The objective of this exercise is to convince yourself that trading is just a game of probabilities. At the micro level, the outcomes to individual trades are independent events and random in relationship to one another. Nonetheless, at the macro level, the outcomes over a series of trades shall produce consistent results.
From a probabilities perspective you can attain consistent results if:
1. You have an edge that certifiably puts the odds of success in your favor;
2. You can think about trading in the appropriate manner (the five fundamental truths);
3. You can do everything you need to do over a series of trades.
Setting up the Exercise
Choose a market that is liquid, one where you can afford the margin requirements and you can afford three hundred shares or three futures contracts per trade.
Define your edge explicitly. This edge can be any trading system you want. Be confident that your system stacks the probabilities in your favor over time. If you are unsure about the soundness of your system, then backtest it thoroughly. Track the results and verify that you do in fact have an edge.
Define your entry levels, stop loss, profit targets as well as the time frame. As indispensable as it is in predefining your risk before opening a trade and placing a stop loss, it is equally crucial to take profits. To instill the belief that you are a consistent winner, you need to create experiences that coincide with that belief. The aim of the belief is winning consistently, and how you take profits in a winning trade is of prime importance.
Trading in sample sizes.
Most traders virtually live or die (emotionally) on the results of the most recent trade. If it was a winner he would gladly put on the next trade; if it was a loss he would start questioning the viability of his edge. To verify that your variables work, you need to adopt a systematic approach, one that does not take any random variables into account. This means that you need to expand your definition of success or failure from the limited trade-by-trade perspective to a sample size of twenty trades or more. You need a feasible sample size to compensate for the variables that are always present in the markets.
Accepting the risk.
Be certain about your risk before starting your sample trading exercise. This means being able to fathom and accept the result of a worst-case scenario. This worst case scenario of course would be twenty losses in a row. Apprehend what this means in dollar terms and make sure you are at harmony with it. If you are not comfortable, reduce your position size and/or find a market that allows you to reduce this risk.
Doing the exercise.
The rules are simple. Plan your trade and trade your plan. This means committing yourself to trade at least the next twenty twenty instances of your “edge”. Not just the next couple of trades but all twenty no matter what!
In order to realize the benefit of having the odds in your favor you must participate in every trade. You cannot discretionarily choose which edges you will participate in, as this will skew the results.
If you believe in the five fundamental truths and you believe trading is just a game of probability then you will find the exercise to be effortless. Your desire to follow through with your commitment to take every trade in your sample size and your belief in probabilities will be in harmony.
Conversely, it is more foreseeable that this exercise is going to create a serious collision between your desire to think objectively in probabilities and all the forces inside you that are in discord with this desire. The degree of difficulty you face in completing this exercise shall be in direct proportion to the degree to which these conflicts exist.
The key to handling these conflicts is to monitor yourself and use the technique of self-discipline to refocus on your objective. Write down the five fundamental truths and the seven principles of consistency, read them and keep them in front of your trading screen at all times. Chant the mantra with firm conviction several times a day. Every time you catch yourself thinking, saying, or doing something that is in conflict with these truths/principles, acknowledge it. Don’t make frivolous attempts to deny the existence of the conflicting forces within you.
When this happens, contemplate on what it is you are trying to do. If your purpose is to think objectively, then refocusing shall disrupt the negative association process so that you can dwell in the “now moment” opportunity flow.
Each time you actually do something that confirms one of the five fundamental truths, you will drag energy out of the conflicting beliefs, and add energy to a belief in probabilities, thereby increasing your ability to produce consistent results. Gradually, your new beliefs will become so powerful that it will take no conscious effort at all to think & act in a way that is consistent with your objectives. Thinking in probabilities shall become a part of your identity!
Mark Douglas’s classic- Trading in the Zone strikes the right chord with the readers by emphasizing on the much finer psychological aspects of trading. In Douglas’s view, a mature trader is one who owes up & takes responsibility for his/her mistakes.
It might happen that you are familiar with a consistently winning trading strategy, but somehow you cannot manage to be profitable with it, then the folly lies in your investor behavior.
Learning endlessly about the markets only to avoid pain compounds your problems, because the more you know, naturally the more you shall expect from the markets, making it all the more aching when the markets do not do their part. This can create a vicious cycle where the more you learn the more feeble you become; the more feeble you become the more compelled you are to learn. This cycle shall go on and on until either you get fed up and quit trading in distaste or you recognize that the root cause of your trading problems is your viewpoint, not your lack of knowledge.
Traders must train themselves to approach the markets as a game of probabilities. At the micro-level, an individual trade is independent of every other. However, at the macro level, they integrate to verify the existence of the “edge”. It is extremely critical for you to understand this phenomenon as its psychological repercussions can be wholesome.
Majority of the traders mistakenly assume that they are thinking in terms of probabilities just because they have a modest understanding of the underlying concepts. As a result, most traders live on the edge with their moods being governed by the outcome of their latest trade.
A trader must imbibe in him the trait of being rigid and flexible at the same time- rigid in our rules and flexible in our expectations. We need to be rigid in our rules so that we can augment a sense of self-trust that can defend ourselves in an environment without any perimeters or boundaries. We need flexibility in our expectations so that we can discern market communication with the highest degree of certainty and clarity.
Be mindful that your potential to endure emotional pain arises from the way you define and interpret the information you are exposed to. It is only when you embrace the fundamental truths that your expectations will be persistently in line with the psychological realities of the market environment.
Creating consistency requires one to be completely approving that trading is not about hoping, wondering or gathering evidence in myriad ways that your next bet is going to fructify.
The only confirmation that you need to gather is whether the variables you use to define an “edge” are present at any stage or not. If you are uncertain about the validity of your edge, you will lack confidence. And to whatever degree you lack confidence, you shall experience fear.
When you are in harmony with not knowing what follows next, you surrender yourself to the “now moment” opportunity flow in the markets and are able to freely comprehend whatever the market is trying to communicate.
The mechanical stage of trading has been precisely designed to build the kind of trading skills (trust, confidence & thinking in probabilities) that shall virtually compel you to create consistent results.
When it boils down to personal transformation, the most crucial ingredients are your willingness to change, clarity of intent & the strength of your desire. In a nutshell, for this process to work you must choose consistency over every other justification you have for trading.