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Article Traders and Mistakes Part 2: No-Rules Discretionary Traders
by Van K. Tharp, Ph.D.
Trading Tip Should the Flash Crash Change the Way You Use Stops? Part 2
by D.R. Barton, Jr.
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If you want to become the best 'mechanical discretionary' trader you can be, take this course." – D.S.
"Very impressed. Ken over delivered on the course objectives and with a lot of his own real-world experiences, all with a good delivery and sense of humor. I leave feeling I can grow my account better than a market benchmark using a disciplined approach without a lot of weekly time and make a little extra using multiple strategies. . ." – D.H.
"It was great to get deeper into Ken’s thought processes, especially how he reads the tortoise reports to set up his overall weekly and daily trading strategies. Ken’s trading ‘dashboard" is rich with information and is extremely powerful when you know how to take advantage of all it has to offer." – E.P.
Traders and Mistakes Part 2: No-Rules Discretionary Traders
In my experience, when most people say “I am a discretionary trader,” it basically means that they are free to do whatever they want. They can take a newsletter recommendation, trade a high probability setup based on what some guru said in a workshop last year, or perhaps just buy something on a whim. They might feel they have 20 different systems with none of them rigid.
In reality, they have no systems at all. What they really have is a little bit of nothing and a lot of “into-wishing” (as opposed to intuition). As a result of having no system and no rules, they have no way of effectively managing their trading. How well do you think a company would operate with no plans, no business systems and no rules? Because they have no rules to follow, everything no-rules discretionary traders do is a mistake.
Now in fairness, some of discretionary traders have rules for at least a portion of their trading. There’s hope for these people because they have a starting point. Those who are totally no-rules discretionary traders, however, have no hope and should either stop trading or totally revamp their trading business.
Are you a discretionary trader? How would you be able to tell? Here is a quiz that will help you decide. Answer Yes or No to the following questions.
- Do you sometimes buy newsletter recommendations without having a real plan for how you’ll get out of the trade?
- Do you occasionally (or often) take trades based upon some interesting indicator that you learned in a workshop (i.e., when you see that indicator go, you usually get into a trade, but again you have no real plan about how you’ll get out of the trade)?
- Do you trade three or more different systems in the same account?
- Do you trade more than ten different systems?
- Do you sometimes enter a trade and later not remember why?
- Are you unsure of how many systems you have?
- Do most of your systems lack a complete set of rules to guide your behavior?
- Are your systems equivalent to the setups used to get into the trades and nothing more?
- Are you unable to list the rules for the last trade you made?
- Are you unable to list the rules for any of the last five trades you made?
If you answered Yes to as many as two of the questions above, you have some elements of a no-rules discretionary trader. However, if you answered Yes to 6 or more questions above, you definitely are a no-rules discretionary trader.
Chances are you seldom make money in the market because you are not playing a winning game. You probably make many mistakes. In fact, since you don’t have rules, I would consider everything you do to be a mistake until you have a set of rules in place. How can you effectively learn from any of your trading experiences if you do not know which ones are mistakes?
If it is any consolation, most traders fall into the no-rules discretionary category. The best among this group might be dedicated to following the trades of a single newsletter. If that applies to you, do you even know the rules of the newsletter? Does the newsletter writer have rules to guide his trading? Chances are, if he must come out with a specific recommendation once every month on a specific date, he doesn’t have such rules. And chances are also good that you don’t follow the recommendations of the newsletter writer exactly: you don’t take some trades, you may miss some others, you buy at a price other than that recommended, and you probably don’t sell when you are told to. Again, these are all signs of a no-rules discretionary trader.
Next week, we’ll look at rules-based discretionary traders.
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Should the Flash Crash Change the Way You Use Stops? Part 2
Last week we talked about the psychological fallout from the May 6th “Flash Crash.” On that day, the huge swing in the afternoon caused many traders and investors to be stopped out of their positions—and some with very large slippage. As a result, these folks were out of their positions when the market rebounded only minutes later.
