Tag: Trading in the Zone

Pattern Addiction

Posted on by Anatoliy Schneider

Developing a Trading Style

Someone who is watching the markets for considerable amount of time learns to see certain patterns almost automatically. Oftentimes we do not even have to name what’s going on in the market, we just know that the current Price Action looks like something we would want to Sell or Buy. There is nothing bad with learning to recognize certain patterns and use such recognition to read the Market. The issue lies in closing our eyes to everything else the Market is showing us, as long as our favorite, easily recognizable pattern is present.

I’ve been watching the markets for more than 11 years now and all this time I’ve been mostly contrarian trader. I would look for opportunities to Sell at exact highs and Buy at exact lows to get great Reward/Risk ratio in these trades. Of course, I realized that the chances of such trades following through are not very high and that such trading opportunities are not provided by the Market often (especially on Daily charts). However, I kept reminding myself of the great return such trades could offer and kept concentrating on them nevertheless.

For many years my main problem was giving up too early. When you start fading a move you have to be ready for a couple failed entries. There is nothing more frustrating than giving up on a trading idea after 2-3 losses and seeing the Market follow through according to your exact scenario – without you. As I studied Price Action and, much more importantly, psychology, I was able to stick with my trading ideas longer and started generating profits out of them, riding some really nice trends. I accepted the reality of the Market – that it can do anything at any given moment – and would be contempt when my idea did not work out.

As I kept on trading and analyzing my successes and failures I started noticing how rarely valid contrarian opportunities (supported by Price Action weakness) were available. Additionally, I noticed how often I would fade the trend, get my small loss (compared to potential profit) and see the trend continue without me for another couple days or even weeks.

For a while I did not even see any problem with that – I just thought of myself as a Contrarian Trader, and was pretty happy with overall results of my trading. However, through constant analysis I could not help but notice how much potential I left on the table by not even considering going with the trend. To me, any time the price is coming to Support or Resistance is a trigger to consider fading such move. Naturally, there are many filters that I developed over the years not to get into obvious traps, but the point is that fading the move is the only possibility I would consider. If I saw that a breakout is likely I would just forget about that setup and move on.

Adjusting Trading Style

Finally, I started reworking my trading system and adding new setups into my arsenal – with-the-trend setups. After spending a couple weeks going through history I identified valid patterns that I wanted to include into my method. I then proceeded with my trading, now looking for these trend setups as well. I thought that because I defined what good with-the-trend entries look like I should be able to jump on a couple soon enough. However, what happened next was quite surprising.

Because of constant work on my mindset and psychology I was not afraid of losses. I also realized that my Trend Setups may not be of very high quality, so I was ready to rework them as necessary, after analyzing a couple live Trend entries. I simply did not see where the problem might come from as I was ready for anything, except… In the next couple weeks of trading I did not find a SINGLE trading opportunity with the Trend! I kept taking my contrarian entries pretty actively, with about the usual degree of success, so I still saw patterns and took trades. But for some reason I just could not find any Trend entries whatsoever – at least not live.

Naturally, I kept analyzing my performance, taking notes about each live entry. I then saw that almost every time I was analyzing a failed contrarian entry where the price was breaking through and continuing with the prior trend, it looked exactly like one of my Trend setup pictures that I prepared. After seeing quite a couple of these extremely clear (in hindsight) Trend setups I started wondering, why the heck didn’t I see a single one of them live? I’ve been watching the Price Action on that exact trading pair very actively, trying to find an entry to fade the trend, but I just did not see the opportunity to follow the Trend, even though it was right in front of me and looked exactly like one of the setups I have prepared.

I finally realized that after all the years of trading the markets in my particular style I became completely blind to any other information the Market was trying to tell me. I would see only what I wanted to see and ignore everything else completely.

Psychological Blindness

Mark Douglas is sharing a very interesting example in “Trading in the Zone”, Chapter 10 (p. 179), where he decided that he wanted to start running. Initially he met extreme resistance just getting out of his apartment and starting running until finally, after great effort and struggle, he “became a runner”. He started thinking of himself as a runner, seeing himself as the runner. Running was something he was not just doing now, it was something that was very natural for him to do. There was no more mental resistance whenever we wanted to run.

Just like Mark Douglas has become a runner, I have become a “Contrarian Trader”. It was not easy, and I struggled for years to be able to fade the trend comfortably, but at some point most of the resistance just went away – fading the trend was something that was very natural for me to do as a Contrarian Trader. Trading with the Trend on the other hand, wasn’t.

