Learning From Traders That Made It (Part 7)

03/25/2008 12:00 am EST


Timothy Morge

President, MarketGeometry.com

I specifically make all my students keep trade plans and capture before and after images of each of their trades because it makes it much easier to do post trade analysis of losing and profitable trades. But more important, it makes traders plan out their trade from beginning to end, before entering the trade, and in so doing, it makes them analyze each step of the trade. This tends to eliminate anticipating trades. Once Andy began religiously filling out his trade plan, he seldom anticipated trades-instead, he let the trade entry come to the area he had diagrammed in his trade entry plan.

Was it easy for Andy to stop anticipating trades? No, it isn't easy for any floor trader to break this habit and it wasn't easy for Andy to break it, either. But I tried a curious method with Andy and his trading partner: they would call me and ask me about a trade entry they were eyeing. I would pull up the chart they were looking at and to my eyes, I could see that they 'almost' had a trade set up, but not all of the requirements for the high probability trade setup had been met. Then I would explain what parts of the setups were missing and what they'd need to see to make this setup meet the classic criteria for that specific setup.

I generally find that when floor traders 'cheat' on their entries by being extra aggressive, they get 'hit by the train,' meaning price runs through their entry order and immediately fills their stop loss order [thankfully, Andy religiously used stop loss orders from day one]. After four or five days of getting phone calls from Andy and then looking over his aggressive entry ideas, I began watching the potential trades unfold and I would invariably see that when Andy was using aggressive trade entries, he got 'hit by the train' many more times than he made money. So I called him and explained why I did not like these types of aggressive entries and also explained why they led to being 'hit by the train' and what that term meant.

Another week went by and after about the fourth time Andy called about an aggressive trade entry, I simply made a 'choo-choo' sound into the phone and hung up. Then I monitored the trade from my screen. Once it looked like Andy had been stopped out, I called him back and asked if he had taken the trade. The answer came back, 'yes, I took the aggressive entry.' I asked if he had gotten stopped out, already knowing he had been stopped out. The answer came back, 'yes, I got hit by the train'.

But after about a week of him calling to show me aggressive trade entries he was going to make and me making a "choo-choo' sound and hanging up-and then making him admit over the phone he had taken the aggressive entry and had been hit by the train-the calls stopped coming. And the aggressive trade entries began to disappear from Andy's trading. Soon we invited Andy to be a trader in the proprietary trading room. To this day in the proprietary trading room, when we talk about trades and one of us recognizes it's an aggressive entry, not a classic entry, we simply make the train sound and wait for the setup to either fulfill all of the requirements or we pass on the trade. It's interesting how a few losses preceded by the sound of a train whistle cured Andy's aggressive trade entry problem.

Andy became profitable on a month-by-month basis very quickly. He studied the materials hard and I think the only problem he had came when I brought in a person to help me research multi-dimensional Action Reaction Lines, or 'Diamonds', as we began to call them. Andy and the rest of the proprietary trading room watched as we researched and developed this new methodology. And despite my warnings to the traders in the room that we were still doing the gritty research on these new trading tools, I began to notice bits and pieces of these new techniques bleed into Andy's trading. This led to further improvising in Andy's trading methodology. And the improvising began to degrade Andy's profitability and win/loss ratio.

When I asked Andy why he was using these 'new entry methods,' he told me he and his trading partner had noticed that a particular entry 'worked really well'. Andy told me the last ten had all been winners. I asked for statistics on a minimum of one hundred trades. He admitted he didn't have them. I asked him for trade entry sheets and before and after images on the ten trades he had mentioned. He admitted again that he didn't have them. They were doing so well, they weren't bothering to keep trading sheets all the time now, especially on the new entry methods they were using.

I went home and thought about it. Then I came in the next morning and explained exactly what was going on: humans are visual in nature. They see patterns, and often the patterns are not there. Humans also tend to have selective memory: we remember what we want to remember, so if we are 'watching' a trade entry technique we like, we tend to remember the winners and tend to forget about the entries that would have been losers; that's why doing statistical analysis on a larger number of trades is so very important.

I pulled out a quarter and asked Andy what the odds were of me flipping heads. He answered fifty percent. I asked him the odds of me flipping tails. Fifty percent, he answered. Then I asked him if he would like to bet all the money in his pocket against all the money in my pocket that I could toss ten heads in a row within an hour. He gave me a grin and said, 'you ain't gonna flip ten heads in a row.' 'We have a bet then', I asked? 'Sure', he laughed.

About ten minutes into flipping the quarter, I was up to eight heads in a row and Andy's face was turning a nice shade of pale white. I asked him if he wanted me to keep flipping or did he want to forget the bet and talk about what was happening. We agreed to talk instead of bet. Even when watching something as simple as flipping a coin, you may see ten favorable outcomes-winning trades-in a row; this is called a positive run. If you flip a coin long enough, you'll see lots of long positive and negative runs, because the coin doesn't have a memory-it doesn't know, care or remember that it just came up heads. Similarly, if we want to really know if a trade entry works, we have to do serious long-term record keeping of actual observed trade entries and their outcomes. A hundred trade entries was a small start, a thousand or more trade entries and outcomes start to show the real truth about that particular entry method. As traders, we have to take out the selective memory and pattern illusions; only doing statistics on a lot of trade entries and exits can do that. Before you start using a new trade entry technique or a new trading tool, you have to put in the work to verify that what you think you see really is what is happening over a large number of trades.

I told Andy that if he continued down this road of improvising, he'd eventually turn right back into the trader he was when he walked off the floor. I could see the bad memories of Andy's last few years on the floor reflected in his eyes.

He told me he was going to take a week off and study all the materials from the Market Maps Seminar, as well as my book and all his trades and notes. And then he was going to come back in and start in again on the right path.

When he came in a week later, Andy was much more thoughtful about each and every trade. He was much more vocal when the group was discussing potential trade entry setups. He soon became the voice of reason in the room, the trader that was the first to point out when a trade looked like a tried and true set up but was missing a crucial part of the set up. Andy had finally let go of his floor trading habits and became a systematic discretionary trader-which means he looks for certain trade setups he knows he can trade, he fills out a trade sheet on these setups as they occur and then he executes the trade.

Does he have losing trades? Of course he does-we all do! But he knows in advance what his winning and losing percentage should be and what his risk reward ratio should be. And if his monthly numbers vary much from his expectations, he goes over his trades for that month with a fine-toothed comb to pinpoint what went wrong. Sometimes he can fix it himself and sometimes, he sits down with me and we tune up his trading. Andy has made it as a 'off floor' trader.

More on part 8 Tomorrow Part 1  |  Part 2  |  Part 3  |  Part 4  |  Part 5  |  Part 6


Timothy Morge


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