Part One is here if you missed it – http://yourtradingcoach.com/trading-business/my-go-to-method-for-solving-trading-problems/
In that article I presented a three question framework which I use to seek solutions to any of my trading problems.
- Can I avoid the problem?
- Can I reduce the frequency?
- Can I reduce the consequences?
Or in simpler English:
- Is there something I can do that will ensure I never even encounter "the problem"?
- Is there something I can do that will ensure "the problem" won't happen as often as it has been?
- Is there something I can do such that when "the problem" does occur, the negative outcome won't be so
To work through an example, we used a question I received on Twitter a short while ago:
In other words…
- An inability to trust a rally resulting in continued attempts to fade the rally and grinding your way into a completely avoidable drawdown.
Visualising "the problem", it would be something like this:
I then requested your feedback on how you might solve such a problem through either one or all of the three questions.
Well didn't that create a lot of work for me! Ha ha.
I must say I was blown away by both the number and quality of the responses. I am 99% certain I replied to all of them. If I missed yours, please let me know.
Rather than simply listing all of the responses here (because there will be a lot of repetition), I will instead just summarise the main ideas:
Can I avoid the problem?
Is there something I can do that will ensure I never even encounter "the problem"?
This is my first go-to option. If I can find a solution here that is quick and easy to implement, I'll try this first.
This is recognising that often we don't need to address the problem and its myriad of potential underlying causes, if we can just avoid it.
If you get sick eating seafood… just don't eat seafood.
So looking at the problem of a trader who continually destroys their session through fading a bullish trend, how can they avoid it?
Many of you came up with the same idea that immediately pops into my mind for the "Avoid" category:
Don't trade bullish environments!
You ask for help changing your mindset. But it's much quicker and easier to:
(a) Accept that this is how you are.
(b) Study your trade history to understand the market structure or environment which leads you to struggle.
(c) And develop clear and unambiguous rules to avoid this structure or environment in future.
In other words, ONLY trade in an environment which is naturally suited to short selling.
And avoid everything in which short selling is a lower probability option.
Maybe something like this:
Or maybe you will have some better idea. After all, you know your trading.
The point is… you need to dig into your trade history. Find and understand the conditions that lead to you fighting a bullish trend. And then set in place rules to avoid them.
Don't try to solve the problem. Avoid it.
Rather than fighting your bias, accept it and embrace it. And maybe specialise in being a short-seller in bearish market environments.
Note what we've done here. The problem still exists. You still have a strong preference for short entries. And the potential for danger still exists if you acted upon this tendency in a strong and persistent uptrend. But you've avoided the problem by setting clear and unambiguous guidelines which seek to avoid these uptrending environments.
We're not trying to find a way to comfortably trade long in an uptrending environment. We're not trying to find a way to improve our skill in shorting an uptrending market. You can work on these later if you wish. First things first though – let's stop the damage through the quickest means available. Identify an uptrending market and stand aside.
Avoid the problem… it's often the quickest and easiest solution.
Can I reduce the frequency?
Don't like the "Avoid" solution?
Ok. That's fine. You won't always find an answer. And you won't always find an answer you like. Let's move on to the other two questions.
Is there something I can do that will ensure "the problem" won't happen as often as it has been?
So here, we're not trying to avoid bullish environments. We're not limiting ourselves to certain sections of the market structure.
We are allowing ourselves to trade in a bullish environment.
But we need some solutions to ensure that when it is bullish, we can (at least sometimes) find a way to align ourselves in that bullish direction, thereby reducing the number of times we find ourselves fading the trend.
Again the responses from readers were spot on, with the following being the main ideas:
Limit to with-trend trades only.
Very closely related to the above solution. But this time we operate with clear and unambiguous rules that limit our trading to with-trend only.
Limit yourself to short opportunity when the trend structure is bearish. Limit yourself to long opportunity when the trend structure is bullish. And stand aside when the trend structure is neutral, sideways or uncertain.
Naturally this doesn't guarantee trading success. Recognition of the environment will not always be perfect. Quick recognition of change of environment will not always be perfect. Execution will not always be perfect. And compliance with our rules may not always be perfect. That's fine. We will deal with this separately if it becomes a problem.
But what this does achieve is that it ensures you will rarely find yourself repeatedly fighting a bullish market.
Trade with a guard rail.
