“Trading in the Zone” by Mark Douglas

This is a book on trading psychology.  Too many traders are governed by emotion (both good, like euphoria and a feeling of invincibility; and bad, like fear and greed) which prevent them from being consistent winners.  The key is to look at trading objectively, from a probability standpoint.  You must accept that the probability of a win is never 100%.

Fear manifests itself when we, either consciously or subconsciously, avoid information which would “prove us wrong.”  Eg. we avoid positive news about a market you already exited (because you would have to admit you exited too soon) or we avoid negative news about a current trade (especially one that’s already a loser that we hope will “bounce back” soon).

Consistent winning can be problem too, if we get a “can’t lose” attitude and become reckless with larger and larger trades.

There is always going to be uncertainty.  The key is to find a strategy that gives an edge, and then don’t worry if it sometimes is a loser – account for that.  Before every trade, predefine: risk (probabilities of up/down), loss-cutting point, profit-taking point.  Don’t emotionally consider recent wins or losses.  Over and over again trade when you see your edge (only risking some predetermined, small percentage of your equity) and don’t worry when you sometimes lose; just make sure your edge wins on average.  Sounds like he is advising traders to be like an automated algorithm!

But … (the big but) how do you find an edge???  He doesn’t really go into that at all; it seems his intended audience are technical analysts who already have an edge but fail to use it consistently.  For those without, well… find one with quantopian?

I like his approach to “scaling out” profits.  He reports noticing that 1 in 10 trades go down and hit his initial stop immediately.  Another 2-3 in 10 go up a few ticks but then go down to the stop.  What to do = scale out of trade gradually.  When up a few ticks, sell 1/3 of position.  At some other predefined rise (something higher than a few ticks), sell another 1/3 and reset your stop on the remaining 1/3 to your entry position.  Now you have already captured some profit and have a “risk-free” position to see how it turns out.

 

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