One of the greatest books on trading contains no practical advice about the markets whatsoever but still describes price action better than a thousand hedge fund managers ever could. The Drunkard’s Walk by Leonard Mlodinow details how virtually all aspects of life are ruled by randomness.
In fact, just the other day I came across a paper by a Hebrew University professor that eviscerates the concept executive performance compensation by proving with a near absolute degree of statistical certainty that 90% of CEO performance is a function of luck rather than skill. For every Steve Jobs, there are a thousand lucky fools just warming the seat.
But back to randomness. If we are honest with ourselves randomness is a massive part of market price action. It’s one of the principal reasons that almost every backtest fails miserably under real market conditions. And it is also the reason that I consider tactics to be much more important than strategy when it comes to making money day trading the market.
My favorite tactic is what we in the BK chat room call, the Boomer entry, where we will enter the trade at one level and if it goes against us we will add to the position allowing us to exit the trade at the original entry rather than the original take profit.
I know. I know. The horror! I am breaking one of the sacrosanct rules of people who never-actually-trade-with-real-money-but-like-to-peddle-trite-theories-of-risk-and-reward. Yes, of course, I am increasing my risk and capitating my reward. Yes, of course, such tactics require much higher win percentage to be profitable. And yes, of course, they can lead to disaster if you don’t properly balance the ratios. But instead of having a religious argument about risk and reward just do the following.
Open a demo account. Place 50 random trades with 5 pip stop and 10 pip take profit and then place another 50 trades with 10 pip stop and 10 pip profit, then another 50 trades with 20 pip stop and 10 pip profit. You’ll notice something interesting — the win/loss ratios are not proportional. At 5TP/10 stop, you could lose 90% of the time but at 20st/10tp you may win 55% maybe even 60% of the time. You will still lose, but much less and it will take much longer than through the “traditional” way of trading.
Because of something called path dependence. In the la-la world of trading gurus where trend spotting is easy (once it’s already happened) and price moves linearly from point A to point B, using 2-1 risk reward ratios is…obvious! But in the real world where every price tick is subject to random variables the path is never smooth nor linear. Add to that the fact that the market, like a skilled poker player, is almost always trying to trick you into the wrong move and your accuracy at any given price is actually more like 25% for to 75% against versus the 50%/50% that is commonly assumed.
That’s why single entry tactics are the height of arrogance, especially in day trading where the stops are small and the margin for error is tiny. On the other hand, our day trading tactics are designed for the maximum possibility of success in a real market environment that is more like the undulating waves of the ocean, than the hard certitude of a concrete floor. Over the years these tactics have made me more pips than all my day trading strategies combined. Why? Because randomness rules.