Every now and again it worthwhile going back and reviewing some basic trading concepts. One of the tasks I get the mentorees to undertake is to find what a perfect move looks like to them. This achieves two things. Firstly, it gets them to start looking at price action in detail – something people are not that good at. They tend to get distracted by the stories around the price action. We are often slaves to whatever narrative fallacy takes our fancy. Secondly, and I think most importantly it provides an archetype to follow. If you don’t know what your picture perfect move has looked like in the past then how will you spot the genesis of one in the future.
One of the great misconceptions in trading is that you will be leaping ninja like at every single shadow you see. This tends to be the view of retards that talk about trading on Facebook. And with most things to do with Facebook its completely wrong…. who would have thought that?
Whilst, this is an exercise I get newbies to undertake it is not just a worthwhile exercise for them but for everyone simply to remind them what they are looking for. I returned to doing this exercise after a recent trade.
The best long sided index trade of this year has undoubtedly been the Nikkei.
With a trough to peak gain of around 53% for this calendar year and a gain of about 66% it has been a remarkable run.
The reason for me revisiting the notion of an ideal trade is that I made another run at the Nikkei when it bounced from the May/June retracement. The trade gave me a signal that was valid but not optimal and it is important to distinguish between the two. Sometimes when you have seen a wildly profitable trade that has ended you want to go back and have a second bite just to be greedy. Within my philosophical framework of trading there is nothing wrong with being greedy. In fact I encourage that but this last trade has caused me to return to the notion of valid and optimal signals.
Consider the chart below, which shows where I last hit the Nikkei.
It has a blue arrow, which is all I need. But consider the level of historical volatility. This is something I ignored and which I shouldn’t have because my favourite trades (and most profitable) come in times of low or constant volatility. Not volatility that is at historical highs. Traders often confuse volatility and trend and talking heads in the media do it all the time. High volatility is not coincide necessarily with a high propensity to trend. Relatively high volatility creates a problem in that you position sizes are naturally lower and you are dropping into the market at a time when there may be rampant indecision. This second feature is not a given but you need to be aware of it.
Contrast this with the breakout that began the Nikkei’s run.
The same signal occurs but it occurs at a time of low volatility. To me low volatility and a breakout signals a consensus – the herd is happy to be moving in the direction of the breakout. Wedded to this is the capacity to generate a relatively larger position size. It satisfies my rule of get in when it is calm and get in big.
Within trading it is easy to forget the things that make you money when they seem second nature. The danger of second nature is that it can seem mundane and therefore slip from your consciousness and be overruled by simply wanting to have a go again.
It pays to remember what has always worked