The degree of one’s emotions varies inversely with one’s knowledge of the facts. – Bertrand Russell
We absolutely love this quote. You know when they say the loudest one in the room is usually the dumbest? I think this quote says this more succinctly.
In trading you are susceptible to different emotions constantly; one minute you can feel on top of the world, the next you can feel like the world is against you. The key is finding out how to make emotion not be a variable that affects your PnL. It is impossible to remove emotion but controlling emotion is possible. There’s so much written on trading psychology and how to master your own emotions but I think this is totally fruitless. That’s a massively long way around, and there are too many variables outside of the markets that can affect your emotions to make trying to master your emotions an effective way to maintain your edge. We don’t believe in subjectivities here – just variables which you can write down on paper and quantify.
The Solution to Controlling Emotion
So the solution to controlling emotion – make sure that you know your strategy(s) inside out. This means testing, testing and more testing. This means understanding what makes you profitable and then ensuring that your sample size of trades is large enough to make your trading hypothesis significant. Once you have a significant hypothesis, you then have a system that can churn out profit in the tested market conditions. Note that I said in the tested market conditions. This doesn’t mean that your strategy isn’t profitable. If your sample size is large enough (1000 + trades if intra-day, less if swing or longer term) you can attribute a losing period to the expected loss rate.
Here is a simple formula to know if you are profitable or not:
(Reward to Risk ratio x win ratio) – Loss ratio = Expectancy Ratio
So if I have a win rate of 50% and an average R of 3, the expectancy would be;
(3 x 0.5) – 0.5
Expectancy Ratio = 1
This means that with this strategy, you will return 1x your losers. You are profitable.
You have to ask yourself why large players are moving toward algorithmic trading heavily. It’s because they can remove human error and act totally impartially, as well as at lightning fast speeds, of course. But you want to try and emulate a robot as much as possible. You want to get to the stage where the correct execution conditions are almost subconscious and you do not have to think about what you are doing, and this can only be achieved by understanding every part of your strategy and repetition.
We’ve partnered up with a firm called Chasing Returns to help you understand your edge as much as possible. Chasing Returns is an automatic trading journal, but almost acts like a mentor due to how effective the software is at identifying where you are going wrong, and where you are excelling.
Credit/Source: https://www.fxtradeacademy.com/