Through many years of hard work I have developed a trading style that was easy for me to follow. However, now that I realized the limitations of trading in only this style, I wanted adjust it. I did not want to become purely Trend Trader, but I wanted to develop a more universal approach, allowing me to look for opportunities during the rejection of Support/Resistance but also when the price is already trending from one S/R zone to another.

Unfortunately, recognizing the need for a change, even recognizing what exact change we want to achieve, is not enough to achieve it. Now that I defined a new mental picture of how I wanted to trade I knew what kind of mindset I wanted to develop in order to become proficient trading the new Trend setups in addition to my Contrarian setups. Implementing such a change of mindset turned out to be a pretty complex task.

After some additional mental work I started seeing Trend setups, but the resistance to act upon them was still great. My brain would quickly find one hundred reasons why I should NOT take a particular Trend setup, no matter how good it looked originally. After recognizing the hesitation problem I started pulling the trigger on more and more Trend setups (almost forcing the decision sometimes).

Next issue was holding the Trend trades. While I would be able to fade a trend and ride the trade in the new direction for weeks, comfortably sitting through heavy draw downs in my floating profit, I did not have any confidence in riding the trend if the trade was initiated with one of my Trend setups. Any time the trend would show some kind of correction, I would see a Contrarian entry possibility. Even though many of such possibilities would be filtered out and I would not establish a position to fade the trend, just seeing one contrarian pattern was enough for me to close my with-the-trend entry.

Trading Mindset

The experience I went through showed once again that having a good Trading Method is not even 50% of our success. In addition to having the edge in Market Analysis and finding good Entry Setups, one needs to develop a proper Mindset that will allow him to trade such method without any resistance. Most traders consider that Trading Psychology is about hesitating pulling the trigger, or worrying too much about an open position. My experience shows that sometimes our brain can simply block out all information that it is not comfortable with. If our Mindset is not developed to work with our Trading Method, we can be assured that the brain will find most elaborate tricks to ruin all chances of our success.

We may believe that trading as about Market Analysis. We may believe it is about being right and knowing what the Market will do next. Some believe it is about statistics (and there is some truth to that, in my opinion). But in the end, trading the Market is about people.

People make decisions and these decisions move the price. People are extremely susceptible to mistakes. People, in general, have huge ego that is telling them what to do. Studying Human Psychology can help us to understand people better. We don’t need to have a masters degree in psychology to trade, but we need to be self-aware and willing to analyze our every thought, decision, action. We also need to be willing to empathize with other traders – be it small speculators (like most of us), large commercial traders, non-commercial businesses that just want to hedge their risks or huge multinational banks that really have the capacity to move the market. They all have their own goals, desires, biases, emotions. They all make mistakes. Understanding this, not only we can be more open to searching for our own mistakes but also we will understand the psychology of other traders and will be able to profit from the mistakes they make as well.

Recommended reading: Emotionally Intelligent Investor by Ravee Mehta

Market Advance featured on Your Trading Coach

Posted on by Anatoliy Schneider

When anyone who knows about Your Trading Coach, reads back into my old blog posts, it should become obvious to them that my understanding of Price Action was heavily influenced by Lance’s approach. Even though my trading system is mid to long term, I am reviewing his Price Action articles anytime I feel like I cannot read the current market structure.

I am very pleased that he decided to show some of my trades on his blog, so that his readers can see that the same principles apply to any market, on any timeframe.

I would like to emphasize, that when I say his blog influenced my understanding of the market, I do not mean that I read it once, had an “a-ha” moment and realized how to trade profitably, never to lose again. The only reason his writing is helping me is because I am coming back to it every single week – not only to read his new article, but to look through the old posts in all categories that he writes. We do not learn by reading some idea once, we learn by systematically reminding ourselves the important principles in that idea and applying them in our daily practice.

If you read “Market Wizards” by Jack Schwagger, you will note that the best traders in the world are constantly improving by learning from other professionals in the field. I do not recall a single interview in the book where the trader would not show his respect for other’s work and would not acknowledge the fact that he is still learning from other traders, books, market newsletters and of course the market itself. It goes to show that no matter how successful a professional trader is, he still needs to constantly learn and improve.

