The Problem of Trying to Outwit Your Trading Plan

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The Problem of Trying to Outwit Your Trading Plan

One of the greatest problems most traders face can be summarized as “Not following their trading plan or strategy.” As humans beings we have several tendencies which cause this. One of the main culprits is that once we have a plan that works (or at least was shown to work in the past), we try to make it better by guessing which signals will be profitable and which will be losers (because even good trading systems have losing trades). The result is frustration, because our actual trading results end up varying greatly from what the system should be producing. Understanding why this occurs, and more importantly how to change it, is a giant step in becoming a consistently profitable trader.

Outwitting Your System

Once you’ve created a trading plan or strategy–or found one in a book or from another trader–that you like, you’ll want to test it. Through testing it on historical data you find that it was profitable, and would have resulted in a nice weekly or monthly income. You can see that while there were likely more winners than losers, there were still quite a few losing trades over the time frame tested.

In your mind you tell yourself that overall it was profitable, and losing trades happen. Happy with your strategy you open a real money account and proceed to trade. But something weird happens.

In real-time you notice a lot of new information–setups maybe don’t look exactly like they did in simulation or like they did in the past, and so instead of trusting the signal and just taking the trade, you start trying to guess which signals will result in a profit and which will result in a loss.

You have a “great feeling” about a signal, but the price blows through you triggering your stop and resulting in a loss. You have a “bad feeling” about the next trade (and you just lost the one prior, which looked so good!) and so you skip it, only to watch in frustration as it moves in your favor and would have been profitable. Or, you lose three or four trades in a row, and decide not to trade the next day…a day which could have made back all your money and more.

By deviating in this way, a profitable system becomes a completely untested system. While you may have put in the work to test the system, by not instituting it correctly you are not becoming a better trader. Your results are now random, and no longer based on research. In essence you are gambling, because you are no longer trading with the same strategy you tested. By skipping signals, you drastically change the results.

If you want to filter signals, define how you will do it, and then test the system again.

Why We Try to Outwit Our Trading Plan

There are several reasons why we try to outwit our trading systems. One is that in real-time there are likely to be external biases which affect our trading. This may be the opinion of others, articles we read or the news we watch. Typically, don’t listen other’s opinions while trading, it’s a bad idea.

Also, knowledge is very different than application. Most of us know that daily exercise will make us feel better, but until we actually do it the knowledge alone doesn’t get us in shape. The paradox is that we need to perfectly institute a trading plan in the market to learn how to apply what we know, but we also have a strong tendency to try to outwit our plan when we do.

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Another problem is that while you can see the trading system was profitable in the past, or that someone else is a making a fortune with it, those results are not real to YOU. Until you personally experience profitability over a length of time, you simply don’t have the mental belief structure that this trading plan will work. Since you don’t truly believe it can actually work for you, you are especially prone to trying to outwit your system…which has the cyclical effect of causing poor performance which reinforces your lack of belief in your system, which results in worse performance, and so on.

Another big problem is that traders believe trading should be exciting, with big risks and big rewards…but actually all they want is the excitement and big reward. The big risk is simply what allows for the excitement. But trading with a system can actually be quite boring. When trading in real-time with a system there is no outlet for artistic expression–instead you’re just a robot executing a plan (but this actually doesn’t have to be boring; just watching for signals can be quite an involved process depending on strategy). While people say they are fine with following a plan, in actuality their desire to “express” themselves outside of the confines of their plan is a much greater impulse.

Dealing with It

Even if you extensively trade a demo account prior to going to real money trading, you’ll likely experience this phenomenon, even if you were able to trade your system very will well in simulation.

To overcome this issue, find a simple trading system and implement it with a small account and a small amount of capital on each trade (smallest trade size possible). With this account your goal is not to make money. It is simply to follow the plan. You are building discipline as well as your belief that you can actually trade this system. Take every signal, and commit to it, even though it will be extremely uncomfortable.

You may want to scream while doing this and pull your hair out, because following a plan in real-time goes against our biology. Talk to yourself while you trade, reminding yourself that you don’t care about the money at this point. You are working on your discipline and belief structure so that down the road you will be a successful trader. Realize that it will be very hard to do this, and go easy on yourself. Don’t berate yourself.

Don’t tell yourself “I should do this….”. There are no “shoulds”, you simply do.

Trading every signal your trading plan offers will build your discipline, so you are actually able to take your knowledge and apply it. There are no short-cuts. You will be uncomfortable, but commit to following a plan and taking every signal in spite of that discomfort. Over time, if the system is profitable it will help build your belief that the system is profitable and that you can be profitable–this will make executing future signals easier and easier. Until you go through process–and actually do in the market what you are supposed to do and have practiced–you’re simply gambling.

The Problem of “Trading Not to Lose” and Overcoming It

Trading not to lose is an issue almost every trader will face at some point in their trading career. Learn why trading with fear can cause a host of problems, then learn how to better handle that fear so you are making better trading decisions.

