Thursday, January 16, 2014
Tight stops and other simplifications
I've been trading 5t stops for a while and so far, its been rough on my win-rate, even though my general direction on a trade may be right. For example, a larger stop (but not 10t stop) would have probably yielded a 20t profit on the short below b7.
The small stop is possibly changing my behavior as well, making me take on some riskier trades. This could be something I just need to work on and get used to. However, I believe that in the long term the 5t stop will pay off very well.
Meanwhile, I've been working on general simplifications to the trading model. One of the reasons traders cannot recall their knowledge base during trading is due to the way human mind works in times of stress.
A trader looking at the screen has four loads on his brain: Visual, Intellectual, Memory and Motor. This is called the VIMM model. The more visual elements on the screen, the harder your brain needs to work just to recognize patterns. Removing everything possible helps you focus on a smaller set of variables. Ideally, you would only focus on one variable. Removing the ema and volume bars has direct effect of freeing up visual work.
Once your vision has processed symbols, your intellect works on recognizing patterns and performing analysis. Your memory enters the picture next, recalling every piece of data relevant to the situation at hand. Last but not the least, you need to actually enter the order in time.
It is a known fact that each stage when simplified, frees processing power for the others. Its also known that stress impairs memory and instincts are heightened. This is why memory failure during stress is so common.
My current hypothesis is that the innumerable patterns and setups scanned for by price action traders are a huge load on the intellectual and memory systems of traders. Under stress, people are unable to process information efficiently and this often results in making mistakes that are obvious in hindsight.
My approach to this problem is to have very few setups. The real factors in trading are time of day, volatility and money management. Setups are important, but secondary. As you can see today, one or two hours on the open is the best time to trade. The rest of the day is often lukewarm. Today is also a poor day to trade because there is no real volatility. On a big day, you can simply enter with trend and ride it out. The 5t stop is the money management and trade management piece. Despite a win rate of only 20%, my Profit Factor for the day is 1.78, which is decent. This enables me to take on more experimental trades enabling me to broaden my knowledge and enhance my trading system.
I'll post more on these in the coming days.