psychology of trading

[stanlawj]

I just want to add, or rather, to explain why trading is so hard. from a maths angle. despite the usual trading without a plan, or not following the plan, not enough efforts made, not capitalized well enough, not learning the right things/knowledge, we still have be exceptionally focused to have a positive expectancy.

supposed you are a trader, trading short-term. supposed to have a good system, a slight edge, say 50% win probability. And u are able to ride out winners and cut losses so you average win/average loss is 2:1 (not unrealistic for a short-term trader). on paper you have +ve expectancy 0.5 x 2 - 0.5 = 0.5

but say if out of those 5 winning trades you cock up one, and assuming the exit u still do properly, then it becomes 0.4 x 2 -0.6 = 0.2 the expected returns go down quite dramatically

if you cock up 2 of those 5 winning trades, then it becomes 0.3 x 2 - 0.7 = -0.1 you start to lose money

and you have to keep repeating the same performance over and over again, with no margin for error.

of course some methods you can aim for a higher average win/average lose, but your win probability will go down correspondingly, like in the case of a trend following method.

that is the level of focus we need to achieve, every 10 trades, the " right" 5 trades you cannot even cock up 1 or 2 .. that is why it is so challenging to be consistently profitable ..

so, the level of focus, and the margin of error ..

The key is to study the non-chart factors to increase trading edge of the system.

I read in an article recently, comparing trading to the pyramid classification of super successful traders at the tip and unsuccessful traders being the base. When there's a buy, there's always a sell and vice versa. To be profitable in trading, we have to climb and rise above traders who are making a loss or break even.

Traders who trade systematically would have a "set up" that they will be waiting for, because the set up has a probability to be a winning trade. Usually we have no control over the outcome of the trade (be it a win or a loss) market moves the prices, we just depend on the probability of the setup. But it would really take a trained mind to control the emotions even if we know this.

The top of the pyramid are mainly the bankers/fund managers (GS, MS, Citadel etc).
They extract money from the retail/public which are the 80% rest of the bottom pyramid.

Imagine the stock market consists only of fund managers/bank traders. Hmmmm... how are they going to extract profits from each other in a zero-sum game with each other only? The system cannot work without retail investors (non-banking/non-finance money) who are willing sheep to be slaughtered (because they supply the money to the finance sector).

The prop traders at the top performing funds use alot of scientific modeling to forecast the markets and identify any statistical arbitrages. With the availability of mindblowing compute power + realtime data collection including satellite photos, they can model almost entire economy, weather, etc to frontrun the retail investors and pension funds. Take note these ppl pass on knowledge to their juniors like any other organisations, so their methods became this sophisticated over long period of time.

To climb up and join the top, to me, is possible, and the fastest way, is to play in markets where the big players are missing or forbidden to join, i.e. markets where retail have an advantage.

a) small caps/penny stocks
b) emerging markets
(3rd option used to be crypto but now it is no longer an option)
Crypto was the market with biggest gains in past decade, because the major institutional players were not in there.

Also one of the most powerful strategy not available to many big funds (non-hft) is going 100% cash: they are too big to exit without changing the price, also cannot show 0% growth because need to pay performance fees. For retail traders, one can exit 100% and go to cash. From what I gather for myself, it is necessary to go 100% cash at right times to maximise capital growth for long-only traders.

 

[iridiot]

The key is to study the non-chart factors to increase trading edge of the system.


The top of the pyramid are mainly the bankers/fund managers (GS, MS, Citadel etc).
They extract money from the retail/public which are the 80% rest of the bottom pyramid.

Imagine the stock market consists only of fund managers/bank traders. Hmmmm... how are they going to extract profits from each other in a zero-sum game with each other only? The system cannot work without retail investors (non-banking/non-finance money) who are willing sheep to be slaughtered (because they supply the money to the finance sector).

The prop traders at the top performing funds use alot of scientific modeling to forecast the markets and identify any statistical arbitrages. With the availability of mindblowing compute power + realtime data collection including satellite photos, they can model almost entire economy, weather, etc to frontrun the retail investors and pension funds.

To climb up and join the top, to me, is possible, and the fastest way, is to play in markets where the big players are missing or forbidden to join, i.e. markets where retail have an advantage.

a) small caps/penny stocks
b) emerging markets
(3rd option used to be crypto but now it is no longer an option)
Crypto was the market with biggest gains in past decade, because the major institutional players were not in there.

Also one of the most powerful strategy not available to many big funds is going 100% cash: they are too big to exit without changing the price, also cannot show 0% growth because need to pay performance fees. For retail traders, one can exit 100% and go to cash. From what I gather for myself, it is necessary to go 100% cash at right times to maximise capital growth for long-only traders.

what do you work as ?

