Trading Is An Open System = Increasing Complexity Over Time

 

I’ve seen posts online stating that trading shouldn’t be difficult because all it involves is buying and selling and the rules are pretty similar to when it originally started.

That mindset is wrong though. This first thing missed is trading isn’t just about buying or selling, but buying or selling at the RIGHT times to maximize profits and avoid losses.

The next oversight is not realizing the market is an “open system”, meaning its overall behavior can and will change over time as new participants enter the market with different buy and sell strategies. Over time, as market participants acquire more knowledge and skills, the market will also change to reflect that.

An example of this would be the Olympics over time. If you look at the sporting events of Olympics at the turn of the century versus now, the skill levels that qualified for medals in past history wouldn’t even pass the qualifying rounds for the same sports today. Even though the rules of the past haven’t changed much compared with current rules, the skills and strategies of the participants have.

Current markets include a mix of humans, computer programs, and artificial intelligence into the mix attempting to execute the best buy and sell strategies. This means to succeed in trading over the long term, one must be capable of adapting to market behavior changes over time.

Open systems will change and adapt to new information received. This means that a “market edge”, an advantage one has over others in the market can only work if the information that creates that edge isn’t known by all members in the system. Otherwise, if the information becomes widespread, the market will adapt and the edge will be neutralized. This is why many books and courses promoting sure fire trading plans don’t work- the information is already known by the market. 

PSA: Ignore The Media When They Cover The Market

At the start of August the market had taken on some roller coaster gyrations and the media has been flashing red alert signs to make you think it could be time to panic.

The problem is the news ignores the day to day market activity unless a big move happens and the then they attempt to connect it to some event happening that day as if they actually know the cause and effect. They actually don’t.

By focusing on the the short term, it’s easy to jump to questionable conclusions.

This is the Dow Jones Chart for Monday 8/5/24, when the market had a big drop:

So the news reported on that. Then they focused on the drop the prior two days to add some more fear to their report:

Thurs 8/1/24 – Monday 8/5/24:

Three days of declines….the month of August off to a scary start as reported in most media.

They do these things and then they wonder why people make panic filled market decisions that they say no one should do.

When you look at longer time frames, the perspective changes.

Here’s several months of market activity this year:

You can see the market has experienced two major declines earlier this year but recovered to make new all time highs.

The thing is at every major decline the news media sounds “alarms”, then ignores the market unless it makes new record lows or hits all time highs.

This should make it clear that they are not at all helpful is gauging market sentiment and it’s best to stick to your own due diligence when managing your investments or trades. 

Risks of Looking for a Mentor to Learn to Trade & How to Avoid Getting Scammed

In the past I wrote about why those looking to find the exact details of how to successfully trade by books, courses, clubs, seminar’s, etc, were likely doomed to failure. 

 

My conclusion was the likely best path outside of finding a legitimate mentor is biting the bullet and making the determination to learn to trade on your own.

I was not positive on seeking help from a mentor since there are a ton of fakes out there and the threats they pose to your success are greater than you may imagine.

The bottom line of successful trading is based on one’s ability to determine the following:

1. Market trend for the time segment you are interested in trading.
2. Optimum entry zone area to place your trade.
3. High probability target area where you exit for profit, and additional target point(s) if you have runners.

Your stop should be beyond your optimal entry zone such that price moving to that level is a signal that your price movement assessment was wrong and you need to exit the trade and reanalyze.

All these things should be determined BEFORE placing the trade. The first problem I see with many “mentors” is they promote only figuring out an entry beforehand and then figuring the rest out as you go along real time. In the age of high speed trading algorithms, this is basically suicidal as there is no way you can reliably react fast enough to market activity against computers that can make thousands of trades per second. The market can turn against you in a split second and there will be no time to start “analyzing”.

Learning to trade successfully is very difficult as shown by the greater than 90% failure rates attributed to many studies.

As hard as learning to trade is, there are big risks in seeking a mentor. The first more obvious risk is wasting your time and money on someone who actually can’t trade. People have spent tens of thousands on signing up for “special” trading classes or sessions that were promoted as sure fire routes to trading success, then when they fail, the customer gets burned by being blamed as not trying hard enough. In truth, the mentor never knew what they were doing and their “expertise” was selling trading courses.

