Do We Really Understand This Probability Game?

I was just reading "Trading In The Zone" by Mark Douglas, and man I came across something that is so good.

Trading In The Zone Excerpt

It is about trading as a probability game, about finding an edge and taking it every time it occurs. Easily said, but do we really understand it? Suppose after intense back-testing a mechanical trader derived Setup A which he knows will result in a positive expectancy if taken over time. It shows up on his favorite stock and he takes it. It ends up as a losing trade. The next week it shows up again, he takes it and again it ends up as a losing trade. At this point the trader gets frustrated and decides that the setup doesn't work, he discards it and continues his search for the next Holy Grail. This trader has failed to understand the probability game. To quote the text above, "He is desperately trying to create certainty where it just doesn't exist".

Another possible outcome is that he is so confident and sure that his trade will work out that he refuses to cut his losses even when his predefined stop loss level has been triggered. Similarly, he has failed to understand the probability game, failed to realize that even a 90% hit rate system has a 10% chance of failure.

I can use my previous posts as examples too. Refer to my recent GBPUSD trade and DOW analysis posts. I was really confident with the setups on both charts but they both ended up as losers (Thankfully I did not make any new US trade). Am I supposed to conclude that my setups don't work and discard them? No! I simply accept that no setup is 100% accurate and remind myself of the fact that if I take them over time, my edge will play out and I'll end up profitable. This is so so important but yet so hard to grasp. Mark Douglas also wrote (not shown above) that it is an inbuilt human trait to want to be right all the time, and that thinking in terms of probabilities is not natural to us, it requires a conscious effort. I mean search yourself, have you really internalized the fact that trading is a probability game? It is definitely not easy, and I for one know that I've not yet attained. I guess we can only be certain that we've understood when we no longer feel a tinge of pain or a shred of doubt when we make losses, even if it is a string of losses in a row.

It is hard to bring justice to the profound wisdom and eye popping revelations in the book, I really suggest that everyone read it as it is one book that will definitely take anyone's trading to the next level. Heck it is not the most popular trading psychology book for nothing...

Great Quote Which Led To Another Long Post :P

I was reading this post by Nial Fuller and I really like a particular quote in it:

“What the mind of man can conceive and believe, it can achieve” –Napoleon Hill

There is biblical truth to that too:

Prov 23:7 - "For as he thinks in his heart, so is he."
Rom 4:17 - ".... calls those things which are not as though they were."

That is really the foundational belief that has been driving me all this while. Great people achieve because they first believe they can achieve. Poor and unhappy people constantly fail because they have a defeated poverty mindset. I think it is so important to constantly remind ourselves tat we can be successful. This is especially even more crucial in trading because of the immense level of negativity that surrounds it. Here are some of my personal experiences:

1. When I tell people I want to be a full time or prop trader, most of the time I get doubtful looks and discouraging words. For non traders, they have heard horror stories of how so many people got burned big in the markets. To them trading = gambling, and the common belief is that one cannot beat the markets unless he has inside info. Mind you these could be close friends or family members whose opinions do bear weight. For people who do trade, they'll tell me that 95% of traders fail, that it is really not easy to consistently make money from trading etc etc. Truth be told, most of them are not beating the markets consistently too, so it is understandable that they feel this way.
2. As traders, failure is something we have to be well acquainted with. I'm referring to losing trades. There is simply no other way. If we cannot accept that losses are a common event in this probability game, it won't be long before we get despondent and throw in the towel. I can't begin to tell you how many times I've felt really down after a loss, sometimes the feeling is strong enough to make me stop trading for a few days. I guess that is an inevitable stage all traders have to go through, but over time it is important for us to grow and realize that failure is just part and parcel of this game and be able to get over it real fast. 

In short, what kind of thoughts occupy our minds? The discouraging words of people? The numerous losses in our trading? Personally, I choose to focus my thoughts on the fact that many traders do achieve success on a consistent basis. Instead of being fazed by the 95% of failed traders, I'm excited to strive towards being the 5%. For once in my life I feel that it is achievable because it is not about the highest IQ or the best PR skills, both of which I'm lacking. I'm sorry to say this, but I can really see who the 95% are when I attend seminars, read forums, and talk to people. 