I was recently reading one of Doyle Brunson’s books–he’s a no limit hold ’em poker legend–where he talks about this issue in the poker world. In order to be a great poker player you need to be opportunity seeking, and not afraid to put your money at risk when there are opportunities to exploit your edge. Ultimately, great traders, athletes, poker players, or anyone at the top of their field, share one similar trait: they aren’t afraid to lose. They go after it, have a killer instinct, and want to take every opportunity they can to implement what they have practiced and studied.

Trading not to lose causes major problems for traders. Here’s what it is, why it’s problematic, and how to get yourself into an opportunity seeking mindset.

Trading Not to Lose is Fear-Based Trading

As traders, we want to respect the market, but not fear it. It’s neither our ally nor our enemy; it’s a neutral sea of both potential and risk. Trading out of fear means we are too focused on the risk, and are unlikely to capitalize fully on the potential.

Trading not to lose, which is fear based, can cause the following symptoms (some or all) to develop:

  • You try to guess which of your trading signals are likely to be winners in an attempt to avoid the losing trades. By skipping signals you move away from your tested trading plan and strategies, and randomize your results. This is known as “trying to outwit” your trading plan.
  • Losses aren’t taken when the stop loss level is reached. The loss is allowed to run, resulting in bigger losses than planned. Fear is a tricky thing in that it can cause us to get more of the very thing we are trying to avoid. When we are afraid to take a loss–because we haven’t fully accepted that losses are a natural and regular occurrence in trading–we may actually try to avoid taking losses and thus run our accounts into the ground. This is an element of “loss aversion.” It’s important to understand, on a belief level, that losses are part of trading. They can’t be avoided, and trying to avoid them may actually cause more damage.
  • Trades are not allowed to develop. Contrary to the problem above, the trader is afraid of any sort of loss, or of a small winning trade turning into a loss. The trader knows the market gyrates back and forth, but they are “jittery” and therefore don’t allow their winning trades to compensate them for the risk they are taking. The trader continually gets out of trades at a small loss or profit even though their stop loss is in no danger of being hit at that moment, and the price hasn’t reached their target.
  • In general, fear can cloud judgment. In real-time, the trader may be so afraid to lose they don’t even see opportunities occurring. If you continually see trades (that you should have taken based on your trading plan) only in hindsight, fear may be causing you to actually filter out information and cloud your perception.

These are symptoms of trading not lose. Trading not to lose is a product of focusing on whether we win or whether we lose. But winning or losing actually shouldn’t be our focus.

As traders, it’s our job to come up with (or learn) strategies, develop a trading plan, and then rigorously test that plan for profitability and our ability to personally implement the plan.

Once we have a plan, our goal is to trade according to that proven plan. The plan is researched, backtested and/or traded in a demo account, and then traded live with small amounts of capital until the plan is proven successful. Wins and losses take care of themselves. While we are trading we can’t care about wins and losses…we only care about following our plan and trading every valid opportunity our trading plan gives us.

When we aren’t trading that is when we can look at our wins, losses, profitability, and trading stats to possibly make adjustments if needed to the plan. But this doesn’t occur during trading; while trading and holding positions our focus is only implementing our plan.

This is easier said than done, but understanding and accepting the following will help.

Believe in Probabilities

While winning is the ambition of traders, “not losing” actually ends up being the dominant factor that affects trader’s decisions. This is because it is very easy to have knowledge of risk, but it is something entirely different to believe you can overcome it. This requires an internal “belief” change, not just knowing that a change is required.

In an effort to not lose the aforementioned symptoms develop, resulting in the trader losing their capital. How can we change our mindset to help avert this?

Consider “the house” or casino in a game of blackjack. Each trade you make represents a hand of blackjack. There is the house (a buyer or seller), and there is the gambler (a buyer or seller on the other side of the trade). The difference between them is that the casino owner has a percentage edge over the gambler. Disciplined traders also have an edge, and can therefore be equated to the house or casino owner.

While playing blackjack have you ever seen a casino owner run downstairs to stop a hand of blackjack from occurring because he thinks he might lose on that hand? Never. Gambling regulations aside, casino owners actually want as many hands as possible to be played because they know they have an edge on each hand. Casino owners also know something else: each hand is independent of other hands. Anything can happen on a single hand! The casino owner knows we can’t predict which hand is going to make the house money and which is going to make the gambler money. All he knows is that each hand is independent–in that anything can happen on a particular hand–and that he has an edge over many hands.

Over a great many hands the casino holds a 3.5% to 4.5% advantage, varying based on house rules. While the casino may lose tons of hands, at the end of year they are likely to have made 3.5% to 4.5% on all the bets placed at their blackjack tables. The more bets placed, the more the edge is exploited, the more profit they make.

