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COMMANDMENTS
By Tradeciety.com
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Trade entries
The stockbroker Gordon Gekko said – quoted several times – in the US-American film “Wall
Street”: "The decisive point is that greed – unfortunately there is no better word for it – is good.
Greed is right, greed works."1
But what is greed and how does it influence us in our daily trading?
FOMO (The Fear Of Missing Out) is a problem that every trader has experienced at least once.
We have prepared our trading plan and now the chart looks almost as if our trade is about to
start, but the last criterion has not yet been fully met. But what if the price suddenly moves
sharply and we miss the trade? All the effort, planning and waiting would then be worthless and
we also missed our possible profits. Should we risk it now and just start early, the trade is almost
confirmed and it looks like it will happen soon anyway?
Every trader regularly fights such or similar scenarios and his/her own greed-driven demons. It
does not seem like a big mistake per Se, because most of the signals are almost confirmed. But
the word almost makes all the decisive difference in this context – and as most traders would
confirm, such trades almost always and rightly end in a loss.
However, losing is not the biggest problem in this case because a trader regularly breaks his/her
rules, quickly becomes inconsistent and the results can no longer be interpreted effectively. If a
trader constantly changes his/her rules or enters a trade completely without observing any rules,
the subsequent trade analysis is of no use. During the follow-up of trades, no conclusions can
then be drawn as to where trading is already running satisfactorily and where some catching up
still needs to be done. Inconsistent results must therefore be avoided since this does not allow
for further development.
If you want to become a professional trader, you must be able to control your greed for entry
and the FOMO mechanisms. Unfortunately, there are no secret shortcuts or tricks for this. The
only way to achieve the goal is to continue improving yourself.
1 https://en.wikipedia.org/wiki/Gordon_Gekko
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2 https://www.chess.com/forum/view/chess-players/magnus-carlsen-grandmaster-flash
[19.04.2018]
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Trade exits
When it comes to dealing with profits and losses we must take a bit more time because such
trade exit related situation can pose great challenges for a trader if managed incorrectly. On the
other hand, a trader who knows how to effectively deal with such scenarios can often improve
his/her edge significantly.
7. Losses
Greed influences us not only in our entry decisions, but also often in how we handle of losses.
We quickly start wondering whether we should really close the trade in a loss, because there is
still the possibility that the price could reverse in the right direction. It might even be
advantageous to re-buy at the current price, because if the price really turns around, we could
make a profit more quickly.
Those who catch themselves with such thoughts can be relatively sure that their inner demon is
just about to drive the trading account against the wall. Anyone who thinks this way has lost
objectivity and is now looking for excuses to avoid the imminent loss. This is one of the worst
habits in trading, because losses are quite normal and occur regularly.
Profitable trading becomes impossible for traders who always let their losses get out of hand and
then also close their winners too early. Those who realise that although they are often right with
their analysis and their trades would have been mostly successful but their account nevertheless
moves in the minus, face emotional problems. This inevitably leads to a further deterioration in
trading.
Good traders are not those who do not make any loss trades, but those who realise their losses
quickly and then move on to the next trade without accumulating emotional burden.
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For example, if you are analysing a Head-and-shoulders formation, you probably have the
following hypothesis:
When the price breaks the neckline downwards, the prevailing upward trend is not only over, but
a new downward trend is initiated since the sellers are stronger and push the price down with
lower highs and lows and falling price waves. The sell-trade hypothesis is active as long as the
price forms new lows. If the price breaks the last high and closes above it, this trade idea is no
longer valid.
The trader would thus remain in his/her selling trade until the price breaks the last high and rises
again. This approach helps in objectively determining when the trade should no longer be held
and in avoiding panicking in the event of short-term price fluctuations.
9. Sample-size-thinking
At this point, it is particularly important to be aware of the actual role of individual trades. If you
are looking to become a professional trader and want to carry out this activity for the next 15 or
20 years, you will make thousands of trades. A single trade is therefore meaningless. You should
never let it get to the point where a single losing trade gets out of hand, because this is not only
harmful for the trading account, but also for your mental assets. Many traders manage to remain
disciplined for three, four or five weeks and make good trades. But then comes this one trade
where they were so sure it would end in a profit. But they somehow lose the overview, make
some fatal mistakes and suddenly have to realize an excessively large loss which neutralises all
profits of the last few weeks. This is frustrating and a strain on the nerves. If this happens
repeatedly, their mental assets are attacked and they lose their mental capital. Sooner or later,
traders will not be able to recover and fall into impulsive behaviour patterns. No matter how
good they trade during a short period, they always come back to square one.
At this point, it is important never to lose perspective. You must learn to realize losing trades
quickly and without emotions. The next trade is already waiting and if you manage to close losses
properly, the next winning trade will have a much bigger effect on the trading account.
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Those, who believe that they can make a lot of money in a short time, but suddenly find
themselves in a cycle of losses often tend to become impulsive and throw all good intentions
overboard.
It is therefore important to know your behavioural pattern and ask yourself whether and why
you want to become a trader in the first place. Independence and freedom appear to be good
goals, but if expectations are too high and unrealistic, they will rather prevent a trader from
achieving his/her true potential. Those, who are then confronted with loss trades, panic quickly
and their goals are still a long way off. They quickly lose the desire to trade when they realise that
there is no chance of reaching the ambitious goals ever.
Especially during the first year(s), it is important to realise that trading is not a way to get rich
immediately, because you then quickly get on the wrong track. But that does not have to be the
case! If you focus completely on yourself, learn as much as possible and constantly work on
yourself without being tensed up and looking at the growth of your account, you can achieve a
lot.