That event led many to ask, “Should I quit using protective stops altogether or at least change to close only stops?”
Let me reiterate my answer to the first question: protective stops, along with proper position sizing techniques, are the trader’s main line of defense against taking too much risk in any given trade or investment. For practically all types of trading, the protective stop is a mandatory part of trading discipline.
With that said, let’s dig into some research to see if Market on Close (MOC) stop orders might perform better for traders.
Data Analysis Shows the Way
In Part 1 of this article series, we covered the advantages and disadvantages of using MOC stops. We learned that one has to balance two possibilities:
- Hitting your stop level early in the day if the market makes a wild intraday swing (like it did on May 6th, 2010), and
- Having the market move against you until you get stopped out at the close with a much bigger than expected loss.
There are many approaches to take if we want to investigate the usefulness of MOC stops versus standard market stop orders. To make the study simpler, I chose to look at getting stopped out of long trades—an issue that affects most market participants (i.e., investors, long-term traders, and swing traders).
So here’s the methodology:
- Review the daily data for the Dow Industrial index dating back to 1928 (20,500 trading days)
- Find the 100 largest range days in terms of percent moves where the close is below the open (the days when you could really get hurt)
- See how many of these days closed in the bottom 33% of their daily range—this should tell us how many of the big range days would significantly hurt those using MOC orders and how many might benefit from an MOC order
Some Surprising Results
Some interesting stats came out of the test:
- The biggest range for a down day was (no surprise) Black Monday (October 19, 1987) at 22.48%
- The “Flash Crash” day (May 6, 2010) was number 10 on the list with a 10.48% range
- 76% of these highest range days closed in the bottom third of their range
- MOST IMPORTANTLY: Of the 24 instances where the close was in the upper two-thirds of the daily range, only 2 of those days would have significantly favored an MOC close—March 26, 1929 and the Flash Crash day (the other 22 instances were either followed by big down days or occurred in the later stages of a big down move that was already underway)
So an MOC stop
- could have caused much bigger losses in 76% of the extreme move days,
- would have made little difference on 22% of the days and,
- would have been the better exit on only 2% of the extreme down days.
The evidence, therefore, overwhelming favors protective stops over MOC stops if your main goal is to protect your positions against outsized losses on days with extreme moves.
Note: This study in its current form does not in itself form a definitive case against MOC stops.
Interestingly, this study also clearly points out a pervasive psychological biases—recent event bias. Our brains tend to value a recent significant event much more strongly than past significant events or even a preponderance of data. So the fact that some positions were stopped out on a nasty drop-and-reverse day may have caused a knee-jerk reaction in some traders and investors. To switch to only MOC stops, however, looks to be a solution for a problem that is quite rare.
Again, for most traders working in intermediate and longer time frames, standard protective stops appear to be the most prudent choice.
Filling in the Gaps
Q: My book shelves and laptop are full of trading information, e-books, and past courses on DVD and hard copy formats. However, Im still not a profitable trader. I believe I've put the hours in and have tried several strategies and techniques with little success. Which of your products would you recommend to enable me to pull this stuff together and fill in the obvious gaps in my trading abilities?
A: What you work on is more important than how much work you do. I recommend that everyone entering my Super Trader program spend their first year or more working on themselves and even suspend trading until they've completed the following home study course and workshops:
- Peak Performance Home Study Course
- Peak 101 Workshop
- Peak 202 Workshop
- Peak 203 Workshop
After the self-work, I ask that they develop a business plan using the processes from the following workshop and CD series:
- Blueprint Workshop
- Business Plan CDs
With a business plan complete, I then request that they develop three systems that meet the following criteria:
- Fit the big picture.
- Fit them and their beliefs.
Finally, they need to be able to document trading their systems at 95% efficiency or better.
Everything that we do here at the Van Tharp Institute is focused around helping you improve as a trader and investor. Therefore, we love to get your feedback, both positive and negative!
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