System Revisited 10/25-10/29

(Apologies for the scarcity of posts this week, my original goal of one per day seems to be much more difficult than I first imagined. In the future, I think I'll shoot for a bit more spontaneity and less artifice than the previous bunch, for the sake of freshness if anything.)

One thing I've noticed about the list of rules that make up my system is that a large number of them start with "Don't"s or "Never"s. Seems like many of the rules I've accumulated over the years were intended to suppress impulsiveness and inspire guilt upon their violation. This is no flaw in itself; as noted in a comment below, the less visible function behind using a system is preventing one from trading when no proven opportunity exists. But having an almost Puritanical impetus behind a system's creation may be counter-productive in the long run -- in fact, it may even backfire if elements of the system attempt to address psychological deficiencies, as opposed to just defining trade entries. If the majority of one's system exists to restrain one's actions and impulses, he may in fact make the issues even worse by trying to avoid them altogether -- a lesson recovering agoraphobiacs can teach us.

Somewhat coincidentally, I've also just picked up Mark Douglas's Trading in the Zone which I would highly recommend to all traders. In developing a trading system, I've primarily treated both strategic and psychological issues empirically, dealing with problems on an symptomatic basis using trial-and-error experimentation. In contrast, Douglas's book goes directly into analyzing our mental attitudes and emotional structures that lurk behind the more apparent obstacles to successful trading, a top-down assessment of how we develop and/or undermine our perceptions of the market over time. It's inspired me to dig deep and not only re-evaluate each of the rules that I've set down for myself, but also to see if I can somehow tie together all those negative reinforcements I've collected like scabs over the years and search for a positive reworking/rewording of their intentions.

Soundtrack

Music can be a useful aid in gauging our emotional balance in real time during the trading day. For most screen-based traders, virtually all information pertinent to the markets arrives visually; sound plays little if any role in our decision-making process. Hence, the ears provide an alternate channel into our psyche distinct from the rational/logical, tapping directly into our "mood centers" which may subtly (or not so subtly -- keyboard smashers of the world unite!) color our perception of market information. Manhattan, Goodfellas, Trainspotting: the great film soundtracks go beyond complementing the action on screen -- they capture the spirit behind the director's motivations and distill the essence of a film to song. Along the same lines, ideally you'd want the "soundtrack" of your trading day to capture and maintain your emotional mindset at its most proficient state: objective, dynamic, equanimous. Any divergence in your mood from this ideal state will create a jarring sensation that will stand out easily against the backdrop of your favorite playlist -- the music acts as a continual acid test of your emotional condition. At any moment you find yourself having difficulty enjoying a song from your all-time favorite band, then it's likely you'll have similar trouble maintaining your objectivity while making trading decisions. Stand up, take a few deep breaths, and give yourself a break from the screen -- don't go back until you're capable of singing along with the chorus of the next track.

Movement 10/18-10/23

Something definitely shifted a bit this week internally, and I'm not sure if I can put it down in words that make any sense as of yet, but here goes. In several posts, I've referred to a system with a capital "S", as if to emphasize the sanctity of that concept in terms of my trading. You might imagine "The System" as a plaque cleverly etched with gold leaf and invisibly framed on the wall above my monitor, the gilded words revealed only under a certain angle of light that would strike for mere seconds each day to unveil its wisdom, ala pulp-Umberto Eco. Well, at least that's the spirit with which I'd originally imagined writing about my system, with oblique reverence and hushed tones to impart some sense of inviolate mystery -- surely for a system to be properly implemented, one needs to have at least a notion of what is "sacred" to be able to follow through. But I think a part of me is struggling to accept and wanting to deflate this notion of system, and re-examine the whole thing under a less divine light. Not even two weeks into this, and I'm already questioning what I've written earlier -- progress or confusion? To be continued . . .

Recipe

Recipe for catching a reversal:

Ingredients: For this recipe you will need one (1) well-known or "classic" technical chart pattern on a daily time frame, preferably near the high or low of the mid-term price range. When your pattern of choice has been observed, you will then need to collect at least two (2) or more instances of public expressions of sentiment which confirm the prognostication of said pattern: pre- or post-market media bytes, business news website headlines, confident/fearful declarations on your favorite trading forum, or any other variety of before-the-fact assumption.