No-one picked up on this solution. But it's one of my personal favourites so I'm going to include it here. I've recommended this to several people over the years, with great effect.
I like clean charts without indicators. But that does not mean I'm against the use of indicators if they add value to your trading. And one good use for an indicator is to provide confidence through placing a "guard rail" at your back
This doesn't seek to avoid bullish environments. And it doesn't prohibit trading short. Instead it acts to increase confidence in holding a long position, thereby reducing the frequency with which you'll find yourself repeatedly fighting the uptrending market.
Multiple Scenario Planning
Always have in mind multiple potential paths for price action. Ideally at least one bullish and one bearish scenario.
You're fighting the uptrend because you believe it should be moving lower. But have you actually viewed the charts too see if there is the possibility of a bullish scenario?
Assuming the market had a chance of going up today, what could it look like?
If you have pre-accepted multiple scenarios for potential price movement, and at least one of them involves price moving higher, you're more likely to recognise and accept the bullish conditions when they occur and more easily able to align yourself in that direction.
Trading level to level
Overlay the higher timeframe market structure with an S/R grid and use that to define the general market bias as price moves from level to level.
Again, this works like the idea of multiple scenario planning, discussed above. It's harder to get stuck in a mindset of "this market should be moving lower" when you've defined clear levels and have accepted that the market is bullish while above certain levels.
Limit counter-trend short entry to key levels only.
Extending the idea above of trading level to level, this now also gives us a solution for how we can still trade short against a rising uptrend.
Limit that sort of trading to ONLY the times when price interacts with one of our higher timeframe levels.
All other action, away from these levels, is limited to with-trend (long) opportunity.
Overwhelm yourself with study after study of bullish market environments.
One response suggested reviewing 100 days of uptrends. Ha ha!
Absolutely yes. This will leave you in no doubt about the fact that markets can and do go up a whole lot more than you expect. It's a beautiful solution.
What is good about the 100 charts solution is that it goes a long way to correcting the faulty underlying beliefs, leading the trader to somewhat accept the idea that markets can safely rally. And while you may at times slip back into old habits of fading the trend, the frequency of occurrence will be reduced due to the many times now when you find the confidence to go long with the trend.
Operate with multiple independent methods of assessing bias.
No-one guessed this solution. It's one of of the ones I came up with, which I think could be effective in limiting how often you get stuck fighting a trend.
I assume that you're operating at the moment with two means of identifying the potential future movement of price – some form of assessment of the trend PLUS gut-feeling. And in your case the gut-feeling is over-riding the trend analysis.
Maybe try increasing the number so that you have three or more independent methods of assessing bias, one of which might still be gut-feeling. Perhaps add some market internals, or VWAP, or a higher-level orderflow tool like cumulative delta. When a majority of methods are suggesting a bullish bias, this may give more confidence in trading in this direction and ignoring the gut feeling of "it should be bearish"
Operate with multiple independent methods of assessing bias AND a measure of confidence.
Taking the above idea one step further, why not add a degree of confidence to your gut-feeling.
We previously discussed this idea as it relates to price targets – http://yourtradingcoach.com/trading-process-and-strategy/applying-a-degree-of-confidence-to-price-targets/
It applies just as well to your bias.
"Ok, I feel like it should be going down… with maybe 60% confidence… but given all the other methods are suggesting bullish then 60% is clearly not enough. I'm trading with-trend."
Turn the chart upside down.
I didn't expect this response but ended up getting it twice.
I actually tried this myself several years ago. Like the reader who posed the question, I also have a preference for short trades. Not to the same extent where it damages my edge. But it's simply a case of short trades feeling comfortable while anything long is really uncomfortable. Even to this day. It just doesn't ever go away.
Back in the days of Ninja Trader 7, I came across an indicator which flipped the chart upside-down.
Perfect. Problem solved. Whenever there was a bullish market, I'd simply shift my focus from my normal chart to the upside down chart, so that it looked bearish.
It works surprisingly well. I could take a long position in that uptrending market, and hold it quite comfortably, simply because it looked like a short position in a down-trending market.
Unfortunately though, I couldn't execute from the chart. So I got rid of it and went back to normal charts.
But if you have a different platform which offers the ability to flip charts, or someone who can code a solution, this might be an option for you.
Can I reduce the consequences?
Is there something I can do such that when "the problem" does occur, the negative outcome won't be so bad?