 

[stanlawj]

what do you work as ?

unable to answer. but i trade in my spare time.

 

[iridiot]

unable to answer. but i trade in my spare time.

Share what you can share about your own journey of trading during your spare time?

Like when did you turn profitable if you turn profitable , what do you trade , etc ?

 

[stanlawj]

Share what you can share about your own journey of trading during your spare time?

Like when did you turn profitable if you turn profitable , what do you trade , etc ?

I make most of my money from small caps/penny stocks in commodity sector. US,TSX,ASX.
For day trading, will be mainly US stocks (any sector) because of low fees and liquidity, which currently doing now mostly due to lack of trending market.
I missed the crypto bull run because my money was tied up in the penny stocks and skepticism towards crypto.
That's about it I will say.

 

[wtaps300]

Also one of the most powerful strategy not available to many big funds (non-hft) is going 100% cash: they are too big to exit without changing the price, also cannot show 0% growth because need to pay performance fees. For retail traders, one can exit 100% and go to cash. From what I gather for myself, it is necessary to go 100% cash at right times to maximise capital growth for long-only traders.


well said! dont squander this advantage!!

 

[stanlawj]

The most common trading strategy peddled on the street is the day/swing technical analysis/price action type, totally chart-based and ignore everything else.

The characteristics of such trading is small percentage gains (1% to 5% of portfolio) with high number (frequency) of trades. Occasionally there will be outlier gains like 10% to 20%, but they are very rare.

The other type of trading strategy based on non-chart factors, has a characteristic of very low number (frequency) of trades, but very large gains, typically more than 10% to 100%. Investing falls into this category, just that investors typically don't call themselves traders (like a stigma is attached to it).

The type of style depends on the ability and preference of the trader. The best trader is the one who can do both to match what the market provides.

When there are obvious non-chart factors/catalysts/information that give exceptional alpha with least effort, it will be foolish to just bury your head in the sand and daytrade like a monkey everyday.

Likewise in absence of factors/catalysts/information, then trading within the narrow volatility range of the market are the only opportunities available.

 

[stanlawj]

I traced the conversations around shorting SIVB since I already detected last year that the Fed couldn't raise rates while US banks still standing as if unaffected by any mark-to-market the losses on existing bonds. However I couldn't generate any actionable trading alpha from this due to lack of interest in finding out about bank internals (AFS, HTM etc).

From Oct 2022, this person already publicly declared his short on SIVB.


From Jan 2023, this person probably also shorted SIVB with the following reasons:


However, in between, SIVB actually rallied and squeezed out many shorts, before the final dive. To actually generate actionable profitable trading from this alone, also requires pinpointing technical entry points to avoid the short squeeze.

The returns are massive in just a short period of time, especially with put options, but only if you have the requisite knowledge to navigate through all the rallies. This is the kind of trading that mostly I spend my time on. Technical based trading is rather boring, after some time, just routine price action, and the daily grind of sub 1% or more is hardly going to lead to "LIFE-CHANGING" gains even after many years. (no wonder selling courses on price action trading is quite a thing among tehnical traders, probably they can't earn much anymore)



If you love banks, this should be the kind of killer trades to go for. (I HATE BANKS so I don't study them, so maybe I should change my mindset about them starting today)

FDIC released their last quarterly report on 20 Dec 2022. Chart 7 reveals the ballooning unrealised losses in the banks.

 

[slowmover]

If you love banks, this should be the kind of killer trades to go for. (I HATE BANKS so I don't study them, so maybe I should change my mindset about them starting today)

Hundreds of million market participants only few person won that particular trade. Statistically is harder than striking 4d 1st prize.

 

[DevilPlate]

If u are in Peter Thiel network, then baojiak. He sent out the warning, u go buy puts lolol

 

[stanlawj]

Hundreds of million market participants only few person won that particular trade. Statistically is harder than striking 4d 1st prize.

Is that a winner's mindset or a loser's mindset?

 

[slowmover]

Is that a winner's mindset or a loser's mindset?

am replying to your 'killer trade to go for' comment. can buy 4d every day but impossible to strike
4d every time.

got earn money is winner. if lose money is loser. what mindset also nvm.

