When you do not follow your rules, you make a mistake, cautions Van K. Tharp, in the recent edition of ‘ Super Trader: Make consistent profits in good and bad markets ’ (www.tatamcgrawhill.com). And making the same mistake repeatedly is called self-sabotage, he adds.
The book introduces you to a simple measure, ‘trader efficiency,’ to measure the impact of mistakes on your trading. Trader efficiency, as instructs Tharp, is a measure of how effective a trader is in making mistake-free trades. “So a person who makes five mistakes in 100 trades is 95 per cent efficient.” Stating that 95 per cent is actually a very good trading efficiency level, the author rues that many traders cannot even trade at 75 per cent efficiency. “That’s one mistake in about every 4 trades.”
Mechanical traders
Tharp discusses elaborately two types of traders, viz. mechanical traders, and no-rules discretionary traders. The former believe that they can eliminate psychologically-related trading problems by becoming mechanical. “Many people aspire to be mechanical traders, letting a computer make all the decisions for them, because they believe it will factor out many human-based errors.” To them, the author’s counsel is that you, the human, could yet decide not to take a trade.
Taking on the question whether mechanical trading is truly objective, Tharp’s answer is in the negative because there are all sorts of errors that can creep into an automated trading system – data errors, errors in the software platform, errors in your own programming, and many more.
Alerting, for instance, that data errors in the form of price errors can show up in streaming data quite regularly, Tharp observes that sometimes these are resolved within seconds and the error ‘disappears,’ but by that point, the bad data may have triggered a trade already. “Additionally, historical stock data may or may not have dividend and split adjustments. And what happens when a company goes bankrupt? What if it goes private, or it is bought out by another company? Those companies’ data may simply disappear from your data set.”
Error of omission
Another error made by mechanical trading systems is the error of omission, highlights Tharp. Because the criteria by which trade setups and entries are so precisely defined, mechanical systems miss many good (or great) trades that a discretionary trader would spot easily, he reasons.
Conceding that such missed opportunities do not qualify as mistakes, Tharp reminds that these can severely limit the potential results of the underlying logic behind the system. He avers, therefore, that the mechanical system results will look rather weak next to the results of a trader who used that same system and was allowed some discretion to take all of those other trades that didn’t quite fit the precise mechanical system rules.
No-rules discretionary traders
Traders who belong to the second category – the no-rules discretionary traders – are basically those who are free to do whatever they want, Tharp notes. “They can take a newsletter recommendation, trade a high probability setup based on what some guru said in a workshop last year, or perhaps just buy something on a whim.”
They might feel they have 20 different systems with none of them rigid, but in reality they have no systems at all, the author points out. What they really have is a little bit of nothing and a lot of ‘into-wishing’ (as opposed to intuition), he chides. “As a result of having no systems and no rules, they have no way of effectively managing their trading. How well do you think a company would operate with no plans, no business systems, and no rules? Because they have no rules to follow, everything no-rules discretionary traders do is a mistake.”
Self-test
A 10-question quiz given in the book can help you check if you are a discretionary trader. The questions include: Do you sometimes buy newsletter recommendations without having a real plan for how you’ll get out of the trade? Do you trade three or more different systems in the same account? Do you sometimes enter a trade and later not remember why? Are you unable to list the rules for any of the last five trades you made?
At the end of the quiz, the author says that if you answered ‘yes’ to as many as two of the 10 questions, you have some elements of a no-rules discretionary trader. Saying ‘yes’ to six or more questions would mean that you definitely are a no-rules discretionary trader. “Chances are you seldom make money in the market because you are not playing a winning game. You probably make many mistakes…”
Educative read, unmistakably.
BookPeek.blogspot.com
