Ego And Cognitive Biases.

After re-reading "Way Of The Turtle" and "Egonomics" I was reminded how important the affect the aforementioned has on trading. I thought I'd write a bit about it here to reinforce the concept in my mind, as well as spark interest in anyone who might want to look into the concepts in more detail...

Outcome Bias- How many times do we put on trades which we knew broke our rules only to find that they happen to become profitable? We then conclude that maybe we should "loosen up" on the rules...after all, we would have missed out on the profit had we had followed our rules. That's where the trouble begins! Our Egos need to be fed and are only too willing to attribute the fact that we made money to our purposeful deviation from the plan rather than ignore that win knowing it has no statistical legs to stand on.

Recency Bias- It's common to feel the affects of the recent trades we've made (positively or negatively) more than trades made a longer time ago. Again, this can interfere with the adherence to a strategy. For example, if you have a strategy that wins 60% of the time and, by chance, the last 10 trades happen to reflect that fact with 6 wins and 4 losses, the order they occur can make or break how efficiently you trade those 10 trades. Maybe the first 4 trades are wins...in which case you're likely to follow through with the plan, pumped up with confidence from the multiple wins. Maybe the first 3 trades are losses...there's a good chance trade 4 is "missed" due to hesitation based on fear. If that trade is a winner, you'll go into the next trade annoyed/angry and maybe get greedy to get back the winner you missed and, in doing so, you give back some (or all) of your profits...you can see how quickly our feelings (based on satisfying Ego) can destroy good trading plans.

EUR/USD (6EH9)

The way I trade best is to go in with my plan, be ready to trade it when the occasion arises but NOT to go out with a need to find it. The mind (at least mine...) can find whatever it's looking for if the need is great enough- even if it's not there. I find that it's best to go about your business and, almost find them "by chance"...

This happened today at 4:07ET. You can see the volume declining on each of the three lows, with each of the three waves declining in magnitude. As it was such a steep drop (seen more clearly on the 30min)it needed to form that rounded bottom to see any real retracement as compared to the first drop into 4:07ET. I've shown what I saw developing in price action after I exited...did eventually pop higher on increasing volume just after that period of really low relative vol-the little white circle on the 1min chart. It exhausted itself at the whole number along with trendline resistance and 1st target congestion zone. Entry 1.4028, Stop 1.4017, Exit 1.4050 (at the resistance shown for a 2R gain)

Relative Strength- why it shouldn't be ignored.

My only trade today was UPS which turned out to be a loser. I entered at 10:10ET. Same story with the way I usually enter and how I position my stop (Entry 52.96, Stop 53.16)The stock selection was fine...the warning to get out came when I noticed the relative strength of the stock compared to the market...

If you study the 1min chart of UPS and, for example,the SPY (you could use the DIA index...same idea)between 10:10ET and 10:20ET, you'll notice the stark contrast in terms of RS. The downside wave created between those times in UPS is much slower than the equivalent downside wave in the SPY. To get a bit more mathematical about it, the difference between the close of the 10:10ET min bar compared to the close of the 10:20ET min bar in UPS is 2 cents compared to the massive 24 cent difference in the SPY- 0.04% to the downside compared to 0.26% respectively. Basically, when a trade should be going in the direction of the market and it's not...act with caution- cut the position down in share size, tighten stops or just get out, regardless of where you are in the trade (that means no "waiting till it gets back to even". Chances are you'll just end up taking the full stop)

A quick look at the action in UPS after the market began to climb after the 10:20ish low confirms the strength in that stock as it broke through the resistances I had been playing off of.

Attempt at YM scalp

This one had a nice "tweezers top" resistance (highlighted with the blue circle)- two candles with long "upper shadows" or "wicks" showing the bulls inability to hold prices above that level. This became support for the setup. The overall bias is with the bears however. There's an equal move support zone on the 30min all-sessions chart using the rally out of Fri 12ths open until the first few minutes of Mon 15th as the first move. There was a momoreversal to start the range that would last until the Fed around 2:00ET on Tue 16th...the second move, however is open to interpretation- I measured it from around 8510-20 from around 9:00ET on the mon 15th. There is also the larger 60min timeframe resistance of the 3-wave trend exhaustion. All these factors forced me to aggressively move my stop to reduce risk but give me a chance to get to my 2R, 1st Target resistance target of 8562...it did get there, but not before stopping me out at 8549 under the low of the candle which brokeout of the downsloping wedge or "foot" *wink at Toni*. My entry was 8544 with a healthy stop of 8535 to cater for the erratic movement that I see at this time of the day in the indices.

