Monthly Archives:January 2013

Impulsive Trading

littl121 post on January 24th, 2013
Posted in Trading Tags:

For The Impulsive Day Trader

Impulsive traders tend to take impulsive trade with less forethought than others at the point of entering the trade.  It does not help even if they had thought through the trade the night before.   This is because impulsiveness blinds or blocks out assessment and recall ability, and for a short term trader this will likely lead to overtrading, and missing out key risk parameters (eg. forgetting to check if there is a demand or supply zone immediately in front of a breakout, or assessing a risk to be less dangerous than it really is).

An impulsive trader is overwhelmed by his emotions and may even act against his logical reasoning.  In his own imagination, his mind may even be cool and contemplative, but the emotions wield an invisible dominance.  Such impulsiveness  differs from intuition which says ” wait a minute, there’s something here…..”. Rather the impulsive trader thinks “ I want…”.

The best therapy I know of is to associate positive or neutral feelings with events that may compel impulsive behavior – i.e. develop a calming disposition by learning how to associate calmness whilst in an extreme,  distressed circumstance – e.g. imagine being in a losing trade and associate it with calmness.  Such techniques are well documented and free resources abound in the internet space, so I shall not dwell on them here.  Of good reference are materials from Dr Brett Steenbarger (you can find his youtube videos and writings readily on the net).

Many impulsive traders however, will not even carry out this simple life saving exercise – which is perhaps the logical behavior expected of many human beings…….

For these traders, here are some suggestions that may help reduce or alter impulsive tendencies.  I know they work for some folks, and I hope they can work for you.

First do not let your emotions be hijacked. The gathering steam of impulsiveness is catalyzed by such feelings as boredom, the need to generate profits, missing out on opportunities, need to make up for losses, being overjoyed with previous winnings,  the need to be in control (especially after an argument with a spouse, or some other frustration).  Once you recognize they exist, change your emotional frame easily by looking at photographs, or listening to music, or making a cup of tea, (do not engage in an eating binge, and create another problem of “comfort” food).  Even consciously diverting your visual glance, (e.g. deliberately looking up to the ceiling), or texting a message to a friend help to reduce impulsive stress to a manageable level.  Do not try to control your impulsive emotions, simply change them.

Second, recognize where the impulsive emotion originated.  If you know you may get impulsive, or feel the onset of impulsiveness, (eg. “need to make up for the lost money”, “ah.. missed the opportunity”, “Since I have enough profits, I can take a risk on this trade …  gambling”, “feeling angry”), try to understand how the emotion came about – e.g. are you are too eager to reach today’s target profits,  have you been on a losing streak,  have you made an unnecessary mistake, have you argued with your spouse or parent.  Just knowing the reason why immediately reduces the impact of emotions.  Knowing why also allows you to introduce solutions – (eg. If you had a loss, tell yourself trading is a long term game, you will lose some points along the way. Can you imagine not losing a single point over the next 12 months?  Is that even possible?  Are you going to grieve over these future losses too?  Not possible. )  However, if you are greatly stressed by a problem and cannot get it out of your head, immediately stop trading for the day.

Third, create a simple process list.   Make sure it is easy to use, and within easy reach.  Always go through this process list before you make a trade entry.  A few major assessment criteria are sufficient for re-tweaking the brain, and cause the trader to rethink more carefully.  Do not have a simple “yes” “no” list, but something requiring more prudent assessment – eg. Instead of asking “Is the higher timeframe in line with your intended trade?” , ask rather “ How is the higher timeframe in line or not in line with your intended trade?”  Put a blank piece of paper on your trading desk – and add one question everyday until you have at least 5 questions. Draw up a process list of between 5 to 10 questions.  You need to answer at least 3 questions before you enter the trade.

Remember these process questions help you better assess the trade opportunity – if you have not even considered them, you are not maximizing your trading advantage.  Determine above all else you will never enter a trade, under any circumstance until you have reviewed your process list.  Use this list as “hard stop” of sorts.   You are not trying to control impulsive emotions here, you are merely introducing an additional process variable – much like when you put in a trade, your process is to submit a trade quantity, trade price and press “enter”.  Frankly, an impulsive trader who is not even willing to do this, should not be trading.  I am sorry, but the end consequences will be disastrous – even if he has some winners along the way, and he will often feel miserable.

