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A Time Traveler and a Trade
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A Time Traveler and a Trade

  #21 (permalink)
Trading Experience: Intermediate
Platform: Bookmap and Jigsaw DOM
Broker/Data: Stage 5 Trading
Favorite Futures: ZN
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tpredictor View Post

This is a "false choice problem". How much action/information are you able to infer from 1 tick? And what certainty can you scratch a trade for only 1 tick of risk? That's what matters. Let's just say, I think discretionary traders in today's markets unlikely to be able to scratch many trades effectively.

Your ability to improve results as action develops is based on the efficiency of the markets and ability to integrate Bayesian probability theory. If every trade is a unique event then you cannot improve your results from knowledge of prior trades. You can only do that if the trades have dependency.

I mean the way this question is posed is would you rather lose $12.50 on a trade or $100? If all things are equal, I will prefer the small loss because the standard deviation of returns will be lower.

I feel like we're speaking two different languages and I'll do my best here to reconcile them (or at least present my understanding of our difference in opinion).

Here's an example from two weeks ago: ZN was selling off pretty hard and I saw the first spot where it paused. Not only did it absorb like five or six thousand contracts on the low, but it lifted 1500 up into the offer and it went bid. I tossed my bid in at the tick lower where the 5-6k had traded. I got filled long and I watched it dance higher by about a tick before going offered again.

I was able to infer a TON of information from the 1 tick difference in price--this is a nice characteristic of thick markets--which I'll describe here. For argument's sake, I'll say I was long at 05. The market had traded like 15,000 at 05 and about 3,000 had lifted into 06. There was a bid of 6000 at 04, which is 1 tick lower than my entry long. The market suddenly ticked against me, so it was 04 bid x 05 offered. The volume wasn't enormous; maybe 1,100 or 1,200 had sold into 04, but the bid of 6,000 had plummeted to 2,000.

All I had to risk was 1 tick to know that I was wrong. I thought I was aligned well with buyers who would drive the market up a couple of ticks. As soon as it ticked lower, all of the bids below me vanished. I hit out for -1 and the market ended up cracking 4 or 5 ticks. There was no need for me to risk any more on that trade because I was dead wrong on the call.

I think part of the reason for our difference in belief is probably because we trade different markets. One tick in ES doesn't mean much. One tick in ZN means a ton.

To the second point: Improving your trading isn't a matter of market efficiency and integrating graduate-level mathematics into the choice to click buy or sell. Improving your trading is all about seeing hundreds of trades (which are each unique, but human behavior follows patterns) and just spending time trading your market.

And finally: Once again, we're talking apples and oranges. I'd rather lose $12.50 on one trade instead of $100. But what about a string of trades? That was the root of my original question...

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  #22 (permalink)
North Carolina
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Platform: NinjaTrader, Tradestation
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Posts: 644 since Nov 2011

@lax99 Yes, I have did something similar many times ES too-- even taking zero ticks risk on many trades. It is possible to trade, also, with extreme precision on the ES. Yes, I understand what you are trying to say but still even if you can often do this unless you're trading with 1 tick stops then you are allowing for possibility of greater risk. This idea you have is very similar to my concept of "market cognition" as to how price discovey works.

As for your question, it is always going to be the case that it is better to lose a smaller amount per trade if the edge per trade is the same. A string of trades or one trade doesn't matter: if your edge is the same and the trades are independent.

Now, as I shared before, if you are trading on a different, longer, fundamental wavelength of information then it may be better to take more ticks of risk.

One way to think about this is a ratio of information. If your trading with 1 tick stop loss, you will most likely be targeting at most several ticks. If you were targeting 4 ticks, you have 1:4 risk/reward and your tick is basically 25% of the information. On the other hand, if you were targeting 10 ticks of profit, your tick 1 tick is only 10% of the information in terms of the range.

If you are trading in a statistical manner and treating each trade as an independent event then it really doesn't matter if you take 8 losses of 1 tick. What you may be grappling with is if you are not trading in a statistical manner, and I'm just conjecturing here, if you take a 1 tick loss but it doesn't invalidate your hypothesis for the trade and you take a series of losses. Let's say you take 8 losses in a row: you have a dependency on the original hypothesis. Serially correlated losses are a very serious matter because they can cause you to lose more with stop losses then without taking stop losses when the horizontal movement exceeds the vertical expansion. Also, if you are trading 8 losses of 1 tick on the same thesis and then let's say the idea works out. You do not limit your loss to the same because you have to re-enter which can cost you at least another tick.

In summary: it is obvious if you can risk less per trade with equivalent edge then that is the better thing to do. On the other hand, if your trades are dependent and/or become serially correlated then it can be a serious matter. So to answer your question: I would always choose to lose only 1 tick per trade if my edge is the same versus 8 ticks. But simply even speaking of 8 ticks of losses of 1 tick, you are peeking into the future so to speak to know that and/or you may be implying the losses are serially correlated. Serial correlation is a serious risk when trading with tight stops: in that case, I would prefer to take 8 ticks as a single loss.

Now for a bit of a tangent but may be useful, it may help to understand or think about accuracy, precision, persistence, and uncertainty. I have saying: "The market judges one according to one's claims." Meaning simply, if you try to trade with 1 tick stop loss you will win or lose based on how well you can do that: if you trade with a larger risk then that will determine how well you can do. It is a common fallacy to believe that one can predict the market by looking at the longer trend. Even if or when true, the precision is often too poor to make any exceptional profits. On the other hand, as you zoom in, yes you should be able to make more precise predictions but the problem becomes uncertainty. For example, let's say your fundamental wavelength of information is a daily bar. Most of the noise one can imagine is filtered out at that view compared to say if your edge is only a few ticks. While you may have a precise edge when trading with a few ticks, even a single large trader with more capital could game you by simply discovering your edge, the optimal stop, then running it and taking the profit. Basically edges on longer time frames are probably going to be more stable but your information is more stale and less relevant. On shorter time frames, your information is more recent and better but greater uncertainty comes into play due to very temporal nature of things.

Last edited by tpredictor; May 20th, 2018 at 05:16 PM.
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  #23 (permalink)
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lax99 View Post
I saw something interesting going around Twitter the other day and I wanted to see how different traders would consider this.

Suppose you're in a trade and a Time Traveler appears in front of you. The Time Traveler has seen the future, and tells you "Your current trade has an 80% chance of quadrupling your net worth and a 20% chance of losing your net worth". He then disappears in a flash of light and you're left staring at your platform with a trade currently sitting at scratch.

What do you do? Do you scratch the trade or do you keep it on, and why?

First of all...
The time traveler picked the wrong trader.

I would never put myself into a trade that risks that much.
He is not from the future but is just a figment of your imagination and hypothetical situations seldom reflect reality.

If the trade goes against me I would lose only the amount that I have already determined would be risked on the trade.
The loss of my entire net worth would not be at stake. (This is not Las Vegas)

If the trade goes in my favor, I could quadruple my net worth but if it went in my favor I would have already moved my stop to break even or better so the 20% chance of loosing just disappeared.

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Knowing it's not about Clouds or Wind. . .
But Learning to Dance in the Rain ! ! !
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