• If an uncle raises his hand during a seminar and asks the instructor "Sir I just bought Olam yesterday, can you look at it and tell me if I should hold or sell it?", he belongs to that 95%
• If some mysterious guy posts in a blog chat box that his "firm" is about to pump Yangzijiang and people actually buy into that rumor, those people belong to that 95%
• If a UOB customer reads an analyst report about the bright future of Noble and buys into that story, he belongs to that 95%
• If someone is boasting on the forum that he tripled his account in just 2 weeks, he is obviously over leveraging and he belongs to that 95%

I can go on and on. Courses give people the illusion that a black box or fixed rules are enough to achieve success. Newspapers and websites are full of ads that promise ridiculous returns. Their victims are the 95%. So.... With so many people out there who are just in for the quick returns and who are unwilling to put in hard work, why can't I be in the 5%?

Right now while I'm not there yet, I need to constantly stay positive and focus on improving day after day. I must journal my trades and make sure I learn from my mistakes, tedious as the process may be. Also, think about it, how did all those prop traders manage to get into prop trading? By first believing they can be a prop trader!!! So if I were to believe the reports of the people who say it is next to impossible to get in and that I should give up, how am I ever going to get in? Heck many prop traders are not even really good, but they got in because "What the mind of man can conceive and believe, it can achieve".

GBP/USD And EUR/AUD Trade Reviews

For this trade review I'm just going to post the images which I use for my trading journal.

GBP/USD 4H

EUR/AUD Daily

GBP/USD Potential Setup

GBPUSD 4H

GBPUSD Daily

I'm super tired so I'm going to make this post as short as possible.

1. First of all refer to my previous post about GBPUSD. I got stopped out of my remaining quarter position, but just look at the 4H chart above. Can you see how huge the drawdown would have been if I did not take partial profits when I could? It is very psychologically damaging, at least for me.


2. There was another super good pin bar setup on the 4H chart just now but I was out so I missed it. Frankly these are what we should be looking for, clear rejection of significant levels, in sync with higher time frames, nice price action setup. The odds are clearly in our favor if we take such setups.


3. I might have missed the 4H setup but I'm still watching the daily chart for a Fakey/Hikkake setup. This is basically a false breakout of an inside bar setup. In our case now we not only have a potential Fakey, it could also be a pin bar setup. Note that I'm not interested in this just because there is a price action setup, the crucial thing is that this setup is occurring at a significant level and there is no significant support below which means a very decent RR. The daily bar will only close at 6am, I'll take my chances and leave a sell stop below the 3 recent bars as indicated by the line above. Lets see how it goes.

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Update 1:04am

Wow I got stopped in as I was writing that post, didn't expect GBP to tank so much. Lets hope it continues to drop! ;)

AUD/CAD Trade

AUDCAD 4H

I mentioned a potential short setup in AUDCAD here. Well it did setup nicely in a huge bearish engulfing candle, I took the trade and made a small profit. I shorted the break of the bearish engulfing, took half profits at the previous swing low and shifted my stop to breakeven. Unfortunately this stop was taken out so I only ended up with a small profit. I want to blog about this trade because there are a couple of things I've learned recently that can be illustrated excellently using it.

1. Taking partial profits and moving stops to breakeven can be really liberating. Well at least for me, because I simply cannot stand watching profits turn into losses. Isn't this trade such a wonderful example? Look at how prices nearly touched the low of the previous swing and rebounded back up. If I hadn't taken partial profits there, my position would only be near breakeven now and that is a really sucky feeling. Worse still, prices could continue to shoot up and my profits would have turned into losses. I like the assurance of a winning trade and hence this method works for me. Yes I might miss a few big runners and price might stop me out at breakeven before turning again, but the idea is to have many small winning trades and once in a while a big trending winner will bring a windfall.


2. There is a common misconception about reward-risk and I only realized it recently. The common teaching is to only take trades with 2:1 or 3:1 reward risk. As such many traders give up perfectly nice setups because they fail to fulfill this criteria. After reading James16 and ForexSchoolOnline, I realized that there is a huge misunderstanding about this. Yes obviously high reward risk trades are good, but what if you know that a setup has a 80% chance of hitting a particular level? Do you forgo it just because the RR is only 1:1? Many traders mistakenly do so and miss out on potential profits. The thing is, if we're very picky and only select A+ setups, we shouldn't be too concerned about a high RR requirement. If a trade has a 70-80% chance of hitting an initial profit target, we know there is a high chance of being able to bank in partial profits and move our stop to breakeven. We already have a sure winner! This is exactly what happened with my AUDCAD trade. Yes the bearish engulfing was very huge, my reward risk sucked, but because it happened at a very strong resistance level I was confident that prices would at least hit the previous swing low. It did and I managed the trade exactly like I planned to. In this case I got unlucky because the rebound was strong, but if the swing low was taken out I would still have half my position to ride the trend.

