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It’s Random Baby
One of the greatest books on trading I ever read contained no practical advice about the markets whatsoever but it described 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 today I came across a paper by professor from Hebrew University that eviscerates the concept executive performance compensation by proving with a high degree of statistical certainty that 90% of CEO performance is a function of luck rather than skill. Watching the recent Congressional hearings of Wells Fargo CEO John Stumpf only proves professor’s point.
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 our 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 ( I am an atheist anyway) just do the following.
Open a demo account. Place 50 random trades with 5 pip stop and 10 pip take profit then another 50 trades with 10 pip stop and 10 pip profit, then another 50 trade 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 over a much longer period of time than through the “traditional” way of trading.
Because of something called path dependence. In the bulls-t world of trading gurus where trend spotting is easy apriori 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 almost 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 chances of accuracy at any given price are 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 maximum possibility for 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 year these tactics have made me more pips than all my day trading strategies combined because randomness rules.