8/16/2009

Whose Game are You Playing?

After a few years of trading I have come to the realization that the key to winning is all in my head. This is a psychological battle with myself. The market participants are irrelevant. There is no giant war against the big banks or hedge funds or you my fellow independents. The game (war sounds so nasty) is me against me. Or as I once penned Bad Solfest against Good Solfest.

I have an edge and the key to success is to only trade within that edge. Good Solfest follows that plan, Bad Solfest wants to make up new rules every time he has a losing trade. Bad Solfest tries to play everyone’s game, Good Solfest only wants to play his game.

Let me put this another way, wander over to your bookshelf and pick up your well thumbed copy of Trading in the Zone, by Mark Douglas. Douglas has a great analogy on page 102 about casinos. He states a casino has a 4.5% edge over all the players in the game of blackjack. A small edge. The casino is very confident in their edge, they don't question it, they don't get concerned if they lose money to some players. They know they have an edge and if the game is played by their rules they will win in the long run. How do they know this? They have stats, millions and millions of games played.

They know.

If someone comes into their house and tries to change the rules (they call it cheating) they take them into a room with no windows and break their kneecaps. That's how we know if we want to play we have to play by their rules. We also know that if we play enough we will lose and they will win. Why people play a game with that reality is beyond me. Or is it the same reason people keep trading even though they are losing money every month?

The successful trader has to be "the house". The game has to be yours not someone else’s. It's your game because you set the rules, your plan is the rule book, and you have set the standards for the game.

There are two issues that must be done right in order for your "casino" to be profitable, your plan must have an edge and you must never deviate from the plan.

How do you know what your edge is? Stats, stats, and more stats. It's all you have; it's the only way to know. Do you have them? If you don't have the stats to back up your plan and you are trading live you are a dead man. You are not the casino, you are the drunk tourist from Hoboken, and let me repeat, you are a dead man.

Get the simulator out of the closet and get yourself a database of trades that means something. If the edge is not there with the current plan you have some work to do.

Now let's assume the stats are there, the edge is solid, now all you have to do is execute. Why is that so hard? Recency bias? We humans are stupid? No, no that's a little harsh, we're just emotional, and the emotions that come roaring out when we are dealing with money are ego, fear, and greed.

How do we combat these emotions? How do we act like the casino with the small edge? We keep our stats and we measure our success based on something other than money.

We know what we have to do, so let's measure our success on how well we do it. It’s our game and we keep the score. The game is not scored by profit or loss but by how many plan certified trades you take. You lose points by missing qualified trades and by taking muts (made up trades).

You can figure out the scoreboard any way you want along those lines. Make adherence to the plan the only thing that matters.

You are the house, the casino, so when you let the other players into your establishment make sure you only play against them by your rules.

If you cheat (don't play by your own rules) I will come to your house, take you into a windowless room and break your kneecaps.

Trading in the Zone: Master the Market with Confidence, Discipline and a Winning Attitude

8 comments:

FX said...

Great post solfest

Solfest said...

Thanks, and thank you Mark Douglas.

Solfest said...

That was a get out of bed and write it down post, it was a little late when I finished so I'm still looking for mistakes.

I should have added that the casinos spend millions of dollars on security as they have to watch thousands of people at the same time in order to make sure no one is breaking their rules.

We only have to watch one person, our self, to make sure we are not cheating.

We should be able to do that.

longandwrong said...

You wrote...

If you don't have the stats to back up your plan and you are trading live you are a dead man

Sometimes I feel like the only boring b*****d who believes in this, you have made me feel slightly less of a weirdo... that marriage might be back on!

Solfest said...

I wonder what percentage of traders don't keep stats.

There is another book called The Excellent Investment Advisor, by Nick Murray that is the best how to be a broker manual I have ever read. A broker is, of course, a salesman so Murray's advice works for any kind of sales.

His premise was the only way for a new broker to get any business is to make cold calls, or slightly warm calls. Most give up on this as we can't take the constant rejection. The way to survive it he says is to keep stats. How many calls do have to make before you get an appointment, how many appointments before you get the sale.

His method was to give the broker a database that he/she could count on in the face of all the rejections they were getting.

Humans don't like to be wrong, losing trades seem wrong to us, getting told to screw off over and over seems wrong to us.

Only by hanging, clinging, clawing, scratching to our database can we muster the fortitude to go on.

The broker’s stats say for every 50 calls he gets one appointment. So the only way to get there is to keeping picking up that phone.

Your stats, the database, is the reason you continue in spite of all your human emotions telling you to quit, or to take some revenge trade.

We must quantify how much pain we have to stand before something good happens, other wise we lose heart and quit.

Statistics. Boring, yes, mandatory, yes.

longandwrong said...

At a very basic level... I have a statistically significant number of trades that have a statistically significant positive expectancy.

I know the historical win-rate for those trades (x %) so expect that (100-x %) will lose. No problem. No stress.

daytrader233 said...

Solfest,
What should be included in a trading plan? It's a broad question. Not looking for specifics. Thanks.

Solfest said...

L&W I think that is how it is supposed to be done. The rest of the day should be devoted to gardening. :)

DT I don't know what should be in a trading plan but I do know what is in mine. I have a business plan and within that business plan there is my trading plan.

I got most if not all of these heading from Van Tharp's book.

Here is my table of contents:

1) Why I Trade

2) Executive Summary

a) Mission Statement
b) History
c) Behavioral Finance
d) Trading Psychology
e) Probabilities
f) Personality Profile

3) Business Description

a) Operational Overview
b) Products & Services
c) Operations
d) Organization, Management, & Employees

4) Industry Overview

a) Futures Markets

5) Financial Information

a) Financial Statements
b) Financial Spreadsheets

6) Trading

a) Strategic Concepts & Beliefs
b) Technical Indicators
c) Risk Management
d) Money Management
e) Strategic Alliances
f) Skill Maintenance, Coaching, & Continuing Education

7) Trading Implementation

a) Securities Description
b) Expectancy
c) Mistakes
d) Support & Resistance
e) Trade Plan

8) Conclusion