I’m back. Good to be writing again. 🙂 I’ll have some more Thinkscript indicators soon, but in the meantime, here’s a philosophy piece:
To revisit my What Would Jesus Trade post, I was listening to a recent podcast by Jeff Quinto where he was talking with another trader about three types of traders. The type they called “Market Savvy” traders would have a framework to define the market environment first and foremost, before any trade setups were even considered. This struck a chord with me.
As I said in my WWJT post, too often we try to tweak the details of our parameters instead of answering the most fundamental questions. It’s like dressing for the weather. If it’s 100 degrees and sunny outside, it’s really pointless to try to decide the best color of raincoat to wear. By a similar token, if it IS raining, then agonizing about whether a yellow or a blue raincoat would be better is equally pointless.
The same is true in trading. If we are in a heavily trending market, then almost ANY trend following setup will do well, and almost EVERY mean reversion setup will do poorly. It doesn’t matter how awesome your backtesting is or what your particular parameters are; these are just the basic facts. Random chop is not too good for anybody but the brokers, and there isn’t a trend following system that can be devised that can make gold out of sewage. The first and most important step is to define how you will interpret and classify market environments. Messing around with other things at the expense of doing this work is foolishness.
So hadn’t you better do the hard work and define some market environments? As they said in the Jeff Quinto podcast, you can’t really learn this from a book or third-hand knowledge. You have to study the market for yourself, and define a model for yourself. It can be simple–Trend or No Trend. That’s simple. You can then refine it to incorporate any other conditions that you want–volume, choppiness, retraces, etc.
One important thing: The market environment definitions are NOT the setups, or the trade plan! They are simply a way to describe generally how the market behaves and how the price action manifests itself. The trade plan and setups follow from that, and almost effortlessly, I would add.
What to do on an up trend day? Buy pullbacks! Trail stops! Maybe take some partials on strength. That’s an easy call. The harder part is knowing how to identify a probable trend day before the day is over. The gifted traders can see a trend day coming within the first 15 minutes of the open. Even CNBC can see a trend day at 4:00 ET.
What about stops? Well, a trend day should make higher highs and higher lows, right? So your stop goes where your market wouldn’t be acting like a trend day anymore. Simple, no agony or optimizing.
You’ve fought 80% of the battle right here. Now just be disciplined to execute and accept the outcomes you get dealt by the probabilistic universe. Of course, your models will need to have some technical parameters or other measurements, but you make a model as a baseline, and then update it if you get a better one. Are you listening, Prospectus? Yes, I am talking to myself here. Very much so.
Quit agonizing about finding a holy grail or a system that “always” works and instead create your own models for different market environments. I’ll be posting some of mine by way of example, but don’t take my word for it. Please do the work yourself and share in the comments if you feel like doing so to inspire others. Apart from learning a few facts, the only profitable reason to read any blog is to gain inspiration to DO SOMETHING, and then use that inspiration to DO SOMETHING. I myself get too caught up in reading and thinking and wishing (and writing) and don’t DO SOMETHING as often as I should. Hope this inspires us all a bit.