 

[stanlawj]

The significant differences between day trading and position trading/investing makes it difficult to switch between the two easily:

1. Day trading:
a) high frequency of trades, each with very small % gains (a few % of portfolio) with even smaller % risk loss. For me, earning 1% while risking 0.3% (3:1 reward-to-risk) is considered v. good and rare. Those wondering why can't get much higher % profit per trade, is because the market is efficient on smaller time scales with many players. So frequency of double digit gains is much less on shorter time frames.

b) to get that high turnover, you constantly need scanning and searching for opportunities. It's like trying to make a million small bites like a mosquito. Cutting loss very often is part of the game as well but with numerous small profitable wins, then 50 x 1% = 50% is actually feasible and attractive in a short period of time.

c) the key point is there are too many unknowns fluctuating the price in the short term, so there is hardly any time nor capacity to try to determine the factors. In the end, it just becomes a statistical play, reacting to price and interpreting price action.

2. Position trading:
a) using the macroeconomic and business fundamental factor to drive (increase or decrease) the asset valuation.
b) very low number of trades because very few opportunities with right timing (to match the flow of the market) when you find it (i.e. need to wait long time for the correct timing even after you found possible opportunity).
c) much lower win rates as you cannot know everything and often timing is wrong due to hidden factors suddenly surfacing
d) very high reward-to-risk, and can earn-while-you-sleep.

Item 1b) took me a long time to get used to, because it is just like a day job, and is probably why most investors don't like day trading even though it works.

Items 2a)-c) are what most day traders find it too steep to climb, but 2d) is what makes position trading/investing worth while: make money and compound it while carrying on with other tasks in life.

 

[stanlawj]

On the topic of reacting vs predicting/forecasting mindset, this is one helluva confused topic among traders & investors that got me wrong and I eventually figured it out how they are different.

You should:
React to: PRICE (and VOLUME for stocks)
Predict/Forecast: Fundamental factors, and their influences on price.

The trouble with most people is to do the opposite. They see the good news about the company, and react to it by buying the shares now. This is REACTING to fundamental business news made public. By the time the news becomes publicly declared on all news papers, it may be too late because all the pros have already forecasted this in advance and positioned before the news.

Or an investor try to predict the price of the stock next week directly, i.e. looking at charts only and predict the price will go higher next week. Although this prediction is part of the scenario planning, it actually isn't the alpha-generating part of the strategy. The alpha actually comes from understanding the fundamental factors and looking for the price to show what kind of influence those factors have on the price, and then readjusting the fundamental model in real-time.

So the holy grail is to be able to predict and then react appropriately & timely.
If you have any comment, let me know.

 

[Compfix]

thank you..

 

[Mephist0pheLes]

BRAD M. BARBER and TERRANCE ODEAN (2000) Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors, THE JOURNAL OF FINANCE
- Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that trade most earn an annual return of 11.4 percent, while the market returns 17.9 percent.
- Avg household underperforms the risk appropriate benchmark by 3.7% p.a.
- 20% household that traded most frequently underperforms the risk appropriate benchmark by 10.3% p.a.
- Traders often overestimate the value of the information they have, causing them to underperform the market

Barber et al. (2009) Just How Much Do Individual Investors Lose by Trading? Review of Financial Studies, Society for Financial Studies
- individuals are less informed than institutions when they place trades
- institutional profits associated with passive trades are realised quickly, as institution provide liquidity to aggressive but uninformed individual investors

Barber et al. (2012) The cross-section of speculator skill: Evidence from day trading, Journal of Financial Markets
- between 1992 and 2006, less than 1% of the day trader in Taiwan is able to earn consistent excess return after cost.

Chague (2019) Day trading for a living? Working paper
- The more a day trader trades, the less likely is it for them to be profitable
- There was no evidence of learning from past trades, and gambling behaviour was observed
- Compared to the 2012 paper which was based on earlier data, traders now do worse because they have to compete with high-frequency trading algorithms


Barber et al. (2019) Learning fast or slow The Review of Asset Pricing Studies
- 3 possible reasons why traders trade despite data show that they dont do well:
1. they do not have standard risk preference (high risk seekers)
2. overconfident in their ability
3. trade for entertainment, gambling and desire to impress others.

 

[stanlawj]

Most of you will be interested in picking bottoms.

There is a reliable way to do so: (bear trap on daily close)
Break support 3-day or weekly low but price closes above the low, either same day or within 2 days.
This needs to repeats another time, i.e. price continues to break support again. Also there will be accompanying bullish divergence with indicators (eg higher lows in RSI) as downwards momentum is decreasing rapidly.

Of course the stock must still have bullish fundamentals (not a scam company).

Check this out for many of the stocks in the past few days, eg BABA/9988.

[Possible explanation: Shortsellers trying to max out their profit, so they close their shorts just after it breaks the new lows, leading to persistent buying.]

