atlus1432's  Instablog

$AMGN

Did you know that the more money you lose trading, the harder it is to make back what you've lost? I can't think of a greater example which personifies the name of my company Fulcrum Shift Trading. For those of you who don't know, a fulcrum is a support or point of rest on which a lever turns. Think of a see-saw, the fulcrum is the balancing point supporting the bench which tips up and down. A fulcrum can be used as a mechanism to gain leverage as you move it (the fulcrum) closer to an object which you may be trying to lift, thereby reducing the load required by you. If you move the fulcrum back toward yourself, the load increases making the object far more difficult to move. The same concept is constantly in play whether you realize it or not when trading. When you lose -20% of your trading capital, it takes more than 20% in return to restore your account balance back to its original starting balance simply because you have less money to work with. My biggest "Achilles heel" when I began my trading career was (among other things) trying to recover from a draw-down as quickly as possible. Let's stop - right here - just think about what I said - " I would try and recover from a draw-down as quickly as possible". ANYONE who even entertains that thought process is doomed as a trader. Your frame of mind enters into one which is demanding - one which is anxious, one which is expecting. If you remember part 1 of this post, frustration is a function of expectation - a need to get back your losses - a need to be right. They say everything in life begins with a thought. The demanding, the anxious, the need to be right thought process, naturally leads to an unfocused and rushed state of mind and it is in this state when you are most vulnerable to trading errors. There is nothing wrong with taking a loss or a string of losses provided they were disciplined.  Ones where you defined your edge and applied your risk management and position sizing, all the while accepting the realities of probability. The greatest traders alive today experience consecutive losses but it is how you choose to respond to a loss or draw-down which will define you as a trader. My tendency was to "double down" on my next trade, trading a position twice the size of my normal trade. If this trade also became a loser I would only compound the problem, reinforcing the mindset that I MUST get these losses back as quickly as possible.

http://www.screencast.com/t/5YvmcGpSfGy (Click to enlarge)

"Frustration is a function of expectation" - I'm not sure who said that but it is universally true, perhaps even more so in the world of trading. If I were to participate in an annual golf tournament that my company holds during the summer, and I know that other than this once a year event, I don't play golf any other time, then I won't expect to shoot a good score. Actually I don't even expect to shoot a decent round given the difficulty of the game. However, if I were an avid golfer who had played for years, plays as many times per week as I can during the summer months, takes lessons and have spent a great deal of money on private lessons and golf equipment, then I would expect to see some results relative to my commitment to the game. The frustration comes when the avid golfer plays poorly, expecting a decent if not a good (perhaps even a great) round of golf  given the time, money and effort spent. The "once a year" golfer can shoot a horrible round by golf standars of what par is,yet is completely o.k. with it and in fact ends the day having had a great time becasue he or she had no real expectation for themselves other than enjoying the day. Probably laughing at how many golf balls they lost along the way!

Frustration in trading is eerily similar when you have huge or unrealistic expectations that do not end up manifesting. The stronger a traders convictions are about the future direction of a particular underlying instrument, the greater the chances are to do serious damage to his or her account balance. We are starting to enter the realm of pyschology here but lets follow these bread crumbs back their origins. When we as traders initiate a directional trade, we must, by default, expect to be right. Allow me to defend that statement by asking it in reverse. When you initiate a trade do you expect to be wrong? Not very likely unless you enjoy the act of throwing away your money. Simply put - we expect to be right on every trade we initate, otherwise we wouldnt. However, we must also acknowledge the reality that we wont be correct on our calls every time hence the need for risk management, position sizing and a factoring in of probability. Stops are a traders best friend contrary to a lot of theorectical approaches that I have read. Scaling into a losing position is an act of denial - having strong convictions that you are right. As mentioned above, the stonger your convictions, the more apt you are at sticking with a losing position until you become "right"  or until you wipe out your acount. Think of the hundreds of thousands (if not millions) of traders and investors who appraoched the market with this mindset last fall during the worst market correction seen in a generation. All the technicians, regardless of whether they were professional money managers or  individual retail trader trading from the comfort of their own home, were crushed when the market continued day after day, week after week to the downside. Technical support levels were penetrated like they didnt even exist. The probabilities of even reaching , 2nd and 3rd standard deviations were so minimal that traders CONVICTIONS of an imminent revesal strengthened which in turn, only bolsterd their expectations of a market reversal to the upside. How FRUSTRATED must they have been - how many margin calls were forced upon those traders  liquidating at horrific losses to their trading accounts and ultimately their net worth. One could not turn on the news without watching headlines daily about the staggering amount of wealth that was being wiped out. All of this could have been avoided with proper risk management and, risk management comes down to your expectations which as I mentioned at the beginning of this post, is the cause of frustration.

Below is a tool that I built within the m3 - Money Management Modeler which manages a traders expectations as to how many winning OR losing streaks they can expect based on their own individual trading results. How often do you experience a winning/losing streak? Well - that question requires some parameters so, first we need to define what you consider a winning streak. 3 winning/losing trades in a row, 4 winning/losing trades in a row, how about 5 or 6 ?You get the point. A streak, technically, could be defined as at least 2 trades or more in a row (1 winning/losing trade does not meet the definition of a streak). The other variable we need factor into this question is over what time frame or sample size so that we can answer the question "how often"? If I experienced a 5 trade consecutive winning streak and someone were to ask me "well... how often does that happen"? I would, without consciously realizing it, "think back" as to the last time that happened. Perhaps it was 3 weeks ago, perhaps 3 months or perhaps I have never experienced the joy of 5 consecutive winning trades in a row! So, lets ask the question again with some constraints - "How often do you experience a winning/losing streak of 5 consecutive trades over the past 500 trades"? Here we have now defined the streak number (5), over a defined period of time (past 500 trades).

The m3 - Money Management Modeler does this for you. It will tell you how many times, over a 500 trade sample size, you can expect to have 3,4,5,6,7 and 8 consecutive streaks - wins or losses and the results are dynamic meaning each time you tap the F9 key on your leyboard you engage the random function built into the platform which shuffles the order of the distribution of wins and losses. Most importantly, you as the trader define the probability of reaching your point objective by manipulating the spinner within the Excel platform based on your own independant trading results. This input along with the F9 random function will manage your expectations so that you never have to feel frustration!

Please clink the link to see an enlarged screen shot of the m3 - Money Management Modeler and I will post part 2 on this topic in my follow up blog.

"TRADE WHAT YOU SEE AND NOT WHAT YOU BELIEVE"
 

Fulcrum Shift Trading
 

m3 - Money Management Modeler