The more dangerous and insidious risk of hooking up with an incompetent mentor is the corruption and poisoning of your mind. If you are fed garbage theories and techniques for trading, you will be trying to fit your understanding of market movement with WRONG assumptions you think are FACTS, which results in you being hopelessly off track in finding actual reliable and repeatable solutions. Any natural solutions your mind might discover will be suppressed by trying to force fit market movements into the phony structure created by the quack mentor.

This is why there is great risk with any information provided that is coming from a non certified source. Some people think that a mentor is harmless or legitimate if they provide free information or don’t charge for their services. But bad information is still bad information regardless of whether one paid for it or got it for free. In the age of people getting paid for viewer clicks, the incentive is to just make info that looks good and attracts people with little regard to quality or accuracy.

You see these suspect fake mentor videos all the time. They supposedly are showing you past trades they made, but they are invariably quiet on exact details and planning to satisfy all criteria of entry, target price, and stop areas and make like they are figuring it out on the fly. 

 

Finding a Mentor that Actually Knows how to Trade

Your first and foremost resource to check is your family tree to see if there is a relative that is actually successfully trading. They likely won’t tell you their exact trading techniques, but they will likely be a great resource for looking at your trading plans and giving you insight on how to go forward. 

 

Testing a Mentor

The only way to be sure your prospective mentor knows what they are doing is to get concrete proof from them and not just accept their word or testimonials from others.

They can prove their legitimacy the following ways:

1. Show you their tax forms showing that they truly earn a living by trading income rather than selling trading education.
2. Demand to see them trade live for at least 3 weeks to a month and have them talk through ALL their trades. Note, it’s critically important you see ALL LIVE TRADES not explanations of past trades. You want to see if they can explain their logic in an understandable way and that they are the ones who are actually trading. I see many videos online where the “trading mentor” looks like they are struggling to make sense of a trade as if it wasn’t their trade, but are trying to tap dance their way through a successful trade someone else did.

Watching someone trade live over several weeks will tell you what their consistency and profitability is. Also make note if they are consistent in using an understandable and repeatable method to determine trend, entry price, target price, and stop, or if it looks like they are just winging it. Someone just trading on the fly is not going to help you with making a trading plan even if they trade successfully.

The vast majority of trading mentors promoting themselves will avoid being cornered to prove their legitimacy which are red flags that they should be avoided.

William J. O'Neil: Legendary Pioneer in Trading Using Both Fundamental / Computer Technical Analysis

 

William J. O'Neil passed away during Memorial Day weekend. He leaves behind a legacy of being an early adopter of computer assisted technical analysis in determining what stocks to invest in and achieved great results with it.

His best selling book, "How to Make Money in Stocks", is one of my first books purchased on trading/investing.

As the founder and former chairman of Investors Business Daily publication, William revolutionized investment analysis, empowering countless individuals to make informed decisions and achieve financial success.

With his CAN SLIM® Investing System, William transformed the way investors approached the stock market. His expertise and commitment to providing accurate information empowered investors of all backgrounds to navigate the complexities of investing. His visionary methodology, which focused on identifying stocks with strong fundamental and technical characteristics, became a cornerstone of Investors Business Daily and a guiding principle for countless investors worldwide.

Beyond his professional accomplishments, William's passion for education and mentorship left an enduring legacy. He shared his knowledge and insights, inspiring a new generation of professionals to embrace integrity and perseverance.

Article Link: Link

Legacy: Link

 

 

Learning Trading Analogy: Much Worse Than The Hardest Jigsaw Puzzle Ever Faced

 

 

 

The struggle of learning to trade has been compared to puzzle solving, in this case a jigsaw puzzle.

While a puzzle analogy looks good, trading is no ordinary puzzle and provides no short cuts that your standard puzzle does.

Standard puzzles come with the following assists that can aid in solving them:

1. You know how many pieces are in the puzzle.
2. You can see the clear shape, color, and configuration of each piece, helping you to figure out which pieces go together. You can easily isolate the border pieces based on the piece shape.
3. You can usually see a picture of the completed puzzle, giving you help using color groupings to match associated puzzle pieces.