Preparation: When the above ingredients have been secured, wait for a daily close which would confirm "ripeness" of the pattern. Next morning, enter a stop order at the confirmation price in the opposite direction of pattern breakout to initiate position. If stop is triggered, immediately enter protective stop at prior low/high.

Parboiling: If market moves quickly in your favor, take profits on at least a partial portion; mentally "set aside" closed profit for re-entry if market pulls back towards initial entry price with next few days. If pullback manages to hold above prior high/low, re-enter full position at your discretion.

Cooking: Set protective stop for entire position at breakeven and let sit undisturbed for a few days or more if possible.

Presentation: Dish is ready when "failure" point of pattern is breached; serve at market or with trailing stop, whichever you prefer.

Anhedonia

anhedonia n. -- A psychological condition characterized by inability to experience pleasure in normally pleasurable acts.

Throughout my years of trading, I've always suffered the biggest hits to my account after a series of winning trades -- the bigger the win streak, the larger the subsequent drawdown that would inevitably strike. Of course, the explanation goes beyond a statistical return to the norm. When we're hot, some of us are prone to nurturing the idea that such gains will be routine for the remainder of our trading days; operating under such a mindset, it takes a surprisingly meager number of round trips for the market remind us of the absurdity of such a notion.

So this lesson I took to heart, to such a point that I think I've severed any connection between successful trading and the pleasure center in my brain. I've never been one to boast of any accomplishment, least of all in this line of work, but my attitude towards success in the markets borders on paranoia. I've come to accept and learn from the mistakes I make, but have difficulty in allowing my achievements to provide anything more than brief affirmation. My progress as a trader seems almost entirely driven by negative reinforcement; if only the pains and frustrations were equally quarantined from my cortex, this trade-off might be deemed fair enough, if somewhat piteous. But this relationship cannot endure, for what ultimate purpose lies in an occupation whose very fruits cannot be relished, much less the process by which they are harvested? I've only begun to rethink my relationship with system, success, and progress, and have nothing yet concrete beyond an awareness that a change must be made.

Mirage

Profits resulting from the violation of one's own system or methodology constitute the most treacherous mirage of success. We've all been tempted at one time or another to suspend our collection of pre-defined rules (so painstakingly accumulated, yet so easily put aside) for the possibility that for this one particular moment, distinguished from all others, things might be different. And perhaps we were right -- this time -- and the register rung. Yet for those of us who have chosen the way of the System, the momentary suspension of discipline is a transgression beyond profit or loss. For no matter the what the outcome of the trade executed, the damage has already been done -- any gains secured in such a manner will only serve as future tuition until that particular lesson is learned. This must be understood before forward progress can occur, for unless process takes precedence over result, the cycle repeats ad infinitum.

Sip of Lethe

In Greek mythology, the River Lethe was one of five rivers which ran through Hades, the Underworld. The dead who drank from this particular river instantly forgot their former lives on the surface and would cease to mourn their past.

Now imagine having a flask of this stuff at your side during market hours -- very handy indeed! Instant objectivity in a bottle, always at arms length when needed. Did a particularly opinionated Fed official drop the 10-yr half a handle at lunch hour with some overly explicit syllogism, leaving your stop-limit twisting in the wind? A perfect moment to spike your Big Gulp with a jigger of Lethe once you've exited at market. Those jokers at the Nymex shake you out by a tick before ramming the price up to record highs? A few drops of undiluted L. on the tongue and voila! You were never long. Better yet, you don't have a clue what CL stands for.

Adjust dosage as necessary.

Weekly Review 10/11-10/15

Like the prior week, the System identified very few entry possibilities, and of those virtually all resulted in scratches. The perception of an extended lack of opportunities can make us stretch for results, and falling prey to this impatience is an open invitation to disaster -- this week being a perfect example. As with any System which remains a work in progress, experiencing a dry spell of unprecendented length can slowly eat away at one's belief in the System's ultimate merit; by Friday I had already exectued several trades outside its parameters, and came into that morning with overnight baggage. Having stops secured at breakeven on each of them, I felt confident that I would be able to manage my holdings and still objectively focus on the any forthcoming System signals.

