Sizing

A common risk reduction technique is to minimize size on less desirable odds and increase size on desirable odds.

For instance, if you had nearly 100% certainty that a certain outcome would occur, it makes sense to bet everything you have on it. In fact, you should sell the farm, borrow money and bet it all on the 100% certain bet. On the other hand if you have a 0% certainty that the same outcome would occur, you would do the same, except bet the opposite way, i.e., that the said outcome wouldn't occur.

From these extremes, it should be obvious that the hardest bet is when the probability is exactly 50%. Its effectively a coin-toss and if you repeat it long enough, you should break even. However, you could have long stretches of wins and losses and therefore you would need to bet smaller amounts. In fact, the right thing to do here is to bet the smallest possible size since your net outcome is the same regardless of the size of the bet but the damage to your account is smaller if you bet the absolute minimum. This makes the bet curve shaped like the letter U with max bets at 0% probability, falling sharply to near zero at 50% and rising sharply at 100% probability.

Placing trades is similar to the above scenario with certain differences. First of all, you can actually sit out and not bet in the mid-probability, which is most of the time in the market. Secondly, there is a transaction cost for every bet and therefore a you are likely to go underwater rapidly if you trade anywhere except a high probability zone simply from the costs. The new shape is like a strike-through letter U. Lastly, to bet something would not happen you would need to do something other than what we do here, such as write options.

Since costs are a significant amount in a high transaction account, simply sitting out low probability trades can push you from a losing account into a winning account.

When you are not certain whether a trade is high or low probability, it makes sense to trade a smaller size. For example, on this day, I placed full sized trades for #1 and #5 which earned handsome profits and smaller sizes of #2,#3 and #4, which effectively were a wash.

Multi-targets

Optimizing exits is something I've been working on for a while and its one of the hardest things to do in trading. There is a conflict between a clean exit and catching a large run.

For example, in today's first trade, I had a MFE of 1.2 and the second had an MFE of 1.5 for three contracts. Catching the top tick is magical and no sane trader should aspire to do it every time. However, if I had chosen to exit all three contracts on both trades today, my take would be .20*6 = 1.2

Another potential optimization is to exit on the close or beyond the first bar that does not have a strong close. In today's example, that would net me .90 + 1.8 = 2.7

Translated to per contract, it would take my winning from just under .30/contract to about .90/contract almost 3x better.

However, this is a reasonable thing to do only when you expect a trading range type behavior. On days when a trend is obvious -- which is quite hard before it sets up -- it may be better to hold on for the large move.

In the coming days you will see me move to a hybrid exit instead of fixed exits for 2nd and 3rd contract.

Trading without ema

I'm currently experimenting trading without an ema. My initial goal is to verify that my accuracy is no worse than trading without it.

CL usually reacts at first contact with ema, but my reasons for eliminating ema are foundational to the concept of price action.

First of all, ema is a computed value, and as such is subject to all the issues of other indicators. Secondly, there are many popular kinds of moving averages at every interval and timeframe. They all would be at a different value and a reaction on contact could simply be a popularity contest.

A trendline on the other hand is always the same at every timeframe. The trendline could be steeper on a higher timeframe or flatter on a lower time frame but eventually, contact with a trendline is always the same and its value as support has more credibility since you would expect every trendline trader to jump in at the same time, while ema traders are likely to jump in at different times.

My hypothesis currently under test is that setups that bounce off a trendline are more likely to succeed without a large pullback and pullbacks on such setups indicate early failure.

Single Trade Rule: A cure for overtrading

The promise of nearly unlimited freedom of being a trader, both in the way you work and your overall lifestyle attracts people of poor discipline to trading.

Discipline is the ability to obey your own rules by sacrificing short term temptations in favor of long term goals.

If your technique and market knowledge is poor, you should still be a break-even trader. A losing trader usually has discipline problems or is engaged in self-destructive behavior such as chronic counter-trend trading, random entries, chasing unexpected moves, reversing and re-entering on every loss and so on.

If you have a modicum of discipline, you should be able to limit your losses and turn the corner using the two strikes principle.

If you are unable to stick to even that, I suggest you try the single trade rule. Any day, you will take exactly one trade, win or lose. The purpose of this system is to slow you down and remove the urgency and unrest when sitting out and reactive behavior on loss (or even wins) that causes so much destruction.

A few months of the single trade system should make you more cautious and more tolerant emotionally to loss. More importantly, this should protect your account from rapid evaporation.

Patience and Agility

One of the hardest things to come to grips with trading is that you need to hone two conflicting instincts. The first and foremost is patience. You should be able to wait patiently for a setup that you are confident is a high probability setup. However, when the setup does show up, you need to jump on it and act without hesitation.

Impatience and unrest when sitting out is an account killer and many new traders fall for this trap and blow their accounts. If you feel an urge to get back into the market right after the moment you are stopped out, you are afflicted by this trading ailment.

When traders see large bars such as b1,b11 or b20 they get anxious about missing out on a potentially huge move. They suspect a potentially large drop or huge rally that will net hundreds of ticks which they have been waiting for all their lives and are compelled to act. Subconsciously, they have made a choice that losing one more trade among the thousands of lost trades is a small risk compared to the huge gain they are going to have if they chase this big bar.

Unfortunately, huge rallies and dramatic crashes are rare. But when they do happen, it leaves a strong impression in our memories simply due to the intensity of such moments. Our instincts are tuned to prepare for such moments and we act accordingly.

To deal with impatience, develop a set of checkmarks that you need before entering a trade. Such a test needs to be simple enough that you can evaluate it in a moment and anticipate such a setup as it develops. If you have to process a lot of information at the second a bar closes, the urgency will force you into errors.

A simple three pronged test I use is the following: The trade should occur with support. For example, trade #1 today was at the low of the prior day and is a potential place of reversal. Trade #2 was the first touch of ema and at a trendline. Trendlines, ema and the high and the low of the prior day are very strong supports for your trade.

The second is a two or three legged move: Both trade #1 and #2 were two or possibly three legged move to support.

The last is a decent signal bar. While strong closes with a body at least half the bar make excellent signal bars, occasionally you can relax this constraint depending on experience. Note that the weaker the bar, the worse the pullback and the larger the required stop.

As the price action unwinds, you would keep track of these three variables and when the market sets up, you would already have made the decision before the bar closes. This ensures that your decision has been made with care and you are not forced to make a split-second decision.

At this point, you should act immediately and without hesitation. You should not be worried about taking a loss or panicking if the trade moves against you. Some amount of losing trades are normal and you should welcome them.

Once you enter, hold your ground and do not exit early. The only reason to adjust your targets are if the move is much weaker than you expect. For example, I expected a strong entry bar for trade #1, when it turned out to be weak and was followed by another weak bar, a breakeven exit is ok to take.