The bottom line is that traders need to adopt the “casino owner mindset,” realizing the result of each trade is unpredictable and therefore every valid trade, within the context of the trading plan, must be traded. Also, know that trades are independent of each other. While you may have a string of losses, that doesn’t mean there is something wrong. Allow your edge to play out over many trades. Trust your edge, as the casino does, that over the course of a week, month and year your edge will produce a profit. This assumes you have edge, which is why you need tested strategies.

No single trade matters to a pro trader. Whether it is a win or loss makes no difference. The only thing that matters is exploiting the edge and taking valid trades, because over the long run all those losses and wins will make the edge (profit) materialize. And the nice thing about trading is that traders can create a much larger edge than the casino has.

Reading or understanding this analogy won’t create any change in behavior, it needs to be incorporated into your belief structure for change to occur. Incorporate it into your belief structure by meditating on the concepts, write down notes and your thoughts related to it, so that it begins to seep into your brain, overtaking the current belief structures you have about the market which result in ‘trading not to lose’. Put notes beside your computer, and continually remind yourself to adopt the “casino owner mindset,” and all that it entails.

Final Word on Trading Not to Lose

Adopt the casino owner mindset. If you do so, you won’t care about whether you win or lose a trade. You will be more open to seeking opportunities. If your system is proven, over many trades you know you have an edge and profits will come. Take every valid signal you can, so your edge materializes. Think of it this way: if you know you can win 60% of the time by guessing heads on a coin flip you’d be trying to get as many people to bet you as possible. The same goes for trading. If you know you win about 60% (even 51% of the time, or 40% if you make more on your winners than you lose on your losers) of the time you should be taking every valid trade you can so you can exploit your probabilistic edge. If you try to figure out in advance which coin flips or trades will be winners and losers, you become the sucker.

For more on these topics, see the interview with Mark Douglas, trader and author of The Disciplined Trader and Trading in the Zone. His books are definitely worth the read, and that interview discusses some of the topics from those books.

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In Trading, It’s Quality, Not Quantity

Today it seems like our lives are ruled by “quantity”. How much money we make, how many toys we own, how many 10-second texts we get/send, throw-away electronics and cheap processed food. Quantity has become very important, and quality has been left in the dust in many ways. The ironic thing is that to get more “quantity” (or quality, hopefully) in our life, many of us turn to trading–a seemingly easy way to make more money. Unfortunately, trading doesn’t reward you for taking as many trades as you can; it rewards you for taking quality trades.

The Drive For Quantity

In trading I see two common themes (there are more, but these are the most common) which drive traders to trade too much, and thus dwindle away their trading capital on low quality trades:

  • The first is the idea is that “If I make $100 (or whatever your profit is on an average trade) on one trade, then I make $1000 if I take 10 trades.”
  • Humans like to find reasons for doing things–even if the reason is totally flawed and illogical. If your brain decides it wants to make a trade (maybe you are bored), your brain then starts giving you all sorts of information to confirm making a trade. In other words, when there is no reason to trade, your brain makes up reasons.

A Move Toward Quality

While the first bullet point is mathematically true, when day trading there are only so many good opportunities each day. The number of high quality opportunities you find will depend on your strategy, but you can’t force good opportunities to arise. Either they show up or they don’t, so you can only trade what is given to you.

Some days there will be no trades; other days there will be more. If you are patient and disciplined, only taking good opportunities as they are arise, you will likely be much better off than if you try to trade more. By trying to take more trades, you’ll typically end up with more losing trades and erase the profit from the good trades.

The second bullet point is harder to overcome. The first step is to ensure you have a detailed trading plan, telling you exactly when and why you will get into and out of trades. If your brain starts telling you to get into a trade, look at your plan. If what your brain is telling you to do isn’t part of the plan, don’t take the trade.

This is hard to do. But slowly the mind will stop sabotaging you. You must remain disciplined and stick to the plan, even when you brain is screaming something different. If you struggle with not being able to stick to your plan, see The Problem of Trying to Outwit Your Trading Plan.

Bringing it Together

Great traders take trades when the price is near certain levels, or experiencing very specific conditions. When those price levels or conditions aren’t present, great traders look for reasons to avoid trades.

Poor traders try to find reasons to make trades at any level, regardless of whether it is an important level or specific conditions are present.

There is a big difference in market outlook between the great and the poor trader. The great trader is opportunity seeking at high probability times only, while the poor trader tries to create opportunity everywhere and ends ups dwindling away his capital.

In trading it is about quality. Focus on refining your strategy to produce a handful of high probability signals most days. Realize that some days there just aren’t many great opportunities, and be disciplined enough to hold onto your capital for days when there are.

Each dollar you waste on a random, undisciplined, low probability trade is money you can’t use when you see great opportunities.

The world is ruled by the quest for quantity. Don’t fall for it. Focus on quality, and your trading–and life–will improve.

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