2nd method is to look left for strong support in the past quarter or year (not too far back though). The stock should have broken multiple support levels (at least 3) before reaching this place. A series of red candles, ending with a long bullish candle appearing. A doji is not good enough, but if you want to gamble on it, it must be followed by a bullish candle, otherwise immediately bail out to cut loss minimally, because a doji can be just a continuation to the downside instead of reversal.

 

[stanlawj]

If you are trader: this would be interesting. The stock market has no money. It is just functions like a record book.

Nearly all the money that buyer paid went to the seller who deposited it into his bank account (some to the middleman - the exchange, brokers - for transaction costs).

When Fed launched BTFP, the stock market rallied. The money from BTFP and discount window converted to bank deposit withdrawals which then mostly went into Treasuries (money market funds), because those cash deposits >250k need to be liquid yet 100% protected since all US banks are insolvent.

So the trigger for the rally is simply a play on the correlation of increase in Fed reserves with the stock market price (2008, 2019, and 2020). A perception of higher value led to the chase, where each buyer is willing to pay a higher price for a stock from the seller, believing ANOTHER BUYER IN THE FUTURE is willing to pay an even higher price.

So those who keep buying falling knife, need to think again, why would a future buyer want to pay a higher price than you now, if everyone wants to buy a falling knife right now hoping for a lower price? Stay away, and wait for the rebound in direction to establish itself.

The rule that will help everyone to become better stock trader is to remember the stock market has NO MONEY. Once you paid the money, it went to the seller's pocket. It is not stored in the stock market. Thus a portfolio of stocks is just a record book (of titles/ownership). Bank crisis illustrates, liquidity (Cash) is king. You can't buy food, or a house with stocks. You need to sell it first to get the cash. To make more money, someone needs to be convinced to pay more than what you paid now.

 

[stanlawj]

A contribution regarding PRICE ACTION: Most people think that price action means just trying to study the candlestick, volume to determine the buy or sell signal. I found out that is the novice mindset, and seldom I find alpha here over longer durations.

Actually the key is INTERMARKET ANALYSIS: studying price action not just multiple time frames, but in multiple asset classes, and comparing their price action to look for possible relationships.

Easiest to explain: eg. gold mining stock
Study price action of both mining stock and spot gold. One can lead the other or lag the other, and the leads and lags are clues.

A simple observation from Stan Weinstein is that the SECTOR performance contributes alot to the performance of the stock. So studying the price action of the GDX gives further clues of how a gold mining stock might perform. So that leads to the "bullish percent gold miners index" as a high probability top or bottom indicator.

Another example: IWM and REM often leads SP500. Instead of trying to be fixated on just SP500, look at what is the price action of IWM and REM and then use that to confirm price action anaysis of SP500. Further slicing the index according to FACTOR STYLES (eg. growth vs value) and studying the price action to look for rotation within the index.


In short: it's not the price action that matters most, it's the relationship between the price action from different correlated assets that matters most to find out what's the motivation of buyers and sellers.
Basically trying to decode what the portfolio managers as an aggregate are doing (who cannot be 100% cash, so when they rebalance their portfolio, their adds and subtracts create the buying and selling pressure).

 

[iridiot]

A contribution regarding PRICE ACTION: Most people think that price action means just trying to study the candlestick, volume to determine the buy or sell signal. I found out that is the novice mindset, and seldom I find alpha here over longer durations.

Actually the key is INTERMARKET ANALYSIS: studying price action not just multiple time frames, but in multiple asset classes, and comparing their price action to look for possible relationships.

Easiest to explain: eg. gold mining stock
Study price action of both mining stock and spot gold. One can lead the other or lag the other, and the leads and lags are clues.

A simple observation from Stan Weinstein is that the SECTOR performance contributes alot to the performance of the stock. So studying the price action of the GDX gives further clues of how a gold mining stock might perform. So that leads to the "bullish percent gold miners index" as a high probability top or bottom indicator.

Another example: IWM and REM often leads SP500. Instead of trying to be fixated on just SP500, look at what is the price action of IWM and REM and then use that to confirm price action anaysis of SP500. Further slicing the index according to FACTOR STYLES (eg. growth vs value) and studying the price action to look for rotation within the index.


In short: it's not the price action that matters most, it's the relationship between the price action from different correlated assets that matters most to find out what's the motivation of buyers and sellers.
Basically trying to decode what the portfolio managers as an aggregate are doing (who cannot be 100% cash, so when they rebalance their portfolio, their adds and subtracts create the buying and selling pressure).

How to do this? Use algos to find correlations?

I think sector rotation by institutions can be used by scanning various indices for the highest growth then look for patterns within various component stocks.