Remind yourself of the dire consequences that may follow an impulsive trade.  An impulsive mistake will often cascade into more painful errors and ends with “What just happened?!”  Recalling previous unpleasant experiences with impulsive trades will normally reinstate a reality check on these inclinations.

If however, you have entered into an impulsive trade, you still have a safety valve – your money management stops.  Do not question your money management rules whilst in a trade.  Do it outside the trade.   This is however not a long term solution – it just helps the impulsive trader to lose money more slowly.

PS:  This article is for the impulsive trader who knows how to trade.  There are traders who trade impulsively because they are unsure of what to do.  Learning to trade properly with understanding, and appropriate lot sizes will help many of these traders stop taking impulsive trades.

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Let Profits Run ……. How far?

littl121 post on January 3rd, 2013
Posted in Exits

Today, my friend bittered how he chickened out and exited a profitable trade too early.

As a short term trader, how far can we let profits run?

If we keep a tight stop, and we let profits run, we risk losing part or all of our profits if the market pulls back quickly, or take out our trailing stop, and then go on with its original run – a common frustration.

Therefore a lot depends on how tolerant our short term stops are.   Our stop tolerances are in turn  dependent on the reward risk ratio and money management strategy associated with the setup and its edge, (and whether the edge is still there). How far we let profits run, depends on these and the potential for further  trending or breakout profits.  There is one more factor to consider – but we shall leave that till the last paragraph.

Take for example, a breakout trade around the European session opening for the EUR/USD.  Generally, the market insiders tend to take out stops on both sides of the range before proceeding with one stronger trend direction.  (Remember this is not necessarily true everyday, – the market will do whatever it wants to do.)  If we see a nice set up for the first breakout and take the trade, watches it reach our expected reward risk ratio - how far do we let profits run thereafter - do we even consider letting profits run?  The answer is simple – do we still have an edge under the circumstance? If we are dependent on HOPE that momentum will carry on, we have better find a way to track that momentum or keep a tight exit stop – the whipsaw back into range can be nasty and fast.

If we are unable to track momentum, and our set up is completed, we can say our edge is gone.  Any ability to let profits run is dependent on how much we have exceeded the expected reward risk ratio, and the potential that price continues to trend beyond our expectation.  The run may be due to further stop catching, position building or unexpected market news – all of which we have no certainty or information on.

Based on the same example, if price action has weakened but subsequently resurfaced with strength, there may be some traders who would exit partial positions and leave partial contracts to let profits run.  I will only do that if my partial exit(s) can give me a monetary return that is the same as what I would get if I had exited fully at set up completion.  Then I will set the remaining positions at a breakeven stop if I cannot find a way to monitor momentum.  If I do not exit partially,  my trailing stop for the full position is at that price level which realises my initial reward risk ratio.  Can I get swung out easily?  Yes, but unless we know our edge, there is no point in taking on potential risks beyond our targetted reward risk ratio.  We can always re-enter with another set up, or we may just have to give this up - remember there are plenty of opportunities down the road.  Some of these opportunities allow us to let profits run extensively, and some do not.

If however the trader insists on taking all such opportunities when they occur on a full trading position, it is best he first considers how to manage the trade, what potential reduction in reward risk ratio he is prepared to accept, the longer term impact on his equity based on continual deployment of this strategy, before he enters the trade.

Remember, there are essentially 2 types of profit runs

1. Price persists in a favorable direction even after the set up has been completed and achieved our desired reward:risk ratio, and we do not have an edge.

2. The set up deployed is meant  to capture continual price trending action, and remains relevant when price persists in a favorable direction even after the targetted reward risk ratio has been achieved. The edge continues to be in play.

The example discussed falls in the 1st category.  In the 2nd category, the set ups meant to capture and follow trending prices will indicate when to exit the trading positions, regardless whether the target reward risk ratios have been achieved.   When the edge is gone, the trader exits fully.  Such set ups generally let profits run, but are never foolproof.  Such set ups are also price movement oriented, not price level oriented.

The last but not least consideration is the trader’s psyche makeup.  If his personality is such that he is less anxious with small ebbing retracements, but freaks out at a large swift pullback, then it is better he keeps a tight stop loss as profits run – otherwise he risks taking foolish action without properly evaluating his options when a big retracement wave hits.

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