Eleven years ago, when I was just starting getting interested in the market, I was believing that I need to learn for a year, possibly two, and then I will just enjoy trading my system and spending the profits. Now, more than a decade later, I am learning much more than when I started, spending more hours each day on learning (certainly spending more time studying the market than actually trading it) and only recently starting to open trades in the right places. I came to realize, that the essence of anything we want to do well in this life, is in constant studying and practice. There is no point where we can stop learning and relax. Instead, we relax by enjoying the learning process, constantly fascinated by the infinity of knowledge we are yet to learn.

 

Part of my everyday trading process, is reading selected market books. Along with new books I add to my library every couple months, there are some that I continue reading every single day. “Trading in the Zone” by Mark Douglas and “Market Wizards” by Jack Schwagger are only two examples without which any progress in my trading would not be possible.

I have read “Trading in the Zone” in Russian when I just got interested in trading eleven years ago, but unfortunately I could not see how it will help me to make any money trading. I put it aside, and continued pursuing more “Holy Grail” trading methods, confident that I will find the one that NEVER loses – why do I need any trading psychology then? Nine years later I was still learning about the market, developing new trading systems, still unable to make any consistent profit, still not finding the “Holy Grail”. Realizing that I am not getting anywhere I started looking for answers, and noticed the book again on Amazon, while shopping for new technical analysis bibles. I bought it in English about a year and a half ago and it made all the difference for my trading performance (I was very lucky to stumble upon Lance’s blog about six months later as well).

Since then I have read “Trading in the Zone” fifteen times, taking notes, highlighting important parts. I cannot emphasize enough how many new insights I am getting with each new reading. Every single day I put a timer for 10 minutes and read it again. Today I am on page 87, and as soon as I am done, I simply go back to page 1.

Last year I was living in Cabo San Lucas, Mexico, and on 15th of September we had the biggest hurricane in modern Baja history – Odile –  hit the town. After one scary night we found ourselves in a house without a single window, ocean water covering everything. Almost all the books in my library got damaged. Still, I decided not to buy them again and instead try to restore them. Here is a photo of my copy of “Trading in the Zone” today:

"Trading in the Zone" by Mark Douglas
“Trading in the Zone” by Mark Douglas
"Trading in the Zone" by Mark Douglas
“Trading in the Zone” by Mark Douglas

 

I am not trying to say that this particular book or Price Action based trading system is a “Holy Grail”. Instead, I am saying that the attitude of constant learning and improvement, such as you can clearly see in Your Trading Coach blog, is that illusive “Holy Grail” that every trader is trying to find outside, not realizing that it’s always been inside – hidden by our ego and only waiting to be developed.

Accepting the Risk, Part 1 – Stop Loss

Posted on by Anatoliy Schneider

…most traders erroneously assume that because they are engaged in the inherently risky activity of putting on and taking off trades, they are also accepting that risk. I will repeat that this assumption couldn’t be further from the truth.

Accepting the risk means accepting the consequences of your trades without emotional discomfort or fear. This means that you must learn how to think about trading and your relationship with the markets in such a way that the possibility of being wrong, losing, missing out, or leaving money on the table doesn’t cause your mental defense mechanisms to kick in and take you out of the opportunity flow.

— Mark Douglas “Trading in the Zone”

Risk and reward are closely related as we cannot have one without the other. I wrote my opinion many times before that a trade should not be judged as amount of pips or dollars that it makes. It should only be judged as the ratio between what was at risk and what was gained (could have been gained). A trade that made 100 pips but had 1000 pips SL has extremely poor 0.1 RR ratio and it is relatively easy to make such a trade and reach profit with it, just by sheer luck. A trade that made $1000 but had no SL has 0.0 RR since the was no risk limit, and we have to assume that the whole account was put at risk.

In terms of profit it does not matter whether we win 10 trades out of 10 with 0.1 RR or just 1 trade with 1 RR. If we risked $100 in each trade, in the end we’ve made $100 in each case. However, it matters a lot in terms of risk – in the first case we risked 10 times $100 to make $100 in the end, while in the second we risked $100 just once and made the same $100.

 It is interesting that most beginning traders prefer to take a smaller profit, while setting a bigger stop loss (actually, most beginners prefer not to set any stop at all, being sure that the market will go in their direction at least a tiny little bit). I think there is some interesting psychology that we can analyze here.

First of all, there is always a balance on the market. If your trading system uses 1:5 RR and you are able to win consistently more than 80% of your trades, it can still work just fine – especially if that is what your find to be psychologically comfortable. The problem here is actually going with the market flow correctly more than 80% of the time – easier said than done.

On the other hand if you take 3 times the profit compared to your risk you only need to be “right” 1 time out of 3 in order to consistently increase your balance.