Monday 15th December 2008- DO & POT.

DO- Had a strong run up in the opening minutes of trade before correcting at 9:45ET and falling into a rising wedge type of range. By 10:32ET you can make out three waves of upside (using that first run up including the gap out of Friday's close) ignoring those three spikes on the 1min chart...on the 60min, it had ran into strong pivot high resistance, made stronger by the fact that it was the trigger of a larger momentum shift out of midday on the 11th of Dec along with support/resistance highlighted with circles and gap resistance, highlighted with the arrow- between the end of Nov and beginning of Dec... Entry 72.07 with 72.40 stop. I got out with a tiny 0.23R gain just as it broke out of 10:45ET. This was because I was watching the relative strength between the indices (which were breaking down sharply) and the stock, which didn't budge...you can see the potential returns that were available...some 16R :o(

POT- Very similar type of setup. The gap forming part of the first wave, the higher timeframe (60min) resistance being formed at the highs of a larger momo shift along with congestion resistance from mid November. I'm very pleased with the analysis of this one! Entry at yellow arrow (70.40) with stop at red line (70.80). Only thing I still have to learn to do is resist taking off too much too soon as I took off more than half in that hour long range from 11:30ish until 12:30ET. My last two stages are shown with the numbers- 2 because of that whole number (69) and first target support, you can see it reacted to this by forming a consolidation and using it as resistance later in th day and,3, the first of the two larger resistance levels using the pivot highs of the prior afternoon. Loved that final exit!

Trading Whilst Tired/Unwell.

I've noticed within my personal trading that, if I'm tired, unwell or otherwise unfocused, my decisions tend to become based more on how I'm feeling instead of what the price action is telling me. One of my weaknesses is the insistance on trading through these periods even though I'm fortunate enough to be able to identify them ahead of time. Luckily, it didn't cost me as much as it could have...

EUR/USD- something I usually just watch because it's $12.50 per tick. Good entry there just after 9:00ET. I usually set my mental stop, have the order ready, and then wait- if the price action is going against me but is showing a bias in my favour, I'm willing to allow price to pass my stop by a few ticks. This was the case here where my mental stop was.0071- highs .0074. I got out just before market open to avoid the expected volatility for basically a flat ($6 something)The lesson here is to not trade instruments with a minimum risk greater than the risk you're able to accept (if you're managing the trade more defensively than usual then you haven't accepted the risk you've just taken it!)

DIA- Got in 10:20ET at 87.56- felt like I rushed the entry but it was valid. The mistake here was ignoring the obvious upside bias and refusing to put my stop on the books until it got to the price I wanted to exit. Unfortunately for me, it then spiked getting me out at 87.85 for a 1.5R loss. The upper timeframe resistance I was playing off was the upper trendchannel line of the pullback from Mon 8th Dec on a 30min-60min chart...

The yellow arrow is the scalp I was looking for (which I didn't take) which stopped at the pivot high of the last 5min of wed 10th's trade in addition to the early afternoon congestion zone (still holding the larger 30min res)

DHR 10th Dec 2008 10:21ET...

Found this one (along with ABT which I didn't get into as I was busy with DHR) Held prior days highs on lower volume...also was running into 60 min downtrend channel resistance. Intraday, had the support of the declining vol and smaller breaks of prior highs. Picked off my entry at 51.56 as I saw the price wicking into the upper resistance line of the pattern.

When the momentum is so strong out of the pattern, I usually look to take off some as the momentum slows. Some kind of pullback normally follows before a second wave of action to continue in the direction the trade was intended. I missed this 51.25 ish slow down when I lost my internet connection. I eventually got out of some at .35, highlighted on the chart. Taking off the rest at 51.05 just before the whole number and into that equal move zone (depending on how you measure it- wick-to-wick measurement gives you the early 50.90's, which it flushed down to)

In retrospect, I saw the pullback after my missed partial exit was on the lowest vol of the session up to that point...it also stopped at the support/resistance line with reversal candlesticks to boot. But my decision to take partials was based on my missing my exit in addition to the fact that I had to get ready for work!

