Most of us know intuitively that following a sensible, proven regimen in life is the way to tame the dualism that exists between our logical, analytic side, and our fun loving, emotional side.
In trading however there is not much need for balancing these two sides. In fact there is no room for emotions because they often lead to loss and failure. In trading nothing matters but the data, the analysis, and the statistical validation.
Fear of Loss and Failure
If someone is learning to trade, and they are counting on future income from trading to get by, and they are unsure how the trading method they are counting on will perform next month, or the following year, etc, then they rightfully ought to be terrified.
It's an easy sell to convince us to learn to trade. It's a completely different process of coming to trust the trading method we have chosen. Our fear of failure is a good thing because it keeps us from jumping into the deep end without a life preserver, and it stimulates us into analytic mode. Fear is good
A Plan in Hand
Professional traders will tell you the way past the fear of loss and lack of trust is a benchmarked trading plan. Without that black and white proof in hand, which you yourself have compiled, you are likely on what my mother calls "a wild goose chase". Have you ever seen a toddler chase a wild goose? In the best case scenario the goose runs and the child exhausts herself. In the worst case, the goose turns and defends its territory.
A benchmark is a record - usually a spreadsheet -- that shows the history of a method's trades in all trading environments, i.e. up markets, down markets, sideways markets, etc. It provides an abundance of useful information including that all important win/loss percentage and the risk: reward ratio. It is your end-game when it comes to market analysis and trading education, and tells you if you're ready to risk your money in the market.
Once you have the statistical proof that the trading method you are considering works -- in the form of that benchmark spreadsheet -- you can start to demo or live trade that method with the goal of matching your own performance to that of the benchmark for the time period you have chosen to trade -- see Figure 1.
Keep in mind it will be hard to match the benchmark because it is unlikely you would be able to stay awake for 5 days straight and manage every trade to the letter of the plan. It is a record of the trades the method you follow has produced. Over time however your own trading should reflect the winning percentage and risk/reward of the benchmark.
Pattern / Fractal = Measurable Data
One of the largest drawbacks for people wishing to learn to trade is they get sold on a method that is reliant on the computer for its indicators. Markets are fractal in nature -- more on this in a moment -- and fractals do not lend themselves to being measured with linear technical indicators which are at best secondary indicators of price itself.
The beauty of fractal design, i.e.: chaos, is that each new iteration, or pattern, is slightly different than the previous pattern! "Chaos" by the way actually means a higher order. While the human eye is very good at recognizing a slight pattern shift, a computer is not. The computer calculates exactness, in a world that is far from exact. In a fractal, or chaotic world, each new pattern is a slight variation of the previous pattern -- think of the branches of a tree, or the waves hitting the beach - where after even just a handful of samples that difference will have increased enough to have thrown off the computer. On the other hand that same little girl who was chasing the goose earlier will easily be able to follow the string of slight changes over an extended period of time.
Another advantage of fractal patterns is they are easy enough to see over different time periods, which makes them easy to collate and record, i.e.: they lend themselves well to benchmarking.
Man versus Machine
An example of a pattern which is easy for the naked eye to see but which a programmer would have a hard time programming is seen in Figure 2. The two retracement levels, which are identical in terms of percentage, are drawn from the low of the last correction to the high of the ensuing rally, and provide high probability levels to watch for "buying dips", while the standard deviation line of the Bollinger Bands provides a nice visual which lends us confidence. "Nice visual" by the way is not in a computer programmer's lexicon. To an experienced trader these two trading opportunities - dips in uptrends - are picture perfect, and stand out nicely. To the computer however they are widely different in scale, length, and timing. In terms of understanding and ease it is far simpler to draw those retracement levels by hand than try to get a program to draw them for you.
While the computer is a great tool, you have to know its limitations, and a big one is pattern recognition. Figure 3 is the same chart only we have highlighted the two patterns by outlining them. The retracement -- support level -- is calculated by drawing a 2/3rd retracement from the low price in the box to the high price in the box.
What does "fractal in nature" mean?
In Figure 3 we get a more intuitive view of the market. First we see the larger pattern on the left with an upside climax, followed by a characteristic dip -- retracement -- to support (the green line), followed by a smaller pattern on the right, within that larger pattern, with again a retracement to the green line that is nearly identical in length to the retracement in the first box. Once you have an experienced eye for pattern recognition you will notice right away the self-similar behavior that markets exhibit on all time frames. For example, notice the small box created by the overlap of the two larger boxes. Notice we have a price "retracement" following a sharp rally, which is again identical in length to the other two retracement levels which we've already highlighted with those short green horizontal lines! It is this self-similar behavior we are referring to when we say markets are fractal in nature. The sum of the parts equals the whole, and the parts themselves are self-similar miniatures of the whole. It is our understanding of this behavior which we have used to construct the trading method that created the benchmark spreadsheet in Figure 1.
Seeing markets from a fractal perspective is definitely an "eye-opener" as many friends describe it, and it also lends itself well to statistical validation, i.e.: benchmarking. I can't help but think of the author of "Trading Chaos" Bill Williams' quote: "In this early part of the 21st century, we have a choice to either be a part of the last generation of traders and investors using linear (ineffective) techniques, or the first generation using nonlinear (chaotic) techniques".
If you are not seeing desirable results in your approach to market analysis and trading, and you still want to continue, you must focus on a method that you can benchmark yourself.
Jay Norris is an Analyst at Trading University. To see him highlight set-ups and signals in live markets every other Thursday go to "Live Market Analysis"
Trading involves risk of loss and is not suitable for all investors
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.