My recent post took an initial look at the real-world challenges of planning and executing trades. That post was sparked by my ongoing observation that few highly successful traders actually trade in the manner that we read about in trading articles and books. They are good at following rules, but they have an uncanny sense for when to bend the rules.
While the idea of planning your trade and trading your plan sounds wonderful as an ideal of discipline, what I find among successful traders is an ability to alter plans in real time as market conditions dictate. These traders are neither highly emotional and reactive in decision making nor robotic in implementing a set of rules. They are more like the expert quarterback who follows a game plan, but doesn't hesitate to call an audible and exploit a weakness in the defense.
The challenge for trade planning occurs when implicit knowledge coming from pattern recognition flies in the face of an explicit set of plans. The plan may be to hold a trade to an anticipated target, but then you sense a shift in the balance between buyers and sellers as volume comes in against your position. Is jumping out of the trade good judgment and trading, or is it a violation of discipline?
My own experience is that I have lost good amounts of money when I've stuck with discipline over trusting my gut.
Or might it be the case that accessing and following implicit knowledge *is* an elite form of discipline? If so, many good traders are very disciplined in how they break their discipline.
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8 comments:
Hi Brett - great blog post but I am rather surprised by what you said. I consider it almost a religion to stick to my trading rules and not bend them under any condition. And while you are correct in saying that sometimes we should use discretion in our decision making, I would not go as far as saying that "gut-feeling" is preferable to discipline.
I can assure you that I have made far more mistakes when I have gone with "gut-feeling". The fact that I am successful in trading now is that I stick to a set of rules and completely shun "personal judgement". The moment we bring personal judgement into trading is the moment we destroy a trading career.
Opportunities I've identified in real time have nearly always been preceded by planning ahead of time for those possibilities. For example, identifying an important support or resistance level. This allowed me to react decisively.
Whereas I've found that reacting emotionally or being "impatient" has decreased my performance quite a bit. This is especially true in a range bound market. If the market isn't doing what we expect then it may be better to flag an action for later instead of exiting at a relatively poor price.
The potential cost of reacting to immediate market sentiment can be:
1. Execution costs. Selling at lows or buying at highs in range-bound markets or false breakouts.
2. Transaction cost.
3. Opportunity cost.
If a trader is adding value to his baseline edge by reacting to current market conditions then I'd expect to see fewer large losses, more wins but slightly smaller wins, more trades, and overall a smoother equity curve then his baseline edge.
The trader that is not adding to his baseline will be expected to show more losses, opportunity costs, and generally not adding value.
Extending from this, we can reason in typical cases the plan should be more sufficient but when things are non typical in terms of volatility, velocity of trade, or others factor then more discretion may be appropriate.
Regardless, if you have a measurable edge (and not just a discretionary edge), you can evaluate if you are adding value to your methods or would be better trading in a mechanical method.
One other thing being truly flexible probably plays a role.
Affirmation I made:
My discipline is perfect, my strategy flexible.
My thought to the above comments - is Dr. Brett witnesses traders with skill, who have developed enough expertise (instinct, knowledge base, "gut feel") through years of trading to know when it is time to exit/enter the trade - despite what their rules state.
Newer traders are probably best left to trading their rules until that inner voice is more "experienced"
Brett, How appropriate to my trading today: "... In the trade, I reviewed my anti-anxiety notes on index cards and this worked again for me. I cycled thru all the internals and price and determined that there was a change in the market environment and it was highly likely that my position was not going to follow thru. I decided to kill with a market order and I was filled at break even.
and later, "...I got strong feeling of intuition that the move over the most recent high was going to break out. I resisted trading because I know that many times I've lost on that kind of trade, but back in Q4 2008, an end-of-day move like that might have exploded 10 points. I was programmed for high volatility back then when I started so I know now to resist certain feelings that are incorrect intuition and to only be fully conscious of all decisions based on my trading plan. I sure was glad I just watched it. It did what it does lately, nothing. NQ moved 3 ticks on the breakout that I sensed and then pulled in near the close.
Few can improvise successfully during trading and that's why having a plan about what to do when you have conflicting ideas (gut feeling vs. trading rules)is imperative. Although, it seems that you abandon trading plan by breaking trading rules when you adhere to gut feeling, it is not quite the true, because it might be part of your grand trading plan.
I support your view here. I found that my trading took a turn for the better when the discretion is applied to 'in trade risk management' perspective rather than a 'trade opportunity' perspective.
It is no substitue for the game plan for the day but can considerably augment your profitability. Your gut can be used if you know how to use it.
Hi Brett,
A plan is something that creates a game plan prior to entering the trade.
Trading plans are more about trade preparation.....an awareness of key levels and what the likelihood of the next price move is likely to be (if market does "A", probability of "B" happening, if market does "C", probability of "D" happening etc, etc)
Does this mean getting out prior to "planned" targets being met (for example)? At times, absolutely. The plan is a best case scenario, and screen-time experience builds the skills to adapt to trading a market which often won't move in sync with your best case scenario. I don't know of any business which doesn't adjust, or modify the game plan according to new data. It's called flexibility, a necessary trait for success.
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