YM Scalp.

This is one I didn't see coming- My larger bias for the short-term (based upon a 15min or greater chart) was to the downside, using that 30min 2T-type trap (after 3 waves on the same timeframe on the all-sessions chart coming out of Friday the 5th December's open) which also allowed for a slightly higher high on the daily as compared to the 28th November's high for a potential 2-wave continuation. So I wasn't willing to hold past the 1st target on this one as 1) I was fighting the larger trend and 2) I'm not able to limit my risk by taking partials as I'm only trading the one contract.

You can see there was Resistance come support using the 60min all-sessions chart on the 14th Nov and the 28th Nov...on the 5min, there was a range that began after the close on the 8th Dec into about 4am EST on the 9th. It broke out, turned around into 6am EST (with a momentum reversal) before selling off back down to the highs of the 5min range mentioned above. Doing so with another momo...I've highlighted the drop in volume on each of the 3 waves of downside on the 1min chart. This shows diminishing interest in taking the market value lower despite making new lows- the smaller range between the successive lows confirms this lack of selling. I waited until the momentum slowed and the price had hit the lower trendline before entering @ 8853 with a stop at 8845. I held it until the first target zone, exiting @8870. It made it up to the pivot resistance zone of 8890 ish (8889) for 4.5 x my risk (4.5R)- I took 2R...

Monday's momo trading.

Here's what I did on monday- as usual, nothing but the momo :o) I'm not paying too much attention to the losers as I've reached the stage where I'm confident in my entries and that my losers are just losing trades within a profitable approach and less likely to be emotionally based (still happens though!) Instead, I know my real issue is how to not take off too much too soon...

(In all trades there is always a 30min or greater support/resistance which I'm playing off...)

CVX- Just one that didn't work out (short trade). Entry 78.12, Exit 78.45 (shown on the chart)

WMT- Nice entry, 57.14 with a stop under the whole number 56.94. Exited in two stages at the highlighted resistance around 57.40 (exits .36 and .39). Later re-entered on the pullback to the resistance-come-support to improve my gains but very much a fear-based exit...

CL- poor entry due to hesitation. Highlighted exit as I had experience repeated drawdowns within the trade and got tired of it just before good gains. Good reason with that overhead resistance but need to find a way to trail stops to allow those potential gains to be realized.

SPY x 2- first trade failed (indicated with the faint yellow and red entry and exit points respectivey) second trade entry I actually "missed" (i.e wasn't ready to take a second loss on the same trade idea) but caught a pullback, keeping my stop above highs(bold yellow and red entry and stop lines respectively) eventually turned into what Toni Hansen calls a "2T" getting close to my stop, before working out. Again, I tend to take off way too much way too soon. I ended up with 1.5 x my risk out of a potential 7 x risk based on my entry and stop...

GBP/USD momoreversal and short-term pattern deviations.

Here's an example of a trade I took in the GBP/USD futures contract (6BZ8) at 9:07am Eastern Standard Time on the 4th of December 2008. There's three waves of downside visible on the 30min, highlighted by the white lines running alongside them, which often leads to trend reversals with the right characteristics in place. One technique I use to help decipher where a wave begins or ends is by using the colours of the candles- you can see that the downside waves are made up mostly of red candles while the ranges between them are a random mix of red and green ones. The larger momentum reversal described here "failed" in the sense that it broke that lower trendchannel line. However price can often deviate from a price pattern briefly before returning to it's prior path.... (area highlighted with the blue circle). On a higher time frame, that deviation would be seen as a wick or a shadow on one candle and is often times referred to as a "flush". The confirmation that this was just a blip in an otherwise strong setup came as price moved back into this 30min wedge-like range and, as if nothing happened, pivoted off the lower trendchannel line (the yellow arrow, where I entered based on the pattern occuring at that point intraday)

You can see my entry there at 1.457 (yellow arrow on the intraday chart). I watch price movement as it comes into that lower support to time the entry with the volume spike suggesting trend exhaustion- stop was 1.456. I exited up at 1.4599 just shy of 3X my risk...