Super Bowl Thoughts
My prediction: Pittsburgh by 7...my heart disagrees however. I didn't write this to discuss football though. I read something really amazing today. I'm currently reading "Fooled By Randomness" by Nassim Taleb, and he brought up an excellent point. It can be shown in psychology that 1 negative event is equivalent in magnitude to 2 and a half good events. So you could be equally as upset over losing one dollar as you could be happy over making 2.50. There are some interesting implications for this. Since we're on the subject of football, they say you have a winning season if you win more games than you lose, but according to this argument you can only have a winning season mentally if you win more than 2.5 times your number of losses. A quick check with some algebra we see that if X is the number of loses and Y is the number of wins, X+Y=16 and 2.5*X < Y, then substitute in and find that you have to win at least 12 games to consider your season a win mentally.
This can be easily translated into trading. Let's say we decide whether to go long or short based of the flip of a coin. Now probability will tell us that as time wore on half of our trades would be profitable and the other half not. (It is probably the best choice to honestly tell yourself as a trader that you might only get half of your trades right.) Also, in order to prevent complete destruction we decide to take a loss if the position moves against us, lets say 10 ticks. This is not an abnormal distance at all. If we place our fill orders 11 ticks from our price that means that we'll be making money in the long term as we average .5*11-.5*10=.5 ticks of profit. Unfortunately if our failures become 2.5 times more detrimental then we have to change the equation to .5*11-.5*2.5*10=-7. Obviously we are taking big mental losses.
I think of trading as a career choice. Anyone that says, "You're career should make you very unhappy" should trade as described above, or worse if you take no stop loss, you must let your winners run indefinitely as well and unless you have an infinite amount of money the fat tails will with 100% efficiency blow you up in time. Thus I have a new rule...A sanity rule.
You MUST, for the sake of your own sanity, place your orders 2 and half times the distance from your maximum loss. If you place your stop loss as described above at 10 ticks from your average price, then be prepared to exit your winners after more than 25 ticks.
One other interesting point to bring up. Taleb speaks of Monte Carlo simulation which is simply a way of showing all possible histories given a certain probability set. If you take all the bear traders, and bull traders and contrarions and mo-mos in a simulator, every single one of them will in time will blow up. The only trader that does not blow up is the buyer of options. By limiting your downside and leaving your upside unlimited, in time the buyer of options will be just fine. In order to be a successfull trader one must then mimic the buyer of options. In the world of futures that can be done simply with the click of a button. By placing a stop loss, we are synthetically buying options on whatever futures contract you are trading. Which brings me to one more rule.
Always...Always...place a stop loss, mental or not, and adhere to it. If you do not you are no better than the gambler with dice. It is the most simple of ideas but the most complex psychologically. If you are disciplined enought to follow this rule and the one above. In time, you will make money. Some might argue that stop losses can be picked off by the market...luckily we are now in a world of electronic trading and the rules have changed. No one sees your stop loss but you, and every trader has the same access as the next. To say that stop losses are bad is taking a pit rule and moving it to the electronic forum. Remember, it's a matter of probability, you WILL make money.
Sounds like certainty in an uncertain world if you ask me...Not too shabby
This can be easily translated into trading. Let's say we decide whether to go long or short based of the flip of a coin. Now probability will tell us that as time wore on half of our trades would be profitable and the other half not. (It is probably the best choice to honestly tell yourself as a trader that you might only get half of your trades right.) Also, in order to prevent complete destruction we decide to take a loss if the position moves against us, lets say 10 ticks. This is not an abnormal distance at all. If we place our fill orders 11 ticks from our price that means that we'll be making money in the long term as we average .5*11-.5*10=.5 ticks of profit. Unfortunately if our failures become 2.5 times more detrimental then we have to change the equation to .5*11-.5*2.5*10=-7. Obviously we are taking big mental losses.
I think of trading as a career choice. Anyone that says, "You're career should make you very unhappy" should trade as described above, or worse if you take no stop loss, you must let your winners run indefinitely as well and unless you have an infinite amount of money the fat tails will with 100% efficiency blow you up in time. Thus I have a new rule...A sanity rule.
You MUST, for the sake of your own sanity, place your orders 2 and half times the distance from your maximum loss. If you place your stop loss as described above at 10 ticks from your average price, then be prepared to exit your winners after more than 25 ticks.
One other interesting point to bring up. Taleb speaks of Monte Carlo simulation which is simply a way of showing all possible histories given a certain probability set. If you take all the bear traders, and bull traders and contrarions and mo-mos in a simulator, every single one of them will in time will blow up. The only trader that does not blow up is the buyer of options. By limiting your downside and leaving your upside unlimited, in time the buyer of options will be just fine. In order to be a successfull trader one must then mimic the buyer of options. In the world of futures that can be done simply with the click of a button. By placing a stop loss, we are synthetically buying options on whatever futures contract you are trading. Which brings me to one more rule.
Always...Always...place a stop loss, mental or not, and adhere to it. If you do not you are no better than the gambler with dice. It is the most simple of ideas but the most complex psychologically. If you are disciplined enought to follow this rule and the one above. In time, you will make money. Some might argue that stop losses can be picked off by the market...luckily we are now in a world of electronic trading and the rules have changed. No one sees your stop loss but you, and every trader has the same access as the next. To say that stop losses are bad is taking a pit rule and moving it to the electronic forum. Remember, it's a matter of probability, you WILL make money.
Sounds like certainty in an uncertain world if you ask me...Not too shabby
posted by Shiptastic at 1:09 PM
2 Comments:
Ouch man... My head hurts now. This really makes winning difficult.
It never was easy I suppose
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