I think those two points are very important and real gems from the stuff I've been reading recently. So, what if we get an A+ setup with 2:1 or 3:1 RR? Well, those are freaking MUST TAKE trades!!!! In fact, an experienced trader should increase his size and perhaps risk 3-5% of his account on such trades. I'm serious, 1-2% rules are for beginners so they won't blow up, but if you have been trading for 10-20 years and you very confidently know that a setup has a 80-90% chance of success, I don't see what is wrong with risking more on it. Even if it goes wrong, a 3-5% risk will not damage the account much, and experienced traders usually are able to cut their losses fast using discretion so they don't lose the full risk amount.

GBP/USD Short

GBPUSD Weekly

GBPUSD 4H

I'm pretty pleased with a trade I made yesterday. GBPUSD weekly's chart had a pin bar at resistance. On the daily chart there was a huge drop last Friday (Not shown). As such I was looking for a pullback on the 4H to short this pair. It came in the form of a bearish pin bar at intraday resistance and the 20EMA. In fact it was also a bearish engulfing bar, and the previous candle also looked like a pin bar. I shorted at the close of the pin bar and not long after prices tanked. The image above showed how I managed the trade. I must admit I was very aggressive in profit taking due to the Christmas hols. The reason why I took quarter profits is because that level was a strong confluence support of the 4H trend line, the daily 20EMA, and two Fib levels (I'm studying James16 and he utilizes Fib confluence levels to great success so I'm experimenting a little with it now). I now have a quarter position left just in case prices decide to tank even further. Due to the bearish picture of the weekly and daily chart, I'll continue to watch this pair for any shorting opportunities.

The main point of this post is the taking of half profits and shifting stop to BE as soon as it seems feasible. This is exactly how I want to manage my trades from now on. I hate watching profits turn to losses and so this method of stop management suits me well.

Watch AUD/CAD For Short Setup

AUDCAD 4H

AUDCAD 4H has just convincingly broke out of a long consolidation zone and it is worthwhile to watch it for any potential short setups. This could come in the form of a pullback to the broken support turned resistance level, it could also come in the form of a bear flag. Price action setups shall be my trigger. It isn't going to happen tonight so I'm going to sleep now, but I'll certainly watch this pair from Wed onwards!

How To Use Indicators Properly

Well first of all I'm certainly not a pro at this subject, but I just want to talk about what I've observed from the various traders I come across in trading forums. As a price action trader, I'm inclined towards naked charts, however it doesn't mean I despise or belittle the use of indicators. Heck so many people have use them successfully. But this is what I've observed - most traders who are able to use indicators successfully are those that who have achieved a certain level of proficiency with price action. I'll provide some examples.

1. The beginner trader reads Alexander Elder books and learns about MACD Divergence. He sees one forming in the midst of a strong trend and immediately jumps into a counter trend trade, getting burned in the process. The experienced trader first identifies the significant support resistance levels. He notices that price has just formed a long tailed pin bar + false breakout of a resistance level. Moving to a higher time frame chart, he realizes that although he is making a countertrend trade on the lower time frame, he is actually shorting a retracement in the higher time frame downtrend. He then checks his MACD and observes that there is also a MACD bearish divergence. He takes the trade and makes a profit out of it. 


2. The beginner trader learns about Stochastics. He comes across the typical crap about trading %D %K lines crossovers or shorting when it is overbought and going long when it is oversold. I don't even need to state the outcome.... The experienced trader looks at his chart and notices that price has just pulled back to a support level in a strong uptrend and formed a pin bar there. He checks his Stochastics and sees that it is oversold. He goes long and makes a profit out of it.


3. The beginner trader learns about how moving averages and Fibonnoci levels can serve as support/resistance. He trades every rebound of his favorite 20EMA or 61.8 Fib retracement and gets burned. The experienced trader looks at his chart and notices that price has just pulled back to a support level in a strong uptrend and formed a pin bar there. He observes that the pin bar also pierces through the 20EMA and 61.8 Fib retracement, as such there is a confluence of 3 support levels there. He goes long and makes a profit.

