To simplify things they always bet 20% so they are always 5 flips away from blowing up (management requires high standards). Given that each coin flipping event is independent and fair, the chances of losing is 50% or 0.5. Losing 5 flips in a row would cause the coin flippers personal account to be blown and he would be sent home in shame, never to work in banks again. The risk of ruin as soon as they sit at their desks as given by myfxbooks stat would be given as 0.5 x 0.5 x 0.5 x 0.5 x 0.5. This is 0.03125 or around 3% who lose 5 flips in a row and get sent home. This is the risk of ruin as given by myfxbook. You could extrapolate this to say to say that it would take 32 coin flips for a coin flipper to be sent home in disgrace. That’s not too likely you might think…

HOWEVER this is not the whole picture. As well as being sent home for guessing 5 coin flips in a row (LLLLL where L is a losing flip), the coin flipper can lose in many different sequences of events. For example he may get the following sequence LLWLLLL and be sent home after 7 coin flips. The probability of this occurring is 0.5 x 0.5 x 0.5 x 0.5 x 0.5 0.5 x 0.5 or about 0.8%. However, he can also lose by LLLWLLL (another 0.8%) or LLLLWLL (add another 0.8% chance of being sent home). All the different sequences of how the coin flips may end up need to be added up to see his chance of failure. Just with those 3 losing permutations above, the chances of ruin increase from 3% to 5.5%, and the expectancy of flips they will last fall from 32 to 18. Working out the different sequences and permutations where the coin flipper can blow his account actually tells you that the chance of blowing the account is significantly higher than you might think.

Learning this maths is quite time consuming – I recall it was an entire module of my maths exam a long time ago (approx 8 weeks of 4 hours lessons a week), so its not something you can just pick up by reading a blog post, but I hope you get the general idea. A website link is included here for anyone who wants to read more: Combinations and Permutations. But if you really wanted to learn then getting a cheap maths book and working through the examples is the easiest way. You will also benefit from a scientific calculator – although you can find online scientific calculators easily enough.

 

[meanreversion]

This is actually uncommon. lets go back to the coin flippers working for the investment bank as an example. They each are given $5 million accounts, and bet 20% or $1 million on each coin flip since that is the minimum bet. Guess wrong and they lose $1 million. Guess correctly, and they gain $1 million.

Hi Goldmember, interesting thread. However, your impression of what bank traders do is off the mark. Most of the P/L is generated from earning bid/ask, handling client flow and orders, structuring products and so on. The days of banks paying punters to sit there and toss coins are long gone, and even when they had active prop desks, it only ever formed a small part of total P/L.

 

[Shakone]

Hi Goldmember, interesting thread. However, your impression of what bank traders do is off the mark. Most of the P/L is generated from earning bid/ask, handling client flow and orders, structuring products and so on. The days of banks paying punters to sit there and toss coins are long gone, and even when they had active prop desks, it only ever formed a small part of total P/L.

Mostly agree, but market making is a form of prop trading, and we only have to look at the London whale to see that there are still guys taking on massive directional risk. A $6 billion loss seems like quite a hefty chunk of total P/L, and his book was apparently $157 billion, and that's just one guy.

 

[goldmember1]

Hi Goldmember, interesting thread. However, your impression of what bank traders do is off the mark. Most of the P/L is generated from earning bid/ask, handling client flow and orders, structuring products and so on. The days of banks paying punters to sit there and toss coins are long gone, and even when they had active prop desks, it only ever formed a small part of total P/L.

Excellent post and totally agree. I wrote investment bankers for effect as opposed to hedge funds since people who I have spoken to are fixated on investment banks so I have written the example in that manner. I am well aware of the Volcker rule and the effect it has had on the banking industry and will be coming back to that in the future hopefully as a bigger topic. But thanks very much for your informative and accurate point.

Part 3: Probability and drawdown

Let us imagine for now that you have gone back to your math textbooks and you now know how to work out the chances of failure of a system (note there are weaknesses to this using just permutations that I will come onto in another post). The next topic is about applying probability and risk to drawdown. Again, we are looking at the coin flipper in particular and of course, we do not think that he has a very high survival rate. What if he cut down his risk? Instead of risking 20% on each coin flip, he had a bigger equity size and decided just to risk 10%. He goes and talks to his manager and they agree. We can then work out the risk compared to his coin flipper neighbour who has also been given a raise (investment bankers (or read hedge fund if you prefer) are fair to their employees). They both pitch their trading plan to the big boss: one plan has 10% risk, with the other coin flipper is still risking 20%

Lets simplify and say that we discount the different combinations and say that only 5 in a row losers will blow an account. The 20% coin flipper has 1/32 per flip chance of blowing up, whereas the 10% coin flipper has 1/1024 chance of blowing up. All things considered, the lifespan of the 20% flipper is 32 flips, whereas the lifespan of the 10% flipper is 1024 flips (ignoring combinations which would reduce both flippers lifespans).

