In today’s blog, I’ll be considering two practices followed by professionals that are usually ignored by retail traders.

The first one is the ability to hold, at the same time, two or more competing ideas on the basis that both are equally valid. In my mentor program’s trading training section. I start with a rule-based approach, as mechanical as the student’s personality will allow. The outcome I seek is to ensure the trader learns ‘to see a trade, take a trade’ and to ‘trade what he sees, rather than what he’d like to see’.

As a trader evolves and becomes a more experienced discretionary trader, he understands that at any given moment, the market can do one of three things: move up, move down or move sideways. He takes all competing information, organises it as best he can and concludes if he will or will not take a trade; if the former, at what price to enter, place a stop etc. He does this without falling into cognitive dissonance.

Cognitive Dissonance theory says that we have a tendency to seek consistency among our beliefs and/or our sensory data or other beliefs. In the case of sensory data, we tend to either change the data to suit our beliefs or change the beliefs to suit the data. In trading, I think a better way is to hold the competing ideas as being equally valid and to then to organise the data as one or more of the possible market behaviours: up, down or sideways. Based on this organization, we come to a trading decision.

Let’s use the current ES as an example. I hold the view that the 18-d (monthly trend) and 13-w (quarterly trend) are in a start of a downtrend; and the 12-M (yearly trend) needs to complete an Upthrust Change in Trend pattern by giving a bearish bar close in February. Now, that’s what I call a bearish mindset!

But, here’s the thing. On Friday, the ES had a bearish setup for the 80-min 5-period swing (1d i.e. Daily trend) - see “A Surprise or Unexpected Event“. The Gann idea I call, ‘the 4th Time Thru’, is a very reliable pattern. If the market is as bearish as I believed, then I’d have expected the ES to breakdown on Friday following the breach of 1337 (basis March). While the ES did move lower, it did so sluggishly. When I went to bed, I was expecting to awaken to see new lows made, with a close near the lows - much like the price action yesterday (except yesterday I was looking for an close).

When on Thursday I analysed the ES, I had to be able to hold two conflicting ideas: the market was bearish, and therefore it should break 1337 and close down. If it was bullish, or at least not as bearish as I believed, then the downside breakout would fail and the market would reverse. In that case, I had to consider if I wanted to be long. I decided I did.

I decided this because if the market reversed then:

  • The minimum target would be 1373 to 1378 and there probably would be a retest of the breakdown zone 1397 to 1400. And
  • If the market did fail on the fourth attempt down, the underlying market trend may be up despite my tools. In other words, the market behaviour and my belief that the trend is down are at odds. In that situation, I am better off deciding on a course of action considering the market’s behaviour rather than closing my mind to the contradictory information.
  • I hold this view despite the fact that I believe the Ambac rescue package will not change the bear trend i.e. the news that pushed prices up on Friday are a ’surprise event, rather than an ‘unexpected event’ (”A Surprise or Unexpected Event“)

Too often the course taken by traders is to block out the information that fails to support their view; in other words to pursue what I call myopia. Unfortunately for us, many times the market rewards myopia until one day… until the day she decides there a lesson to be taught. On that day, the learning is painful.

A good, and tragic, example of this is the ‘High Probability Trader’s’ experience on ‘Soc Gen Day’.

So that’s one trait. The second trait is the unfailing use by professionals of their monthly (or weekly reports or quarterly reports). Certainly one weekend a month I pore over my psychology and equity stats to look for patterns of behaviour that positively or negatively impact my trading. If I see a large loss, or a series of losses, I look seek to identify the events that contributed to the losses. The same for profits.

Of all the ideas I teach, this one is the most honoured by its breach. I thought that perhaps it was because I asked students to do it manually rather than by Excel macro. So I asked someone to do it on the basis I’d sell it at my speaking engagements. He charged S200 (about US$150). Not what I’d call a fortune. Out of 60-odd members, 2 took up the offer. So doing it manually is not the answer.

I don’t know what the answer is, but I do know that your period’s benchmarks are critical to success.

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An aside: On Mar 1 & 2, I’ll be speaking at Singapore’s Asian Traders Investment Convention (ATIC) to be held at Suntec City. See
http://www.theatic.net/mailblast/sg_atic_2008.htm

This is a quality event for a very low price. In fact, you can even avoid the entry fee, S$18.00 (to the convention) by filling in the survey in the link above BEFORE February 28. I’ll be presenting new and unique ideas on managing impulse trades and position sizing. Note that for key note speakers there is a fee of S$30.00.

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