The “trading” puzzle has no such advantages:

1. You have no idea of how many pieces of the puzzle you need to create a working trading system. The market is a complex system of the resulting input of millions of traders/investors/computers. That creates an infinite number of solution paths along with their corresponding puzzle pieces that are waiting to be discovered.
2. You don’t have any kind of descriptor information on any piece. You have to work to find working pieces of the puzzle through pain staking observation. There are a myriad of potential behaviors/conditions to analyze to try to determine some type of connection/relationship for each “puzzle piece” to be discovered.
3. There is no advance “completed picture” to look at that will help you put the puzzle pieces together.

Faced with these additional hurdles, it’s clear the level of difficulty in solving the trading puzzle will be extremely high compared to even complex jigsaw puzzles.

While solving a hard jigsaw puzzle can take weeks or months, solving the puzzle of learning to trade can takes years or even decades, if ever.

 

 

How to Evaluate a Trade: Good or Bad?

 

 

 

When it comes to trading, the false belief many have is a profitable trade is a "good" trade while one that loses money is a "bad" one.

In reality, this isn't the case if ones goal is to develop good discipline in creating a trading plan that generates consistent profits.

Your developed trading plan MUST answer the following parameters:

1. Best entry value/range - this is your best predetermined entry area. This is critical as a good entry will have minimal whipsaw into loss area that can cause you to lose confidence in your trade.
2. Profit target - this is where you exit assuming the market moves according to your plans. You know the target in advance.
3. Stop Loss- If the market moves against your position, this is the value at which you have decided your trading plan isn't going to work out and you are exiting your trade to minimize loss.

It's important to note that the above 3 values are determined BEFORE you initiate your trade. In the age of super computers, thinking that you are going to have enough time to respond to market moves on the fly is a recipe for future disaster. Having your values set in advance puts your trade in cruise control. Either your trade moves to the profit target or it hits the stop loss.

Evaluating the Trade

Once the trade is completed you have two possible outcomes:

1. Winning Trade.
2. Losing Trade.

Executing the trade will also have two possibilities:

1. You followed the full trading plan.
2. You deviated from the trading plan.

This gives you four potential outcomes which will be the grade of your trade:

I. You followed the trading plan and had a winning trade

This is a clear good trade. You had a plan, properly executed it and the result was a winning trade.

II. You followed the trading plan and had a losing trade

This also falls under being a good trade. The trading rules were followed. Your next step here is to do some analysis to determine why the trade didn't work out- whether it falls within the expected win/loss ratio of your plan or if your plan needs adjusting.

III. You deviated from the trading plan and had a losing trade

This is a no brainer bad trade that can be expected from not following the trading plan.

IV. You deviated from the trading plan and had a winning trade

This is a bad trade and something many people get wrong by not realizing it. Not following the trading plan results in inconsistent actions and inconsistent results, and can reinforce bad habits. The trade being profitable in this case doesn't change the fact that the trading plan wasn't followed which is going to sabotage any hope of being consistent in generating profits.

 

Market Takes a Breather and Drops over 9% in 4 Days

What a difference a week makes! Last Tuesday, the Dow closed around 17500. Today the Dow closed at 15781, about 9.3% lower – erasing all its gains for the year.

Of course all the market talking heads have plenty to say about it after the fact, but what were they saying before it happened? If they don’t have the ability to warn of impending market reversals, then how much weight should you put in their “after market” analysis?

Mega moves like this is a great illustration of why one should always employ stop losses and risk management when in the market. The only absolute control you have is when you enter the market and when you exit.

It’s a guaranteed fact that there were traders who were long in this market without employing any stop losses. It’s also a near guarantee that those traders had their accounts wiped out.

It’s also likely that there are traders who were short without using stops, and those who didn’t blow up their accounts with the market’s move up during this year likely made a killing these last few days, but these type of traders are doomed to give their returns back to the market because eventually they will be on the wrong side of a massive move and suffer the same fate as the traders who wiped out their accounts. Trading without using stop losses is equivalent to engaging in Russian Roulette on a continual basis- it’s not a question of if you will suffer devastating losses, but when.

The true professionals love downdrafts like this as they look for some good bargains that were oversold due to excessive fear. Of course low prices can head even lower, so risk management and stop losses are still needed.

Those like myself, analyzing market price behavior, have been given a golden year of data. The market spent several months in a pretty narrow trading range that heavily favored a delta neutral style of trading. The big drops now favor trending and momentum players. Seeing how the market behaves in both a tight range and trending environment provides great insight opportunities.