Forget Setup Selection

In all areas of life, doing the right thing at the right time is critical. Certainly a hallmark of good trading.

In this article, I want to argue that the the “Right thing” isn’t what you think it is.

Mark Douglas is quoted as saying :

"Trade to trade well, not to make money. Money is a by-product of trading well."

What does it mean to trade well?
What actually makes your PnL curve move the right direction?

Most people who enter markets feel as if they must do “smart” things. They must move in the market as an elite setup chooser and cunning competitor.

I disagree.

I think having a “clever” system is the high on the list of meaningless endeavors. While you need to know when one thing is more likely than another, you do not need that to be complex or “cutting edge”. Imagine Harrison Ford shooting the swordsman in Raiders of the Lost Ark.

“You choose your fancy tools, trades and methods. I just double up when I’m right”.

So, the “Right thing” isn’t taking trades at levels you can defend to your friends or trading setups that make for good screen shots. Doing the right thing is being as right as you can the few times you are right and, most of the time when you are wrong, being wrong as little as possible, all while holding your mental in check, above all else.

In the above image, I have posted the hypothetical results of a positive expectancy program. I thought this was an ideal display for a few reasons.

This system has a 60% win rate and a I varied between 1:1 and 2:1 Risk Reward. If you look at the points, you can see this.

On paper we would all take a 60% win rate and a 1.5/2:1 risk reward.

You may look at this graph and be excited about the lower left to upper right quality of the trades, however, I want you to look into to the pattern here a bit more.
Notice two things:

1. The system immediately produces a negative PnL.
2. After a major run up, it posts 6 losses in a row.


Almost everyone can find a “winning” strategy.
Almost no-one can trade that strategy.

Winning trades are a dime a dozen. I could care less about how cool, interesting or clever a trader’s system is. This quality has little, if nothing to do with being a great trader.

Set your math aside for a moment. Set aside how clever you are or how well you done in other areas of your life. I have the same resume. It means nothing.

Let me say that again. IT MEANS NOTHING.

What does matter?

"There is a random distribution of wins and losses in any given set of edges".

In any set of random outcomes a few things will happen. The most important is “trend”.

Trend will happen in any given set of random outcomes. In a 50/50 bet of a coin, there will be trend. You will see multiple tails in a row.

In a 50/50 bet, the trend distance only last about 3-4 flips. I’ve had more in a row but, consistently you can’t expect more than this.
How do you win? When you win, double the bet size.

Ideally, you would have a product that trends more than a 50/50 quarter toss. In this case, you should be adding MORE as you find that trend.

Understand me here. The worst thing you can do in a market is not take a loss, the second is take profits.

Let profits run.

Meaningful data:
You need to be realistic about how far the trend can run. If, in a coin flip, you double up every time looking for a 5-7 heads run, you will lose.

This is the most meaningful data you can get ahold of for a product. How long can it trend? How long can I keep hitting double size before it reverses?
Forget everything else you know. If you focus on this one thing AND taking those loses fast without irritation, you can win with any strategy.

The Mental Game

This, as you can imagine, is not done easily. It’s done only with a specific mental quality. It’s not just toughness or resolve. It’s about speed and control of thought. About building habits. About full rational thinking in the midst of high pressure situations. You have to find this for yourself. Some will, and some won’t. That is a fact.

Can you guess with your hard earned capital?

Most people cannot. I can. That’s my edge.
I can guess with my capital and I can guess harder than most. If I guess right, I double up. If I guess wrong, or get a sense that I have guessed wrong, I bail fast.

It’s truly as simple and as complex as that.

Learn to think in probabilities
There are a lot of ways to do this. A few games can help.
Let me toss this link out:

This is a simple coin flip game exercise. As you flip, think of these as trades. Visualize the drawdown.
Let the pain sink in. Then trust the probabilities.

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