Gosh I'm so proud of myself for being able to come up with those examples :P Haha actually it wasn't that hard because I was that beginner trader. I'm not saying that I'm now an experienced trader, but at least I think I know how NOT to use those indicators. So time and again as I read the posts and blogs of pros, I noticed that the way they use indicators is to use them as confirmation and additional weight to price action setups. Price action first, indicators second. This is really sinking into me deep, I'm so convicted by this that it is hard to convince me otherwise. 

Thanksgiving - Super Long Post

I think I'm really blessed. I don't know how to describe it but I really do. It has been slightly more than a year and a half since I got introduced into the world of trading. Since then it seems like there has been a divine hand guiding me along the right path. I do not say that because I'm now very profitable or super rich, I say that because it could have been so much worse. I read a lot, and as a result I have come across numerous stories of how so many traders blew their accounts and took years before they became consistently profitable. So many were stuck in the search of the Holy Grail, experimenting indicator after indicator, black box after black box. You know what, everyone who has been down that road knows the outcome, but I personally feel that it is a road everyone cannot avoid. So it is with all the common mistakes that traders often make. Let me give some examples:

1. You'll never know that having 5 indicators and 3 moving averages doesn't work until you've tried it.
2. You'll never know that a $3k black box system doesn't work until you've tried it.
3. You'll never know that disobeying a stop loss is disastrous until you've done it.
4. You'll never know that oversizing on a position is dangerous until you've done it.
5. You'll never know that trading your favourite candlestick pattern whenever it appears doesn't work until you've tried it.
6. You'll never know that trading based on tips or calls by others is stupid until you've done it.

I could go on and on... We read about these common pitfalls and mock at people who commit them, but can you find a trader out there who has never committed them? With the exception of purchasing a black box, I've committed all the others. And I feel blessed, because I have not blew up. So many people blew up 5 digit accounts multiple times before they got it. So many people are still tinkering with indicator settings after years of non profitability. In every course or seminar that I've attended, every forum that I patronize, every facebook group that I'm in, people just crave after tips and tips and tips. They post their trades and then ask if they should take profits or cut loss. To me it just shows that they do not have a trading plan, and to put it bluntly, are bound for failure. They are just in it for the money and they want quick rewards with minimal effort.

I'm really glad that I just love trading for trading and not for the money. There is a quote at the top of my blog that says "The goal is to become the best trader you can be, the money will follow". I really believe in that. If you're in this not for the passion but for the money, there is absolutely 0% chance you'll make it. I really mean it. Trading is not like engineering, teaching, accounting, or any other profession where you'll still be paid monthly even if you suck at your job. If you suck at trading, you're not just not going to make money, you'll lose it, period. 

The secret to being a successful trader often eludes beginner traders because it is dull and unappealing. Yes a good trading strategy is important, but try talking to a beginner about discipline, money management, psychology, power of compounding etc. It is impossible for them to appreciate it, simply because there is too much to learn all at once and it is natural to be drawn to trading methods initially. There is nothing wrong with that, all of us start that way, I know I sure did. Whats wrong is not progressing, is repeating the same mistakes, is continually focusing on methods and not other aspects of trading.

And so, while I'm far from being successful, I'm grateful that I've learned what took many others years to learn. I'm referring to the search of the Holy Grail, which I've come to realize resides not in methods but in self mastery. I'm at the stage where I think I've sufficient knowledge about trading strategies to at least not lose money, it is now about continual improvement, discipline, psychology, money management, and self mastery.

Methods wise, I'm grateful that it didn't take me long before I stumbled upon Wyckoff, VSA, and price action. I believe that in the long run my methods will purely be price action based, but Wyckoff and VSA really helped me understand how the markets work and opened my eyes to how it is all about supply and demand. The thought that I could still be meddling with indicator combinations and different systems freak me out, and I'm so glad I didn't go down that route.

I'm also grateful that I started trading Forex. You have no no idea how much that changed everything. Yes I haven't started for long, but already I can see how not having to pay a minimum comms can open the door to important trading strategies that I cannot implement on equities due to my pathetic trading size. Partial exits are just so important, but if I do that on equities my comms will literally balloon. Simple example, if I make a trade on IG markets and decide to take partial profits and trail the rest until it is stopped out, I'll incur a min comms of $45 ($15 per trade). That is A LOT for my trade size. I can do the same thing on FOREX for $0 min comms, see the difference? I can also trade real small and focus on achieving consistency before increasing my size. In equities I can't do so because of the min comms. There are also so much more useful resources and forums on Forex. I so wish I had started it earlier. 

