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Achieving Positive Trade Expectancy

If there is one thing I am sure of it is that market movement is far simpler than we all initially make it out to be. I am certain of this because I see it every day. While most of us can identify a market's predominant direction, the minute we start to plan on profiting from it, the complications set in. Let's compare trading to planting a garden. In gardening, we turn over the soil, plant the seeds, and water every couple of days. And we don't generally spend much time worrying about whether the garden will grow - we are confident from past seasons, or from seeing other gardens, that the odds are in favor of our garden growing. It can be said that we have a positive expectancy. Growing a garden is a simple process that just takes a bit of time. Now if we gardened like many of us trade, it would be a much more hands on experience. We would probably get reams of material on soil conditions and geology, check the weather conditions regularly, consult our growing library of gardening book, perhaps get a book or two on meteorology, and then after planting our seeds, dig them up every half hour to see if they were growing. And if a seed was not growing, we would likely throw it away -- clearly it was Home Depot's fault for selling us the bad seed -- and drive to the garden center two towns over - where we could remain anonymous-- and get new seeds, without having to explain how the first seeds were faulty.

If not for my own stubbornness, and great mentors I would likely still be reading reams of inconsequential information and digging up seeds to see if they were growing. I haven't completely rid myself of my own complications - my last hurdle is giving up on thinking I need to somehow coordinate the "macro picture" with price actions. I do however see the wisdom of the trading / gardening analogy. You don't have to stare at the garden all day long to see if it's growing. Often enough you don't even have to water the garden because nature takes care of that for us. Occasionally checking the weather forecast will suffice. The analogy is showing us that often the smartest thing we can do once we've put a trade on, i.e.: planted our seed, is set the stop 10 ticks (pips) further back than our first inclination, and walk away and do something we enjoy. We can come back from time to time to see how the trade is progressing, and if we are a short-term trader, check the calendar to make sure we don't get caught in any central banker announcements or employment numbers. While walkng away and allowing the trade to develop rather than jumping out at the first sign of a profit is easier said than done, it can be done if we prepare our self's ahead of time.

What every trader wants is positive trade expectancy, or the knowledge that over time they are going to be successful. In other words we all want peace of mind. There are three steps to achieve this, and while they are simple, they don't always come easily for most of us because of our penchant for making decisions based on our emotions, and not our needs, and our urge to control things. The three steps are:

1. Select a method.

2. Test that method for whatever time frame you have selected to trade.

3. Demo or micro trade that method in a live markets to give you a large enough sample size to determine that by following this method you will be successful.

Do not think that you can take any short cuts while completing these three steps if you want peace of mind when it comes to risking your money to make more money. Each step builds on and confirms the step before.

The most important step, arguably, will be Number 1. It is important that your chosen method is based on a simple concept. In addition it must be easily explained. If you don't grasp why it works right away, then you better be careful about wasting your time on step 2 and 3. And it must be based on studies that make intuitive sense to you - such as a trend trading method based on fractal geometry, or a mean reverting method based on a specific market environment, or a macro strategy based on an obvious economic development. Your own intuition is your best tool in deciding on a method, and the key is making sure the strategy resonates with your needs, and not your ego or your fears.

When it comes to step 2 - back-testing -- you must be aware if the actual trade signal is time based. The funny thing about back-testing is that the chart only records signals that occurred on a closed candle basis. Back testing will not record those times over the life of an individual candle that a moving average crossed and uncrossed, or price traded above resistance but then closed back below it, or a MACD increased or decreased. Back-testing always produces better results because you only deal with closed candles. If a trading educator does not cover time based, or fact based signals up front it may be a warning sign. The most important thing you will learn in the back-testing process will be the importance of sticking to your plan - your method -by letting a profit run when the method tells you to, or exiting a trade when the method tells you to. Unless you stick to your plan you can easily produce vastly different results than what you desire, thus skewing your benchmark. You will learn that by not doing what the market and your plan tell you to do, you are wasting a lot of time.

Number 3 - testing the method in a demo or micro account in a live market in real time-- is the only way you will obtain subconscious positive trade expectancy. You will also learn how it is not always easy to carry out a simple task. Your trading plan may be as simple as deciding on which vegetable to grow, planting that seed, and watering it, but you will find out how difficult it is to not interfere with that plan, and how hard it is to do what the market tells you to do when it tells you to do it. You will find out how dependent your previous decision making process was on your emotional wants instead of your long-term needs - particularly when you are sitting alone in front of a computer screen for hours and hours. But if you stick with it, and overcome the emotional urge to deviate from the trading plan for the sake of control, your faults will eventually become apparent to you. And in time you will stop allowing your emotions to throw obstacles in your own path, which will allow you to simplify your thinking, and stick to your method and plan which will lead to the shift in your trade expectancy.

How long will all this take? That will be up to you, but my guess, a little longer than you think.

Jay Norris is the Author of The Secret to Trading: Risk Tolerance Threshold Theory To see Jay highlight trade set-ups and signals in live markets every Monday and Thursday go to Live Market Analysis

Trading is a risky endeavor and not suitable for all investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.