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factors that a trader can control 100%; these factors do not include price movements or the
result.
Traders should always focus on the factors they can influence actively. This gives them a feeling of control, power and self-
assurance. You should not see yourself as a victim, which often happens when you use your energy to change the uncontrollable
aspects.
When analysing your trades, you should ask yourself the following question and answer as
objectively as possible: Have I done everything right? Has the trade worked out or not? Or have
I made mistakes, am I the reason for the loss?
In addition to these questions, the trading journal of www.edgewonk.com and its analysis tools
are helpful in objectively assessing your trading results in a better manner.
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Not every profitable trade is good and not every loss means you have done something wrong. It is important to judge your
performance based on decision-making and not just based on short-term results.
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below the self-imposed target and runs out of time, he/she often tends to slide into over-trading
and force trades or increase the risk – all this only because he/she wants to achieve the arbitrarily
set target. This worsens the quality of trading – the opposite of what was hoped happens and
bad trades push the self-imposed targets further and further away.
On the other hand, a trader, who quickly achieves his/her goal due to favourable market
conditions and then reduces his/her trading activity, can leave a lot of money on the table.
Instead of setting the performance targets, a trader should strive for process-defined goals. As
trading coach Dr. Alexander Elder said in his well-known book “Come into my trading room”, the
only goal of a trader should be to make the best possible trades. Making money is then a by-
product of good trades.
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System metrics
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The WR says nothing about the magnitude of profits and losses. This is a major weakness of the
WR when it is viewed out of context. Therefore, traders should not make the mistake of getting
too attached to the WR.
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The RRR measures the ratio between the entry ($100) in the trade and the potential target ($130), as well as the stop loss ($95).
The potential profit is $30 and the potential risk is $5 in this case, giving us a RRR of 6:1.
The planned RRR helps traders in determining the potential expected value before entering the
trades. If a trade offers too small a profit opportunity, the trader should consider whether the
trade is worthwhile.
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This is comparable to professional poker or betting in sports. Even the best hand is not necessarily
playable if the bet is too high when compared to the possible win. The best sports betting experts
do not bet on every game and even if the outcome of a game seems very clear, it is still not a
good bet if the possible win does not justify the bet.
If we apply this context to trading, it means: The best set-up must be avoided now and then if
the profit potential is not good enough. What exactly “not good” means in this context will
become clear later.
The realised RRR, often also called R multiple, is a key performance indicator that indicates the
magnitude of the realised profit or loss as compared to the risk taken. An R multiple of +2 means
that the profit trade has achieved a profit equal to double the initial risk. If the stop-loss distance
was $5, an R-multiple of +2 means a profit of $10 per position. A loss, at which the price has
reached the stop loss, is then equal to an R multiple of -1 and a loss of $-5.
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RRR meets WR
We first need to understand how the RRR and the WR are directly linked. We can calculate the
required minimum WR from the average RRR. If the average RRR of a trader is 1: 1, this means
that his/her profit and loss trades have the same size and that this trader needs a WR of over
50% to be profitable. An RRR of 2: 1 means that two out of three trades are winners. This trader
only needs to successfully complete one of three trades to be profitable. This means that a WR
of over 33% is required. For most traders, it is a revelation and a great relief to understand that
they do not have to achieve either a high WR or a particularly high RRR. They only need to know
the correct combination.
The general formula for calculating the required WR is:
Minimum WR
Minimum WR = 1 / (1 + RRR)
The following table compares the RRR and the required WR:
Historical WR Minimum WR
25 % 3:1
33 % 2:1
40 % 1.5 : 1
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50 % 1:1
60 % 0.7 : 1
75 % 0.3 : 1
The WR and the RRR are directly correlated. The curve shows the combination of the WR and the RRR that are required by a trader
to avoid losses.
As already explained, most problems arise when traders try to avoid all losing trades and always
chase after enormous winners. However, it should have become clear that even a lower WR can
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lead to profitable trading. A combination of a low WR and a moderate RRR is sufficient for this
purpose. This brings profitable trading within reach for many traders.
Timeframes
As we have already seen, the investment horizon and the choice of timeframes used to identify
trading opportunities are extremely important.
Trading usually distinguishes between low and high timeframes, which are divided into two
classes. The low timeframes are the 1-hour, 30-minute, 15-minute and 5-minute charts. The high
timeframes include the 4-hour, daily and weekly charts.
Most traders choose one of the two categories and then restrict themselves to the respective
timeframes. This has the advantage that the trader can make consistent decisions and his/her
approach is clearly defined. They should always avoid jumping from one timeframe to the other.
This is because the differences are serious.
Especially the demands on the emotional profile of a trader differ fundamentally. In the low
timeframes, you have more trading opportunities and the patience factor does not play such a
big role. But if a trader is emotionally unstable and quickly loses his/her nerve after losing trades,
he/she runs the risk of quickly sliding into revenge trading or over-trading. In the low timeframes,
you must keep a cool head and shake off losing trades quickly so that you can perceive the next
opportunity and remain objective.
In case of trading higher timeframes, you may have to wait for hours or even days for a new
trade. Traders who suffer from FOMO (the fear of missing out) or are generally bored quickly
often have a hard time in the high timeframes. However, it is a huge advantage that you do not
have to sit in front of the charts all the time and you can control your emotions better if you have
more time to plan and execute trades. Furthermore, your holding time will also be much higher
which has various implications and can pose challenges as we will see shortly.
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The selection of the timeframes influences the entire trading and different timeframes also have different requirements for
traders. It is therefore very important to be aware of the choice of the timeframe and to adapt it as per your own strengths.
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