Again we don't seek to avoid bullish environments. And this time we don't want to limit our ability to short an uptrending market.
But is there some way we can do this more safely, such that the damage incurred will be less in those times we do get it wrong?
Reduced position sizing for counter-trend setups.
Not necessarily a permanent solution. But perhaps one you can use temporarily, until such time that you can improve your skill in timing a counter-trend short entry.
Cut your size to the absolute smallest allowed in your market.
Continue to monitor stats and the impact these setups have on your edge. If you can't develop a positive edge, you will eventually need to abandon them. But until you've accepted that once and for all, cut the size to ensure smaller losses.
You can always increase again if you improve in skill to the point where these trades are providing a positive input to your edge.
Limit counter-trend drawdown to a fixed number of losses.
I've talked about my personal rule before: When two trading ideas fail to work, I consider the need for a break. When three fail to work, I force a break. Either I'm wrong about the market bias, or my execution is poor, so I have no business trading. Take a break. Walk away. Do not come back till your mind is clear and the structure and conditions have shifted to something more tradeable.
If you can do this, the consequences of fighting a market bias will be reduced to (at worst) three losses.
Better counter-trend entries… closer to the stop.
There was only one response which suggested this. I like it.
It attempts to limit the consequences of fading a persistent uptrend through bringing your entry price closer to your stop. Maybe this will be enough to bring these sequences closer to breakeven or small profit.
The suggestion was that, rather than using your entry signal as a trigger to place a MARKET or STOP entry order, you use that signal as a trigger to place a LIMIT order higher. You're fading the trend. There is a good chance of some retrace. So try to take advantage of it and improve your entry price.
As with any of these "reduce consequences" options – they're still allowing you to trade in the environment that was causing problems, in the direction that opposes the market bias. So you need to monitor stats and track the impact this has on your edge. As mentioned above, if you can't get this to provide a positive edge then you seriously need to abandon this idea of trading counter-trend against a bullish market.
So there we are. It really is quite simple.
In the majority of cases all we had to do was come up with a set of rules to limit our ability to short an uptrending market. The markets offer incredible freedom to enter and exit at any time of your choosing. Successful traders place limits on this freedom, to ensure trade decisions have the greatest chance of providing a positive edge.
For the trader who sent me the original question: Your path from here is to identify the potential solution (or multiple solutions) which you feel may best suit your needs. And test it. Implement the idea through a trial period, tracking the results to confirm whether or not it was effective.
For everyone else: The point of this was not to provide you with techniques to limit the damage from constantly selling into an uptrending market. Rather the point was to demonstrate the problem solving framework in action.
And given the number and quality of responses I received, it's clear that many of you have seen how easy it is to come up with solutions.
That is where the three questions help. They provide some structure to your decision making, taking you from "stuck" to at least having some idea of where to look.
This works not just with "I keep getting run over by an uptrending market". You'll find it helps with many problems throughout your trading career. So whenever you're stuck, ask:
- Can I avoid the problem?
- Can I reduce the frequency?
- Can I reduce the consequences?
Sometimes, depending upon the type of problem being solved, you'll find some overlap between the "Avoid" and "Reduce" categories. You might have felt that with the solutions presented above. If you feel a solution that you come up with fits best in the "Avoid" category while I put it in one of the "Reduce" categories, that is fine. Either way the three-question framework has led you to a potential solution. That is all that matters.
PS. What are Questions Four and Five?
I was asked by a few people about questions four and five in the original framework. I didn't include these as they're not relevant to most trading problems. But for those interested, here they are:
4. Can I transfer the risk?
This typically means to shift the risk to another agency which is better able to manage or accept that risk. For problems outside of the trading world, insurance is the perfect example of this solution. Faced with the risk of loss of property, we can transfer this risk to another party through purchasing insurance cover.
In trading, an example of risk transfer might include building up a track record via sim and then seeking employment with a Prop firm, or perhaps seeking funding through one of the online sites which provide such a service. Not a viable solution for problems of continually fading a rallying market, as you'll quickly find yourself unemployed. But certainly it is a solution that could be perfect for other problems, such as lack of funding.
5. Can I accept the risk?
Sometimes, having considered options for avoiding, reducing frequency, reducing consequences or transferring the risk, we find that there is NOTHING MORE that can be done. We then have no option but to accept it. In other words, do not worry about things you cannot change. Consider whether or not that is acceptable. Sometimes it is.