Stats, Poker, Cars & Ammo

One of the philosophies that began to change my trading results was introduced to me by one of my mentors. This philosophy made perfect sense to me and like everything else I do, it was based on . . . you guessed it . . . back testing. The crux of the philosophy is simply not to rely on hunches, or feelings or even just plain old experience as to where to place stops and profit targets, position sizing, etc. It was based on the use of empirical data, or statistics. The statistics are based on the back testing results for what I have determined to be a valid set up.

I looked at every signal, determined the most profitable trades, observed how the indicators behaved during those trades, calculated averages of stops, profit targets, winners, losers, etc., etc., This is how I developed my trading plan and subsequent rules to build a case for entering the market. I don’t like to guess when I have money on the line and I like the odds to be in my favor.

Many traders use the standard 10 pips above swings for stops and are all over the map for profit targets. You may notice over time that “head fakes” up or down usually target these areas to take out these stops. I don’t know if there are such things as stop hunters, I just know it happens quite frequently. I got tired of being stopped out only to have the market roll back over in the direction of my trade and as I sat frozen, not knowing if I should re-enter, when to re-enter, where to re-enter or how to control my emotions. I just got used to another loss and swore I’d never do it again. (And of course I did it again – over and over!)

The other big problem I had in my early trading experience was that I got so nervous and excited when I was actually in profit. I always closed a trade way too early, only to watch the market move another 100-300 pips in the direction of my trade. I froze again . . . do I re-enter and chase the trade? What are my exit rules if I do? Where are my stops if I do? I also had to figure out where to place my profit targets consistently so that I could relieve myself of the anxiety of staring at my computer for hours on end watching each tick that may go against my position.

The result of this behavior and these actions was that I became programmed to expect a loss.

It’s just like the Las Vegas visitor that budgets $500 for gambling losses before actually gambling. And sure enough, when returning from a trip to Vegas, inevitably the question comes up “Did you gamble? . . .  did you win or lose?” And the answer is almost always the same “I budgeted $500 and when I lost it, I stopped gambling . . but I had fun.” Losing is fun? We will do anything to justify the result and the result always reveals our underlying intent. If you expect to lose, you will. No one in the general public ever really studies gambling statistics. That’s why most people lose and they expect to lose. They know they have not done the work or have the knowledge to prove they really can win or should expect to win. There are very successful gamblers. They analyze stats, apply a rule set, increase their edge and as a result, expect to win.

From 2003 – 2006 I was doing a lot of business in Vegas and poker was getting popular on TV. I liked playing cards in general and poker in particular. I started studying and reading about odds, stats, etc. I played 3 days a week at the Mirage for 8-12 hour stretches. Knowledge, patience, control, confidence and rules. Once these improved, so did my winnings. Every time I sat down, I now expected to win. It changed my entire focus and attitude. Yes I lost some hands, but I made other players pay to beat me. I became a formidable player and this became clear after a few hands when I would sit down to play. I would start with $100 in chips and within one month was winning an average of $600 per session. That was not that much money to risk or to win, but it was the consistency that was my goal. I also knew that for my level of knowledge, to ramp up to the higher limit tables, I could easily be outmatched by players with a higher tolerance for risk, more experience and more knowledge. I knew I had to pay my dues before advancing to that level.

It wasn’t long before I began to apply this mindset from poker toward my approach to the market. The subsequent lessons from my mentor to use statistics began to fill in the gaps. Compiling the data, using the same rules for analysis, applying the same rules to my trade parameters . . . I soon began to develop some consistent profitability. The great transformation was now every time I placed a trade I expected it to be profitable – my back testing stats proved the odds were in my favor.

That is ultimately where your mind must be. It will never be there until you develop the belief in your trading system by proving it will produce a profit over time.

Every time you turn they key in your car, you expect it to start. Why? Because historically it has proven time and time again that it will. When it does not, you are surprised. But, you know with a high degree of confidence that with some regular maintenance, it will continue to start over and over again.

Just like a trading system with a positive expectancy. You expect it to win, but know that occasionally it will not and that perhaps tweaks are required. Again, over time, you know it will produce a profit. Without back testing, it’s like crossing your fingers every time you turn the key, maybe the car will start or maybe it won’t. Most of us could never accept that level of uncertainty, yet traders do it every day multiple times.

If you do not have this backtesting data, this ammunition at your disposal, you are doomed to lose the gunfight. You will always be shooting blanks against traders firing back with nukes – those that follow their plan and rules without deviation  – those that have done the work, paid their dues and rely on the fact that you won’t. My mentor summarized my experiences after I shared with him how much I had lost trading and how much I had spent on crap before I finally got it – he simply said “Welcome to the Machine.”

Rick

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