When does a victory feels like defeat?

When a trade is on a round-trip ticket!

There are two different categories of technical traders, whether their approaches are based on numeric schemes, charts, trend indicators, mean reversion or whatever. The two categories are:

  • Systematic
  • Discretionary

Systematic trading

A systematic trading program is basically an algorithm (primarily computerized) that makes all the decisions in a trading operation. All of the variables such as position sizing, risk management, trade entry, trade exit, markets traded, etc. are built into the algorithm. The concept of systematic trading hinges on two principles:

  1. The implementation is intended to be without subjective interpretation. The trading plan is mechanical.
  2. The job of the trader is to execute. Any modification needs to be made to the algorithm on a periodic basis, not on a trade-by-trade basis.

All of the best judgments of systematic traders and trading firms are specified, quantified and built into the algorithm.

By the way, the vast overwhelming proportion of managed funds in forex and futures are managed according to systematic programs. In fact, only about 10 percent of managed forex and futures assets are subject to discretionary programs. Needless to say, HFT programs are also systematic.

The only blogger I know of who is a systems trader is Michael Bigger. There may be others.  Michael’s blog (http://thisisbigger.com) offers wonderful insight on the true nature of risk control. I highly recommend his web site.

Discretionary trading

Discretionary trading, by contrast, relies on subjective judgment to one degree or another during the course of plan implementation. Yet, among professional full-time traders who define themselves as discretionary, the distinction is not as great as you might think. The reason is that most professional discretionary traders have developed plans that are highly rules-based. There are, for sure, some gun-slinging traders who improvise on a trade-by-trade basis in much the same way as a football quarterback who scrambles, but this breed is rare.

I am a discretionary trader, yet I am heavily rules based. My discretionary judgements come into play when I identify a candidate trade and when I detrmine sizing or leverage. That is where my discretionary interplay with a trade ends. Once I identify a trading candidate my decision making is 90 percent determined by the rules and guidelines of my trading plan. I have built rules into my plan for precisely the same reason systematic traders adopt algorithms — to trump my day-to-day emotional urges which usually are counter productive to a long-term profitable trading campaign.

I have rules for how I enter a trade, how I set an initial stop, how I move the stop, how I take profits, etc.

I bring this subject up because it will help you understand my trading actions in the S&Ps. Once I identified the H&S top in the S&Ps my rules took over. My entry on July 29 was subject to a rule I call, “Major Pattern, Anticipatory Entry.” My pyramid on August 1 was based on a rule I call, “Pyramid, Retest Provision.” My entry on August 2 was based on a rule I call, “Major Pattern, Completion.”

The protective stops I used for these positions were based on rules. All the time I was jawboning about my bearish opinion in the stock market in this blog, my actual trading decisions were being executed according to rules, not judgement.

I exited the first layer of the trade on August 8 based on a rule I call, “Profit at Target.” I exited the second layer of the trade on August 9 based on a rule I call, “Profit at Target with Reversal.”

The intraday chart I featured most of last week represented the judgement part of my trading. It was my interpretation that the market was putting in a wedge. This was the subjective part of my trading. Yet, all of the trading that would have been executed based on that small pattern would have been 90-percent rules based.

I retain one layer of my original short position. That position, too, is subject to rules. And now that the market today officially closed above the high of the low day (August 9), the rules specify that I need to move my protective stop to above the high of August 5. I am not going into the complicated reasoning behind the rule. But, even though I my stop is well below my entry point, I will have a sense of defeat if I am stopped out. Who said disciplined traders don’t have feelings?

Do I periodically override my rules? Yes. Do I usually regret overriding rules. Yes again. My trading rules are based on what I know about market behavior, not on how I feel at any given moment. One of the metrics I maintain and review quarterly is how much my rules violations have cost me. Believe me, there has never been a year when rules violations have contributed to the net bottom line.

Battling the emotional pull to override trading rules is the toughest part of my job. There is not even a close second.

The rising wedge I had been watching has now been nulified. I am still bearish, by opinion. I am still short, by position. But in terms of pyramiding my present position I am back to the drawing board. The market is not showing me anything right now, other than a possible flag. I like trading bull flags — I am not fond of bear flags. I would become interested again if the market forms a small reversal or if prices have a more serious test of the top and then form a smaller secondary topping pattern. A move below 1175 by Sept. S&Ps will be some evidence of the bear flag.

I have often commented in this blog that an opinion is not a position and a position is not an opinion. I hope you now have a better understanding of what this means to me. This is a tough lesson for novice traders to learn. But it is a lesson that must be learned.

I have no interest in trading from the long side — it would take at least 10 weeks for a buy signal to even develop. I will leave the long side to folks more heroic. I remain a long-term bear. I believe we have a major H&S top in the stock market. I believe we are going much, much lower. I believe that all near and intermediate-term doubt will be resolved to the downside. But in terms of positions, I will rely on my rules.

Markets: $SPY, $ES_F, $SPX


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  1. […] pm via StockTwits WebReplyRetweetFavorite@gtotoygtotoy On a similar note,  in a post titled When does a victory feels like defeat?, Peter writes:…an opinion is not a position and a position is not an opinion…This is a […]

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