Tag Archives: Uncertainty

Trading Success – Predicting the Unpredictable

A very small percentage of people who unsubscribe from my email newsletter take the time to advise me of their reasons why. This effort on their part is very much appreciated, as it allows me to see in some cases where I need to focus future articles.

Last week, one of the unsubscribe emails contained the following single line reasoning: 

  • “I can’t predict the unpredictable”

 

Now, I must start with a disclaimer to the effect that I have not communicated with that person beyond their statement; it’s not appropriate considering the act of unsubscribing is in part a request for no more communications. As such, any of the following discussion in relation to their intent and meaning is based purely on speculation.

That being said, it does appear to be a common statement from those struggling to find their way in this game of trading.

“I can’t predict the unpredictable”.

There are a couple of problems with this statement.

Firstly, there is an underlying assumption that markets are unpredictable. While it’s understandable for a trader to form this conclusion having worked so hard to unlock the code of the markets with little success, it’s not entirely correct.

While it’s not possible to forecast future market action with 100% accuracy every time, it’s also not entirely random. Proper application of market analysis will allow you to identify market biases, which will provide you with an edge when combined with effective money and risk management.

As we discussed in the Rock, Paper, Scissors article, this game of trading is not so much about price, but rather about determining the future actions of other market participants. If we know their likely actions, we can position ourselves to profit from the resultant orderflow. Future actions of individual traders may be unknown, but with experience you’ll learn to identify places on the chart at which the masses are most likely to take action. In particular, at areas where they’re suffering drawdown and operating under extreme stress.

The main problem in the statement though is with the word ‘predict’

www.dictionary.com states that to PREDICT is usually to foretell with precision of calculation, knowledge, or shrewd inference from facts or experience.

While this implies a potential for error, I suspect that the reality is that most people are searching for certainty, rather than learning to deal in probabilities.

At a rational level, they know that this is a probabilities game. But at a deeper level, we do not operate well in an environment of probabilities – people crave certainty and will go to desperate lengths to find it.

Mark Douglas said it best in The Disciplined Trader

“Most people like to think of themselves as risk takers, but what they really want is a guaranteed outcome with some momentary suspense to make them feel as if the outcome had been in doubt.”

In the market environment where certainty does not exist, these people will typically end up quitting out of frustration. Very few will persist to the point where they are finally forced to learn to operate in an uncertain environment.

It’s the difference between seeking certainty and managing probability and risk. Net long-term losers are typically seeking certainty in the markets. Net long-term winners have learnt to manage probabilities and risk.

So, if you’re trying to predict the unpredictable, stop it. You’re taking the wrong approach.

Identify a market bias; identify areas where order flow is likely to occur in the direction of the market bias; confirm the setup area provides a suitable risk:reward ratio and provides a technical place to put a stop which invalidates the trade premise, and then work the best entry you can within that area.

While at some level we are forecasting or predicting future market direction, we are in no way seeking certainty. We have simply identified opportunity and so act to take advantage of that opportunity, while managing risk in case this is one of our many losers. We can’t know in advance which of our trades will be winners and which will be losers. So, we accept either outcome, entering the trade and managing the risk.

It’s not about seeking certainty. It’s not about predicting the unpredictable. It’s about identifying opportunity and managing risk.

Lance Beggs

 

Dealing With Market Uncertainty

The nature of the markets is uncertainty. Human beings do not like uncertainty. In fact we fear it at the very depths of our soul. Much of our society has evolved in an effort to reduce the uncertainty we face in day to day life, through controlling the environment, and implementing a structure of laws, rules and regulations. This has been largely successful. Although uncertainty in life cannot be totally removed, we have managed to create a structure in which people can live with relative safety and generally a higher standard of living compared with previous generations.

The markets though are different. Unlike society, where we can influence the actions of other people, and where we have some level of influence over the environment, the typical retail trader will have no influence over the action of the market. None, at all!

When you enter a trade, no matter how skilled you are at analysis, there is no certainty in outcome.

So how do we, as technical analysts, attempt to work within the uncertainty of price action?

Generally the first step, because we’re human, is to create structure where there is none. My preferred approach is through a framework of support and resistance lines, but there’s certainly no shortage of other approaches – whether through an indicator based approach, trendlines and classic charting patterns, wave patterns, or cycles of lunar and planetary movement. Whatever approach people choose, they’re overlaying price with an approximation of market movement that provides structure.

The purpose of this structure is to provide a framework within which the trader can identify low risk and/or high probability trades.

That’s where a problem occurs for most novice traders. Not used to accepting uncertainty, these traders mistake the structure they’ve applied to the market, and the entry trigger they’ve chosen to get into trades, for the truth. They say they understand the probabilistic nature of the markets, but their actions do not show that. Rather, the novice trader trades as if their approximation of the market is actually the reality of the market. They act surprised when the trade goes against them, and wish and hope and pray for the trade to turn out profitable, rather than acting quickly to minimize risk. The novice trader consistently demonstrates poor risk control, poor money management and poor trade management.

Knowledge of technical analysis, whether indicator based or via classic charting patterns, is not the same as knowing the future direction of price.

The structure you apply to the markets does not, and was never meant to, provide certainty. Rather it simply provides a framework within which you can understand past market movement, and hopefully identify low risk and/or high probability trades.

Note that I did not say zero risk, or guaranteed 100% profitable trades. No matter how certain you are, you’re dealing with probabilities, and some trades will lose. Even a 99.9% profitable system will lose 1 out of a thousand times, and if you’re betting everything on each trade it’s only a matter of time till you’re account is wiped out.

Successful traders have not found some magic system that provides certainty in the markets. Rather, they’ve learnt to live with the uncertainty.

How do they do this? 

  1. They have developed and tested a positive expectancy system.

  2. They trade that positive expectancy system in a consistent manner, secure in the knowledge and understanding that the outcome of any single trade is not important. Success comes from consistent trading over a long series of trades.

  3. They manage risk. No single trade is EVER allowed to place their future survival at risk.

  4. And so they trade with confidence that the market cannot hurt them, and a confidence that they will take the correct actions to ensure consistent implementation of their trading plan.

 

 So, if you’re stuck in the never-ending cycle of going from course to course, or from forum strategy to forum strategy, STOP NOW. Ask yourself if you’re trying to find certainty in the markets. Certainty doesn’t exist – your approach is wrong. You’re looking in the wrong place.

Rather than continuing to look for a better way to define market structure or enter your trades, just find one system that others are trading successfully, learn it, and learn how to manage risk, and improve your trading edge through better trade management and exits.

Do not confuse knowledge with knowing!

You may be a master analyst, but you cannot ever know future direction of the price.

Stop searching for certainty. Stop trading as if you can know the future. And just manage your risk.

Lance Beggs