Mind Over Market Part 2 of 7
Douglas then talks about how to accept the randomness principle, which is to accept the fact that any trade event can be a random unique outcome, but that can produce a consistent result over the long run. He then talks about how traders who fail to acknowledge this principle will find that trading can be very frustrating.
I disagree slightly with this mindset. I do not believe that a trade, or series of trades are random. I believe there are very good order flow and liquidity reasons for the market to be making such movements. That doesn’t mean that order flow traders should expect 100% winrates or even close to that – they shouldn’t. But what I am saying is that believing in the randomness principle is more of a path to mediocrity. George Soros did not embrace the randomness principle when he broke the Bank of England and made $1 billion in a day. He discovered the order flow generators and triggers for a big move and went for the jugular. He knew there was nothing random about the markets movements in the weeks before Black Wednesday and the weeks following. He knew there were good order flow and liquidity reasons.
Instead of believing in the randomness principle, I believe in the taking losses principle. Everyone will need to take trading small losses, and should preferably keep them small. As an order flow trader I always still acknowledge that. But acknowledging that you will have losing trades is very different from believing that the trade of a series of trades are random. When I take a loss, very rarely is it due to the markets noise or a random event. It is usually due to some wildly unexpected event, wrong interpretation of the order flow situation, or my own greed and fear. Very rarely is an order flow traders loss due to the “randomness” of the markets.
Mark Douglas then proceeds to explain a bit about technical methods:
Technical methods define and identify patterns and collective human behavior. The patterns definitely exist, they repeat themselves over and over again. The problem is that the outcomes do not always correspond with the patterns on a trade by trade basis.
Now applying my order flow mindset to the above quote, I would say to find order flow and liquidity patterns that identify the market participants behavior. Find the order flow generators and scenarios that consistently generate order flow, preferably a massive amount of order flow. Some small tweaking of the parameters and triggers can be needed on a day by day basis. The patterns exist. The repeat themselves over and over again. And yes, there are patterns that have an extremely high correlation between the outcome and the pattern on a trade by trade basis.
The host of the show then interjects and says:
If the last trade was a winner, this trade, even if the charts are the same, even if the same exact signal, the same looking chart, there is no guarantee this trade, that this trade will be the exact same as the past one.
And this is the path that many traders fall into. Obviously the same trading signal will not be exactly the same. You can’t have the market posting the exact up and down gyrations each and every single time. The market will not make the same movements to the exact pip value and tenth of a pip value. That is obviously not possible.
However, the trap the host of the show falls into is that he states that “even if the charts are the same, there is no guarantee this trade will be the exact same as the past one.” Presumably he is referring to a previous winning trade. And that is the trap. He states that “even if the charts look the same”, thus implying that the system’s signals are based on chart patterns.
Of course the next trade can be a loser even if the charts look exactly the same!
How is that so? Well the charts do not measure what is going on outside of them. The charts cannot measure what is happening off the charts. The charts alone cannot tell you where all the stops are, the cannot tell you where all the option barriers are. The charts alone cannot tell you what billions of dollar of order flow expectations are riding on. The charts alone cannot tell you how the market is positioned. The charts alone cannot tell you what the global macro outlook is. The charts alone cannot tell you what the market sentiment is. The charts alone cannot tell you what news was released and how important it is.
And as such, they cannot tell you the real reasons why the market moved and will move the in the future. Which is why it is obvious that even if the charts are the same the next trade can be a loser even if the previous one is a winner. Now obviously the host does not know about order flow trading, but it is still interesting to see how many people are still stuck in the technical mentality and chart pattern mentality.
Mark Douglas then talks about how there is a “random distribution between wins and losses over any sequence of trades that you might look at.” He then talks about thinking in terms of probabilities.
And yes, order flow traders should think in terms of probabilities. They want the probabilities in their favor. You want sufficient win rate coupled with sufficient reward risk ratio in order to have a winning trading system. But I never think in terms of a random distribution of wins and losses. For I always know that I can tighten my trade parameters to nail a big winning trade, if I so choose to. It involves more work, more research, and more patience, but I always know that with order flow and liquidity knowledge, you can find very good trades that do not fall into the trap of “random distribution.” If the trade happens to be a loser, then I take the loss, figure out what went wrong, acknowledge and develop new order flow generators, scenarios, etc, and move on the next trade. I almost never try to attribute the loss to “random distribution.” That is just the way I view the markets.
Then the host asks the question to Mark Douglas about how does a trader who “has their charts lined up.” There comes the fallacy. The belief that if the charts line up then your trade has a certain success rate.
I don’t want the “charts to line up.” Most of the time I don’t care what the charts look like. I want the order flow to line up. I want the news to line up. I want the global macro situation to line up. I want the market sentiment, sensitivity, and shattered expectations to line up. Then I know a good trade has come.
Finally, Mark Douglas talks about the big difficulties with trading:
Now we have to get into the nuts and bolts of how the markets work. One of the reasons why people have such a difficult time with this is because their initial exposure to the markets themselves is through electronics. Through electronics there is a real disconnect between what your are actually participating in and what is causing you to want to participate in it in the first place. Markets started as exchanges. All prices are people generated events. Everything happens because of what people believe.
The most important points are that prices are people generated events. That is how it was 100 years ago, and still is today. Notice how prices are not MACD generated events. They are not stochastic generated events. They are not chart pattern generated events. They are not forex robot generated events. They are people generated events.
Knowing that, it doesn’t take that much of a leap of faith to assume that price movement is a result of people generated events as well. Prices move due to people generated events. Order flow and transaction flow.
Even with the rise of some quants, and high frequency trading, etc, the markets are moved by people making decisions. You are not going to see a 1,000 pip gradual move based on some algorithms battling it out. The price movements are people generated events.
And since they are people generated events, it pays to know what these types of traders are thinking. Especially the big traders, and big groups of traders that can move the market. It pays to get into their heads to understand what they believe the market sentiment is, how they view the news, what their expectations are, what is their current positioning and how much more they can put on, what are their profit objectives, what are their pain tolerance points, what they are sensitive to, etc.
I highly doubt a 300 pip move is caused by a MACD divergence, for price movement are people generated events.
Mark Douglas talks about how prices actually move and how there are traders who actually trade at a level who can move prices, and it is their intention to move prices.
Mark Douglas says:
What actually has to happen for prices to move is this: If the last price of something is $10, for the market to actually move to $12, all the offers at $11 have to be taken out. In other words, people who are trying to sell at $11 they have to get their orders filled before they can get to $12. For someone to actually bid it to eleven, or bid it to twelve they are doing the exact opposite in that moment of what it takes to be successful. They are not buying low, they are buying high. They are buying high relative to the last price, or buying higher relative to the last price.
Mark Douglas gives words of wisdom about having to understand how prices move. Then they will understand how their technical method relates to this movement.
I would say once you understand how prices move, do not go to technical methods. Instead go directly to order flow and liquidity methods that can actually explain why prices move. Why would you want to go from understanding how prices move to loading up your charts with technical indicators and mathematical formulas that are just so far removed from what generates order flow? Despite that logical reasoning, there are still many traders attempting to do trade using those technical methods. Their choice. I wish them well.
For the rest of you, skipping to the higher points on the trading profit ladder can be of earnest interest.