Relate Real Life Situations To What Happens In The Market

Part of Trading is always looking around you in order to try and relate real life situations to what happens in the market. Try this and it will help your trading I guarantee it.

Many people get very upset with themselves and the market in general when it refuses to perform or behave in the same way two days in a row. Part of the reason we get upset is because we have been conditioned to learn in a certain way and further to expect other people to react to us in a standard pattern when we interact with them.

I will give you an example, as a child we very quickly learn how to react in order to gain attention from our parents and further we understand what we need to do in order to receive a treat like a sweet from them. We perform an action and this produces a response. We then repeat the event and expect the same response At school get good marks and everyone will always smile at you and youll be liked, get poor results and you are viewed as the dunce action and response. At work put your head down and produce something you SHOULD get a salary increase action and response. I am sure that you can come up with other examples.

Now lets compare all this to what happens on the trading floor of Betfair.

Trader A decides that he will adopt a policy of controlling his losses; he understands very well that the preservation of his trading capital is of paramount importance and his ticket to being able to come into the market everyday in the pursuit of gain. He is a well rounded trader who understands risk control and money management.

Lets say when he backs a horse at 1.96 he applies a very tight stop of 0.5 points and if the price reaches 2.01 hell be stopped out of the market, he moves on to the next trade. Trader A decides that he needs to let his trades run a little in order that they really profit. Trader As method is profitable 70% of the time and so he decides that he will take profits at 0.10 points, so when be backs at 1.96 he will neutralize his trade by Laying at 1.86.

Trader A realizes that the market is always right and that his method purely takes out of the market what the market will offer him based upon Trader As well defined trading rules

Trader B hears about Trader A, his 70% win ratio a 0.10 profit target and a 0.5 stop loss. He does his maths and reckons this is about as good as it can get and so decides he will shirt tail Trader A precisely.

Now lets examine some trades which then occurred during an afternoons racing and the results of those trades for both traders.

Trade 1: Stopped Out. Price moved almost immediately to the stop point and stopped both traders out.

Trade 2: Stopped Out. Price moved almost immediately to the stop level and stopped both traders out. Trader B notices however that the price only went briefly past the stop out point before coming back - and making what would have been a profitable trade in fact had he held on a bit longer instead of having such a tight stop.

Trade 3: Trader B, based on what he saw in Trade 2, extends his stop to 0.10 points. The trade takes place and is a Stop out. Trader A gets stopped out for 0.5 and trader B for 0.10

Trade 4: The Fourth trade is very nice and is immediately successful hitting the 0.10 profit target fro both traders.

Trade 5: The fifth trade is also successful and the winning target of 0.10 is easily obtained. In fact it is so easily obtained that trader B decides he would like to get back some of the losses he took earlier and therefore extends his target to 0.20 points for the next trade.

Trade 6: This trade reaches the 0.10 target for trader A, and in fact moves into profit by as much as 0.16 points, but falls short of the 0.20 points required to hit the new target set by trader B. Price then does a nose dive and trades down the whole back to trader Bs stop out price and Trader B is stopped out.

Trader B is furious and stops trading the method, blaming the market, the system and anyone else around him for his malaise.

Trader A feels like a happy bunny, counts his trades and  tots up his totals as follows:

Trade 1 -0.5
Trade 2 -0.5
Trade 3 -0.5
Trade 4 0.10
Trade 5 0.10
Trade 6 0.10

Total 0.15 Win rate 50%

For the record here are trader Bs results

Trade 1 -0.5
Trade 2 -0.5
Trade 3 -0.10
Trade 4 0.10
Trade 5 0.10
Trade 6 -0.20

Total -0.20 Win rate 33%

How can we use a real life situation to give an example of what we just saw above? Well perhaps we could look at a group of Chimps and a tea party?

Imagine that Trader A and Trader B were in fact chimps and they are part of an experiment in conditioning.

Lets say that we attempt to teach the chimps that at certain times throughout the day we will open a hatch and present them with a plate of food. We want to see how they react. In trading terms we could say this is the market presenting us with a trading opportunity.

After some time both of the chimps realize that when the hatches open, there is food available for them and they go towards the hatch to eat. There then follow a series of events similar to the trading examples I gave earlier in my article and the experiment turns a little more complex.

On some occasions the hatch opens and then closes rather quickly so that the chimps do not have time to get to the food and eat it. Other times the hatch stays open for a long time and the chimps are able to eat the plate clean if they want to. We also have the situation where the hatch closes whilst the chimps are eating although they have had enough time to eat sufficient food.

Lastly the chimps have to make do with the fact that the hatch opens at irregular intervals, sometimes quite frequently and other times, rather infrequently.

One chimp gradually managed to understand that the best solution was to always eat moderately when the opportunity arose and he didnt get upset when the hatch didnt open or when the hatch closed before he had time to finish eating - as he knew another dinner would be on its way sometime.

Whilst the above might sound rather cruel for the chimps we are only talking fiction here, and I am just trying to point out the various situations the chimps have to respond to just as we traders have to respond to situations in the market.

To complete the picture well examine each case and make the comparison between the chimps and the traders

Hatch opens at irregular intervals Market offers trader a trading opportunity when the market decides it wants to give such an opportunity.

Hatch closes before chimps can eat Trade gets stopped out.

Hatch stays open for a long period allowing chimps to eat as much as they want Trade meets its profit target objective and goes beyond target price.

Hatch stays open for a reasonable time allowing chimps to eat sufficient food then closes Trade meets its profit target.

If you look at the comparison between chimp and trader I think it is quite easy to see why Trader A takes the course he does and manages to profit in moderation. He understands that once a proven plan is in place he needs to trade that plan and if this means just taking bite size chunks of profit out of the market when the trading opportunities come along then this is what he will do.

Attempting to rescale your trading by increasing stops and or decreasing targets as you go based on the last trade result which is what so many traders do is sheer folly and a sure way to the poor house. As traders we have to understand that the market will congratulate you for doing one thing one day and punish you for doing the same thing the next day and this runs contrary to our conditioning as human beings.

If you want to be a trader you have to understand that this type of condition where we expect the same response from the market every time we do the same thing, just like we expected the same response from our parents imply does not exist. It is vital to grasp this as otherwise the pattern of repetitively changing a non broken method and adjusting it to the last trade will never end and in effect last your entire trading career.

Enjoy the fact that you understand this point and let the market wash itself all over you happy in the knowledge that you will have the last laugh.

So what ever your sport, investigate and research it and come up with a method which allows you to take those bite size chunks.

Be like the chimp that also learnt to eat moderately and went on to win the Chimpanzee Chase.

If you would like to talk trading then drop me a line.

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