Market Reflections

Thoughts, ideas and musings on current state and evolution of financial markets

Market Change Affects Profits

From trading literature we have learned that winning traders are self-disciplined. They control their feelings, and execute their trading strategy with ease and perfection. The disciplined trader is decisive. He or she acts on trading strategy signals without wavering and second guessing. Of course, a great trading strategy must produce its entry and exit signals without any ambiguity for the discipline to pay off in form of profits. All the above is common knowledge, intuitively understandable and accepted. Yet, here’s where the contradiction is. The very same unwavering trader’s discipline has turned many substantial trading fortunes into even greater losses. How come?

Discipline and lack of ambiguity in signals means that the trader will always react same way based on the market behavior and/or whatever the strategy’s signals are based on. As the market character changes the same basis for entry and exit signals may no longer be relevant. An unwavering trader will no longer make money or in worse case, will be forced to stop after all the profits and more are lost.

Maintaining an equity curve is a well known way to find out whether you keep winning or are losing instead. Yet, with equity curve the decision to continue or stop trading a strategy is rarely as clear-cut as described in the books. For example, an equity curve of a simple break-out strategy that performed great for some time, then just ok for about a year and has been losing big time recent months. At which point would you have decided to pull the plug?


Most of the time the decision to continue with a strategy or to abandon it is much more puzzling. Look at the equity curve of the same break-out strategy on a different market and think would you still be trading it? If not then what time did you decide to quit and why?


To make things worse exactly the opposite happens as well – a strategy that did not work on a market at all, all of a sudden will do just great based on the equity curve. For example, different break-out strategy equity curve.


Perhaps being a self-disciplined trader that quits only after all the money is gone is no longer the best idea even though it was in the past. On today’s rapidly changing markets knowing exactly what characteristics a strategy is sensitive to, closely monitoring any change of these aspects and evaluating impact to the strategy works better than simply “trying it out” with your money on line. Many break-out strategies are very sensitive to the volume. They work when the volume is just right and stop working when it is too low or too high. Year-to-year (2007/2008) volume decline of most CME Group market volumes has been profound. An average 49% decline across the board reaching 60% decline and more on financial markets and equity indexes may render some great strategies incapacitated … or the opposite — make them worth trading.
This is in contrast to most NYMEX markets where the volume has steadily grown

Self-discipline is good but in today’s fast changing complex market conditions not enough for a trader to be profitable. Happy trading but watch out for “common knowledge”!

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