THE HOLY GRAIL OF TRADING

We all love to hear a too-good-to-be-true story and quite often we are hooked by offers for unrealistic returns and results. For instance, recently I came across a spam-site which promises 165% returns in 40 days on deposits – how would that be even remotely realistic. Or, reading an advertisement for a jump-rope, which you can even use while sitting for incredible results – I just cannot help but laugh. Such is also the story for the holy grail of trading. We are constantly looking for a method which would provide us with the ultimate edge, telling us exactly when and where we should enter the market with no risk, making a fortune in no time. And finally, making all that work obsolete, so that we can lie on a beach somewhere drinking cocktails from coconuts until the rest of our lives.

Though there does not seem to be a holy grail in trading, it has wisely been said that a trading edge must consist of three M’s – and that is the closest we get to it. These three M’s are

Method,

Money-Management &

Mind.

They refer to the way that a trader is generating signals, protecting his account and reacting to changes in the market place.

Quite often it has been said that the least important of these is the method, while the mind-element takes up to 80% of the importance here. This might be just slightly different from what your broker was telling you when you were signing up for your account. Though I would suggest that any successful strategy must have a strong component of all of these, different people put a different value on the distribution and specialize in different fields.

For instance, most people believe that it is necessary to be able to forecast the market in order to make money and so they look for some way to do this – whether through fundamental analysis or technical analysis, they try to find some kind of what they consider to be a cause-effect relationship and dedicate themselves to staying alert to the causes, betting on the effects. Here, the almost mythological W. D. Gann comes to mind, who has been said to have been able to forecast dates and prices years in advance. If we could only do that, too, we reason, than we would have no issues with our trading. However, since few people seem to have been able to reproduce even parts of his work, we have to assume that we have to deal with the uncertainty and operate in an environment of risk. Even though W. D. Gann has made the impression to be right in the majority of cases, his trading books, some of them over 100 years old, still give plenty of practical money-management strategies and psychological tips to the layman.

On the other hand, in economic theory and academic circles it has always been assumed that the market is unforecastable and the stochastic element has to be taken into account. And since no one has an accuracy of 100%, we have to ration our capital the same way a poker player does, with a system of percentages of our capital for all of our bets. But the problem goes deeper: not only do we believe that the market is a random-walk process, but, as Nassim Taleb shows us in his Black Swan, even this assertion is wrong. Making such a statement already generates a probabilistic outlook on the markets, while he explains that we have a totally wrong understanding of those processes. We tend to underestimate extremely unlikely events and live in a world which we believe to be normally distributed – until it isn’t and we go broke. Coping with his understanding of the world he looks to create a risk-management strategy which is anti-fragile, i.e. gains from shocks, instead of breaking down. Ultimately, assuming that we have absolutely no clue about the market, we just have to make sure to make profits. Bingo.

Lastly, other people think that the previous two components are useless, if the mind is not stable and strong. Trading is a mindset and it requires discipline, dedication, consistency and hard work. In one such extreme we could look at tape-readers, who say that the pulse of the market can be felt and anticipated through constant monitoring of the market and the right mindset about trading. For instance, in an interview Tom Hougaard from WhichWayToday has said that he does not even have a system, instead he just assumes that he is watching another group of people who exhibit their regular behavioural patterns. Other people just watch 1minute charts and go with the flow, while others set up statistical trading robots and just repeat to themselves that in the long run the system will make money.

Whatever it is, a combination and knowledge of all three of the above seems to be absolutely necessary for making speculation a profitable profession. Whichever you specialize in, though, the markets are a fascinating guiding light and challenge – however, the ultimate goal is solely to make money. Do not forget that.