Oh ya one more thing. I'm glad that trading is a business where everyone is bound to fail at the start regardless of how high his IQ is. High IQ people are used to top grades and a sense of control over their profession, as such it is hard for them to accept the probabilistic nature of the markets. They can read lots of books and derive a top A+ setup, but when it fails they simply cannot accept it. All their lives they're used to things going their way but that's just not how Mr Market works. As such I'm glad that I'm on level playing field with these guys, just because they're smarter doesn't mean they'll fare better than me. If I can have better discipline and psychology than them, I'll trump them.

I am also grateful for my beloved wife who has been so patient and understanding, who always tries to accommodate me and put up with the excessive hours I spend in front of the computer or books. Sometimes I set my alarm to wake up in the wee hours and watch how the US market closes but she doesn't bark about that either.

Wow this is a long post isn't it? I guess it is meant as a diary post for me to pen down the plethora of thoughts swimming in my head. I got into a very introspective mood after reading some James16 posts. This guy is for real, I really respect his contributions to price action and I admire his generosity. I'm only few pages into his thread and a couple of his videos but already I've learned quite a few interesting stuff. Here are the posts (non trading related) that for some reason brought goosebumps to me:

http://www.forexfactory.com/showthread.php?p=84617#post84617
http://www.forexfactory.com/showthread.php?p=4005559#post4005559

Case Study on USDCHF

USDCHF 4H

Just want to discuss a setup on the USDCHF 4H charts and talk about why trade management is so important. I didn't take this trade because I felt that the retracement on the daily chart wasn't strong enough; I wanted it to retrace to a stronger resistance level before considering any shorts. Of course in hindsight I should have taken it.

So anyway, the setup is a nice pin bar at broken support turned resistance and the EMA. A typical entry would be a break below the pin bar which came 2 bars later. Note that this was also an inside bar breakdown setup. Now here is the important part. If one did not take partial profits at the swing low or moved his stop to breakeven, he would eventually be stopped out with a 1R loss. This is so so so important, and I only learned this recently after studying sites like ForexSchoolOnline and James16. I've seen and personally experienced this so many times, where the trade initially went well before reversing and eventually ending up in a loss. It is so crucial not to let this happen, to take partial profits and move stops to break even once price has reached a trouble area.

Having said that, this is obviously just a preferred style of trade management for traders who fancy a high hit rate. The catch is that you'll miss out on larger gains (because you've already taken partial profits) should price just break the support and continue to fall. I personally prefer to be right most of the time and hence am adopting the above trade management strategy. I've seen my profits turned to losses way way too many times and really don't like that feeling. This strategy will minimize my losses and protect my profits as soon as possible.

Poor Entries Can Lead To Poor Trade Management

I've been doing some reflection on what goes through my mind/emotions when I'm making or managing my trades, and I discovered something that I know will really help me with my trading. Basically, whenever I make a trade on some suboptimal setup, I tend to be more nervous. Things I'll typically do are to constantly check the lower time frame charts or feel comforted knowing that some friend of mine is also in the same trade etc. The moment an opposite signal occurs on a lower time frame chart, the nervousness in me shoots up and I do things like cut my position in half or tighten my stop so tight that it is easily hit. I subconsciously know that I've made a poor trade entry and want to reduce my stress by getting out of the position ASAP. Very often this leads to poor trade management decisions.

On the other hand, when I make a setup that fulfills all my entry criteria, I tend to be much more confident. I know that if my stop is hit, so be it. Given a choice I would still have taken the trade all over again. I do not get shaken out easily by lower time frame movements.

So my point is, it is very important to be very disciplined and selective with our trade setups lest our psychology gets affected while managing the trades. I'm still having problems with over trading and am working on it. I'm trying to trade only 4H and daily charts for now as that would give me more time to really "hunt" and wait for setups instead of jumping into them.

J.K Rowling Harvard Commencement Speech

http://www.youtube.com/watch?v=wHGqp8lz36c

Main quotes from the video:

“It is impossible to live without failing at something, unless you live so cautiously that you might as well not have lived at all - in which case, you fail by default.” 

“Rock bottom became the solid foundation on which I rebuilt my life…”

"What we achieve inwardly will change outer reality"

So It Should Be For Our Trading.....