Doomed Energy So Implement Rock-Solid Edges
|The desire to be right|
The desire to be right:
William Eckhardt, ex partner of Richard Dennis, and with a great track record of over 20 years, said "Human nature does not operate to maximize gain but rather to maximize the chance of a gain. The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to performance. Two of the cardinal sins of trading - giving losses too much rope and taking profits prematurely - are both attempts to make current positions more likely to succeed, to the severe detriment of long-term performance. Don't think about what the market's going to do; you have absolutely no control over that. Think about what you're going to do if it gets there."
In the download sectionyou will find an Excel
spreadsheet, which contains a simplified illustration of this market phenomenon.
It shows how and why the desire to be right takes a whole lot of traders out of the market each and every day. They focus on % correct (profitable) trades and % false (losing) trades instead of other much more important trading statistics.
Generally you have the choice between
• being wrong more often than being right and achieve large profits relative to the losses (Math driven), or
• being right more often than being wrong and achieve large losses relative to the profits (Ego driven).
So not the number of trades which are profitable (a
failed signal is the most reliable of all signals) but the SIZE of the profitable trades are relevant.
- EmphaSIZE on Position SIZE
Usage of the spreadsheet:
Move one of the two sliders to change the percentage of "how often you want to be right" (don't enter your percentage into cell "B7", use the slider instead). You can choose between being correct 10% of the time to being correct 90% of the time.
Each time you move the slider, random trades are calculated according to the currently selected winning/losing percentage. To recalculate without changing the current winning/losing percentage just click on the Chart.
More on the desire to be right:
For a lot of "investors" the desire to be right unconsciously is one of the core motivations to invest in the stock or futures markets. That's why the crowd loves to trade according to predictions (either their own or the predictions of the currently available market gurus). If they are right, they are happy, no matter what amount they win when they win, no matter what amount they lose when they lose. They even accept a negative expectancy as a result of there ego-driven behaviour.
See also: http://www.turtletrader.com/analysts-bias.html
Just imagine if you trade with a profit target of just 3%, i.e. you sell as soon as your return reaches or exceeds 3%.
No stop loss, no other exit technique. - You will have a very high percentage of profitable trades.
I tested this "strategy" on the S&P using monthly data from January 1871 (!) until January 2000 (for those interested: download "ie_data.xls" from http://aida.econ.yale.edu/~shiller/data/).
There were exactly 100 trades, with only 12 (12%, sic!) losers and 88 (88%) winners. No surprise. This is right what hundreds of trading system vendors sell to their "unlucky" customers for thousands of dollars.
Reacting is a business decision, predicting is an ego play:
If you just react to market action it will do. It doesn't count if you enter a market 1 or 5 days later.
• when and how you exit a trade and
• how much you risk
on each trade.
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