Not! By the end of the day, in addition to missing 2 exceptional setups which would have more than made up for the meager harvest of the last few weeks, I managed to press onto my prior night's holdings out of frustration, which conveniently allowed me to cancel my preset stops for "recalculation". . . need I continue? Let's just say I notched a new high on the vomit bucket for a single day's retchings. Those open profits I carried into the morning not only gave me a false sense of security, the positions behind them provided that fraction-of-a-second hesitation en route to a "statistical catastrophe" (Slansky again), and left me flailing. All in all, a pathetic way to end the week.

Tuition

For the trader still early along the learning curve, coping with the concept of market tuition can be frustrating to say the least. In essence, a pupil of speculation is forced to pay, quite begrudgingly and usually when least expected, an instructor in absentia for lessons as yet to be revealed. He may make a series of down payments without ever realizing what exactly he is to be taught, nor have any inkling of the remaining balance owed, for the final cost of tutelage is not determined until the course itself has been passed.

How do we minimize the cost of tuition for so amorphous a lesson? A way to begin is to distinguish those losses which may provide some insight to ourselves from those that are just part and parcel to any trading plan. Was the trade itself an expression of our methodology, or done on impulse? Did the loss occur at a point in time and/or price that specifically invalidated the reason for the trade? Was the magnitude of the loss predetermined before the trade was executed, or the result of some arbitrary threshold of pain? Is there a pattern emerging from past trades that we can identify? The list goes on.

The bottom line is not to let our losses go to waste; vivisect them while they're still fresh in the spinal cord, look into the impetus behind the trades and try to glean the nature of their source, whether technical/external or psychological/internal. We need not dwell on our mistakes excessively, but to relegate them to bad luck or sweep them under the rug of "revenge" profits is to squander a pre-paid opportunity for progress. Maximize the value of your tuition, or end up maximizing the total cost of education.

Objectivity and The Fundamental Theorem of Poker

From David Sklansky's The Theory of Poker:

Every time you play a hand differently from the way you would have played it if you could see all your opponents' cards, you lose; and every time you play your hand the same way you would have played it if you could see their cards, they lose.

An analogy in trading can be made concerning objectivity while holding a position:

Every time you execute a trade that you would not have executed had you been flat, you lose; additionally, every time you refrain from executing a trade that you would have executed had you been flat, you lose.

As always there are exceptions; one may argue entries and exits are not entirely symmetrical. But generally, the goal in objectivity is to prevent your current position from interfering with future opportunities. Taken a step further, try to pay extra attention to scenarios that run counter to any inclinations you may have stemming from current holdings -- seek to minimize the time it takes to reverse your mindset from long to short and vice versa if circumstances require.

Reversi

Wild day. Here is an intraday of the euro, bearing much resemblance to the action in bonds as well as crude, which rebounded to close at record highs. Stock indices lost their morning gaps, while copper and other base metals gave the sharp stick in the eye to anyone riding the skyward trend.

Moves of such extremes, by session's end, generally elicit sighs of relief and howls of frustration in equal parts. A day like this teaches us the following: a) to dispense with stops, as faith alone shall suffice in our salvation; and b) not to be such greedy motherfuckers. *wink*

System

The first rule for any trading system: Trade only the system.

This rule would be much easier to follow if one always incurred losses when trading outside the system. Somehow, the gains from these outlier trades always seem to be of an order greater than the gains typically achieved when playing by the book; hence, the tendency to stray. One can only hope for a series of excruciating drawdowns to realign his journey on the proper path.

10/12/04

Hello world.

What follows here will be a day-to-day journal of my trading life from a psychological angle, a record of what passes through my mind at any given moment with respect to the markets and my connection to them.

It will be my attempt to clarify my own thoughts, inclinations, musings, doubts, ambitions, sufferings.

I will strive towards honesty, while veering from tedium. Or was it the other way around? Whichever you prefer, I am nothing if not accommodating.

It's midnight and I'm tired and going to bed.