The 20% flipper starts with $10 million and ends up with a potential of $3 418 000 000 if he wins every flip at his 32nd flip where he is past his time to blow up.

The 10% flipper starts with $10 million and ends up with a potential of $24,328,178,969,536,839,355,491,975,986,536,468,220,739,584, 000, 000 after 1024 flips. Of course at 32 flips, the 10% flipper only has a potential of $211 million and feels a fool compared to the 20% flipper, but in the end has the potential of a far superior plan.

Applying this to trading directly - I realise few people trade 20% risk, but there are plenty of people who trade 2% risk as opposed to 1% risk. The calculations would be very similar in how much would be made overall, and the lifespan of the trading account. I was messaged by someone recently who asked if I provided trading signals (I do not) and I mentioned that signals were a bad idea because money management was a large part of trading, and that signal followers would multiply up their risk without understanding the consequences - the underlying assumption is that if you double risk you just double the drawdown but the consequences are far more far reaching as I have posted.

 

[D70]

Excellent .................

................ posted.

Why is your myfxbook track record not verified?

 

[goldmember1]

Why is your myfxbook track record not verified?

It had not been verified since my broker moved my account from server 1 to server 2 at the start of the year. I'll be putting up another real money account that I trade as well as this one in a couple of months (end of August) once that has 12 months history on it.

 

[Shakone]

Excellent post and totally agree. I wrote investment bankers for effect as opposed to hedge funds since people who I have spoken to are fixated on investment banks so I have written the example in that manner. I am well aware of the Volcker rule and the effect it has had on the banking industry and will be coming back to that in the future hopefully as a bigger topic. But thanks very much for your informative and accurate point.

Part 3: Probability and drawdown

Let us imagine for now that you have gone back to your math textbooks and you now know how to work out the chances of failure of a system (note there are weaknesses to this using just permutations that I will come onto in another post). The next topic is about applying probability and risk to drawdown. Again, we are looking at the coin flipper in particular and of course, we do not think that he has a very high survival rate. What if he cut down his risk? Instead of risking 20% on each coin flip, he had a bigger equity size and decided just to risk 10%. He goes and talks to his manager and they agree. We can then work out the risk compared to his coin flipper neighbour who has also been given a raise (investment bankers (or read hedge fund if you prefer) are fair to their employees). However, this coin flipper is still risking 20%.

Lets simplify and say that we discount the different combinations and say that only 5 in a row losers will blow an account. The 20% coin flipper has 1/32 per flip chance of blowing up, whereas the 10% coin flipper has 1/1024 chance of blowing up. All things considered, the lifespan of the 20% flipper is 32 flips, whereas the lifespan of the 10% flipper is 1024 flips (ignoring combinations which would reduce both flippers lifespans).

The 20% flipper starts with $10 million and ends up with $3 418 000 000 at his 32nd flip where he is past his time to blow up.

The 10% flipper starts with $10 million and ends up with $24,328,178,969,536,839,355,491,975,986,536,468,220,739,584, 000, 000 after 1024 flips. Of course at 32 flips, the 10% flipper only has $211 million and feels a fool compared to the 20% flipper, but in the end has a far superior account.

Applying this to trading directly - I realise few people trade 20% risk, but there are plenty of people who trade 2% risk as opposed to 1% risk. The calculations would be very similar in how much would be made overall, and the lifespan of the trading account. I was messaged by someone recently who asked if I provided trading signals (I do not) and I mentioned that signals were a bad idea because money management was a large part of trading, and that signal followers would multiply up their risk without understanding the consequences - the underlying assumption is that if you double risk you just double the drawdown but the consequences are far more far reaching as I have posted.

EDIT: Ok so you're compounding when positive, but not reducing when losing.

Without trading metrics you can't decide what is the optimum to risk, and without an actual person with his own utility, you can't decide how much risk the trader can handle. So what is the point of the example? Yes risking 1% will keep you in the game longer than 2% all things being equal. So would risking 0.25% or risking 0%

What are you trying to say, as I've obviously missed the point of your post?