Let’s think about it from a different point of view. Imagine that you trade manually and you put 100 pips stop loss trying to make 20 pips. What kind of trading opportunites are you looking for? What is the market setup where you say “The market gives signs that it will go 20 pips in my direction, but it can first retrace 100 pips against me”? Imagine the trade goes against you by 90 pips. What should the market conditions be at that moment that you still keep your trade with confidence – now you want the market to move 110 pips in your direction, having only 10 pips breathing space on the other side.

It really seems to me that trading in this way is a very dangerous psychological trap. It’s like we want our trades to be perfect, we really hate when the market goes against our positions and forces us to take a loss. But we learned that trading without loss protection is a financial suicide, so we calm ourselves by setting a huge stop loss while trying to take a tiny profit – after all, we are protecting our account, right? It really comes down to truly accepting the risk of our trading.

Accepting the risk of losing money

When a trader puts on a trade with a stop loss, he immediately assumes that he is accepting the risk that comes with that trade and that he is in control over his trading. However, we are not benefiting in any way from the risk “acceptance” that comes from the overwhelming fear of losing money.

A trader can put a stop loss, but still hope or even assume that the market will never reach it. He likes to put a bigger SL not because he is ready to take a bigger risk in his trading but because he is afraid to take any loss at all. He hopes that the bigger SL will never be hit. If there is any fear in placing the trade it means that the risk for that trade was never truly accepted.

When seeing your trade being closed in a loss causes you any emotional discomfort it is natural that you will do anything to avoid taking the loss in the first place. The smaller your stop is, the more often it will be hit. It seems that most traders prefer to increase the distance to their stop so that they do not have to experience the emotional pain that comes with losing money as often. Accordingly, bigger stop loss will possibly lead to more emotional pain when it is hit, but there is another element that I find even more important – the pain of being wrong.

Accepting the risk of being wrong

When the trade is stopped out an average trader not only feels the pain of losing money. He also perceives that the market is making him wrong, and for many traders the pain of being wrong is even stronger than that of a financial loss. I would say that even though the pain of losing money can be similar in one big loss or many small losses, the pain of being wrong on any given trade is about the same.

From this perspective we can see that for someone trading without proper mindset (someone experiencing any psychological discomfort at all about his trades) it makes sense to avoid the losses at all costs. He will much rather take $10 profit 10 times in a row, increasing his confidence (and often his ego) and then have 1 loss that takes all $100 away, than experience the pain from losing $10 and being wrong 5 times in a row and then making $100 on the trade that is opened with the market flow. In reality, such trader is very unlikely to last through 5 losses in a row and still continue following his system to get to that 6th trade that makes up for all his losses and more.

The risk of being wrong is rarely acknowledged, which makes it much trickier to work with. Unless a trader specifically studies trading psychology, he is rarely aware that he is actually afraid to take a trade because it might not work out.

How is it possible not to accept the risk?

In other words, how is it possible to participate in an activity (trading) that is risky by its very nature and not to accept the risk? Mark Douglas provides a very good explanation to the underlying psychology in his book:

The typical trader won’t predefine the risk of getting into a trade because he doesn’t believe it’s necessary. The only way he could believe “it isn’t necessary” is if he believes he knows what’s going to happen next. The reason he believes he knows what’s going to happen next is because he won’t get into a trade until he is convinced that he’s right. At the point where he’s convinced the trade will be a winner, it’s no longer necessary to define the risk (because if he’s right, there is no risk). Typical traders go through the exercise of convincing themselves that they’re right before they get into a trade, because the alternative (being wrong) is simply unacceptable.

Such thinking is leading to many problems in our trading. Instead of looking at the market as the source of trading opportunities he can act on, the trader thinks of it as the enemy he needs to fight. He is trying to learn everything he can about the market so that he can build such a trading system that will not lose any trades. The only way such trader can be psychologically comfortable with his trading is if he can win all his trades, since any single loss causes a lot of psychological pain that makes him start questioning his trading system.

You can imagine how difficult and frustrating such trading will be.

On the other hand, it is simply a matter of adjusting one’s beliefs and expectations about the market in order to solve this problem once and for all. A good trader does not simply say that it is possible to lose money on the market, he expects to lose money on any single trade he makes. He never knows what trades are going to be winners and which ones will pay the market for the opportunity to trade. A good trader sees such loses as the cost of doing business, similar to a restaurant owner who has to buy food before he can serve it to his customers for profit.