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Presumably, those traders believe that trading success is only about management (cut losses short, let winners ride), which they believe is independent of the nature of the market.
Not sure trade management would do the trick if the markets were indeed completely random, because one's winners would just not have enough of a follow through without positive feedback loops (traders jumping on a band wagon once a trend is in place).
You are never in the wrong place... but sometimes you are in the right place looking at things in the wrong way.
OK, so if you are racing at Nürburgring. Except the turns and track are now random. Does it mean that a driver with skill is still able to complete this race safely, without blowing up, and also in good time (ahead of all his mates) to -- in essence -- win?
Another example, Blackjack. The odds are against you, yet some make money. Is it luck? Is it just a matter of time before they eventually lose? Or do they try to minimize their number of hands, knowing that the more hands they play, the less likely they are to continue to win in the long term?
And another, trading. If the market was pure math, pure chaotic, randomness, whatever word you want to use... how would you go about beating all the other participants in this game? It is not possible to have an edge against a random event in simplest terms, so are you left turning to risk and money management? Is risk and money management not itself considered part of the edge?
Money management alone can not be considered part of your edge. You need to have the edge first in place. The Blackjack guy would never risk a penny unless he knows the odds have changed in his favor by couting the cards. Only when the odds favor him will he size his bets accordingly.
I am not saying solely money management = edge. I am saying money management and risk management should be treated as part of your overall methodology and overall edge.
You are not saying money management and risk don't matter in terms of being consistently profitable, right?
A "Market" is place where parties argue about a price. If there are many players in a big market, the price moves quickly, but prices follow patterns based on human psychology and beliefs. Traders who win anticipate changes in sentiment and have strong money management skills.
The first emini trader I met who knew how to make money played the market like a bomb disposal tech. Darting in on pull backs, sell half at profit then setting tight break even stops, then raising her stops with the market. She respected the instability of the futures market, like a mouse zipping past a house cat to get some cheese. That is a long way from Hollywood movies where a tycoon yells "Buy 10000 March Cotton" in the phone and them millions flow in their pocket.
The real question is, can you predict the market and the answer is -- not 100% on any one trade, but over a enough trades good traders win more than loose, I do it, so does my brother and so do many funds, I have beat most "pros" for over 20 years, I know it can be done. Benjamin Graham did it a hundred years ago, and the instruments get fancier and things go way way faster, but deep down it is the very same game.
Mike, I appreciate you taking time to come up with such interesting thought experiments and questions.
My thesis is two-fold:
i) If the markets are random, they are theoretically not beatable, not even with risk / money management.
ii) The markets are not random.
First some thoughts on your analogies.
The racing analogy is interesting, but very loose. The randomness of the track for a race driver is different than the randomness of market moves for a trader. All other things being equal, the best driver will win on any track (random or not). This is not the case in trading (more below).
As for Blackjack, winning when the odds are against could be considered 'luck', if by luck you mean a less likely outcome happening. They cannot win in the long term if they make bets on unfavorable outcomes.
i) Now, suppose that the markets are random. This would mean that the moves are not biased either up or down, they have equidistant probabilities. Now imagine trader Joe who wants to trade at some level, say 20. The chance of getting to 30 or getting to 10 would be 50% (forget the transaction cost...etc. for the moment). So Joe cannot win by either buying or selling, half the time he will win 10, half the time lose 10. Because the market is random (i.e. our assumption for this example), there is no edge trading anywhere. Ok, enter risk management. Suppose Joe thinks that he can win by keeping his losses small and his winners big. He decides he wants his wins to be twice as big (1 to 2 Risk Reward Ratio). So he puts his stop loss point at half the distance of his take profit point. Can this be his edge? It cannot, because since the market is random, by cutting the size of his losses in two, he also doubled the chances of his stop loss being hit. In a random market, there is a corresponding increase in the chance of being stopped out for every increase in take profit profit (or decrease in stop loss point).
This argument applies for any situation in a random market, where the trader is trying to exploit risk management. It cannot be done, because risk reduction cannot be mathematically achieved in random situations. You would be merely exchanging one coin toss for another, as you would have a corresponding trade-off between occurrence and magnitude that negates the effect.
(Maybe I'll address money management in another post, but a similar argument applies.)
ii) To argue that the markets are not random, I will only state that:
1) trends tend to persist and skew probability beyond the random 50/50, sometimes to 60/40, in extremes 80/20.
2) volatility tends to persist as well (bunching).
1 and 2 are non-random effects and demonstrate that at times the markets are not random.
You are never in the wrong place... but sometimes you are in the right place looking at things in the wrong way.
I don't believe markets are random. But I am trying to understand why some do, and also trying to understand why some say it doesn't matter if they are random or not --- they still want to trade it. Is that just gambling for the thrill of it?
I know a lot of traders view trading as gambling, and there are naturally a lot of similar concepts. But I don't view it as the same. I've never been a gambler, I do not enjoy gambling. Going to Vegas, for me, is more about drinking and having fun at clubs and bars, site seeing, etc, than it is about gambling.
I view trading as a business where the decisions I make will directly effect the outcome. I believe I am in more control than I would be receiving cards dealt to me at a blackjack table. The control very well may be an illusion, since of course the market can deal out ticks in any way it chooses, but I believe that this is more ordered and crowd psychology "dealings" than it is at blackjack with a random card shuffler.
So I say the market is more predictable than it is random, and that predictable nature comes from behavioral finance/crowd psychology, which is in essence what I am trading.
Some traders believe it doesn't matter if the markets are random, because they (incorrectly) feel that they could trade a random market profitably just because of their trade management. What they don't understand is that while good trade management is an essential part of one's edge, this would not be the case in random markets (but it works great in nonrandom ones because of determinate human tendencies reflected in price behavior).
Good blackjack players have something like 1-2% edge... and they get hassled for it. Good traders have a much larger edge. We're in a much better position as traders, provided we don't mind waiting for hours. When the deck is loaded, bet.
The market is never random in the sense of being indeterminate. Every tick is determined by an agreement, and there is always a reason, even if we don't know it.
In the sense of predictability, the market appears random at most times (but not all the time by any means). It's when it's not that one needs to step in, take on good risk, and manage the position accordingly.
You are never in the wrong place... but sometimes you are in the right place looking at things in the wrong way.
