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The Trader's Guide to Mythological Constructs

Like anything else, trading has its fair share of fads. They come and (generally) have a much harder time disappearing vs. something like fanny packs. People are drawn to novelties and things perceived as “easy”. Whether it be a new diet, kitchen gadget or anything else out there, “set it and forget it” sounds great, but rarely works.

I have just as much trouble digging through the trash for nuggets, and whether I'm looking at a piece of fundamental data or technical output, there are slews conflicting studies out there pointing you in way imaginable.

Everyone goes through this.

I have also said many times in the past here: I could care less how anyone invests or trades. The bottom line is the bottom line, and if it works and makes sense to you, then go for it. This post is, therefore, more of a caveat emptor and explanation of a highly misconstrued topic than anything else. My only intent here is to toss up a few considerations in terms of inputs versus methods (most people confuse the two) as well as intervals, and a polluted river I see far too many people traversing.

When I dipped head first into truly short term trading I had already been working in the industry for quite a few years. Making this transition, even with the amount of experience I had up till that point was a massive undertaking. I would be sitting in my home office right through bedtime every night trying to “crack the code”, or whatever you want to call it. I felt like a noob again, and to say it was frustrating would be the understatement of the century. At the time, I knew what I was doing could take years to get around, and turns out I was right.

The problem is that you only have so much information with which to work, and the information in and of itself poses their own set of issues. One of the bigger reasons people lose so much money in this business is that they're looking at surface level analysis and/or have their timeframes all mixed up. I could go to Google right now, and find about 5,000 arguments as to why “price action does not lag”, when in every ounce of common sense it most certainly does.  This has always sounded ridiculous to me. Compared to standard, exponentially or arithmetically calculated indicators, like an RSI, it obviously “lags” less, but it most certainly lags to a great extent.

These days, when somebody asks me about my general thoughts on price action, the short answer I provide them with is simply:

“It's a framework. It's structural. Its largest benefit is timing”.

And the reason I say this is because in the most basic sense, prices are the end result of all decision making. Leading into prices themselves, we have an exhaustive list of factors, depending on what it is that's being priced.

Whether it be an agricultural product, a company, or a currency, every market has its own series of levers which determine the final output: price.

So by the time you look at that chart, everything is there, right in front of you. Prices are the very last thing to occur in this drawn out, value-seeking and otherwise transactional process. If that isn't “laggy”, I don't know what is. And so it is not that this poses a great deal of detriment for anyone looking to incorporate it into their analysis, but he/she does need to realize what it is they are doing.

The bottom line is that it's not the input, it's the method, explained below.

Two camps of strategies:

There are a couple of different ways to look at strategy assembly. I generally put all things trading into two separate categories:

Proactive to price – reactive to fundamental or other inputs leading prices themselves (observing fundamentals, economic or market-driven, or leading indicators, and assuming that the value of this data is not yet “priced in”).  When we are using a proactive strategy, we're putting together pieces of a much larger puzzle, and (typically) weighting indicators which we believe to have a higher weight from a forecasting sense. For a while now, Bridgewater has had a good example of proactive weighting of sovereigns posted on Dalio's “Economic Principles” website. Here is the link: . This approach can (and has been) applied to virtually any single or basket of instruments (eg Ben Graham's value investing).

Reactive – reactive to prices (eg buying or selling support and resistance, etc.) or other data (following the herd or late-stage trend following strategies).  When we are using a reactive strategy, we are observing historical price data to assess (statically or not) a reaction in prices from historical levels or other inputs.

More colloquially, the above can also be labeled as convergent and divergent strategies. Page 18 of the following outlines this in more detail:

Both of these primary methods can hold credence, or not, depending on how well they are executed. I have seen both plenty profitable and unprofitable over the years. “Good” trading and investing entails a consistent approach which is clean from an execution sense, and highly prudent when it comes to risk. One of the larger issues with traditional retail day trading as I have seen it over the years is an extremely poor approach when it comes to both finding short term value and the management of risk. Risk management when trading a single instrument requires very strict rules when it comes to the big three: stop, entry and exit. Most people cannot handle this because they're trying to go from 0-60 in 1.9 seconds.

The Turtle Always Wins

As few of you know I have had a solid pile of surgeries on my right hand over the years following a fluke accident. My orthopedic surgeon has 40 years of experience under his belt. I just imagine having any one of these surgeries performed by one of his residents, and how likely subpar the results would be versus his own.

And so I do my best to stress to everyone, don't expect any miracles. This is a profession which favors longevity, not short term gains. What makes anyone think they'll turn themselves into a surgeon overnight?

The easiest way I know to extend your learning curve by about 5 years is by trying to take shortcuts.

And so I digress, we have heard all of this before, and yet the cycle continues (it always will). Unlike becoming a surgeon, the barrier to entry is nearly nonexistent yet it requires a great deal of experience, thus skill, to do it properly.

Extending Timeframes

So going back to our fads, whatever timeframe you are using for analysis will have a direct impact on the length of your positions. And this is a primary reason I highly discourage discretionary traders from using things like footprint charts, one-off analysis of iceberg orders, attempting to “master the tape” and so forth. As a tool for understanding the composition of price, fine, and actually essential. It is why you'll still see me posting some of these just to help explain what is going on behind the scenes. But for full on application, it's basically a flat no from me. Again, a component, fine, but not in totality.

You need yield. And that yield can only come from latching onto runs on price or otherwise lengthy movements relative to anything you're going to bring home from such short term information. I'll give you an example, paraphrasing a conversation I had not too long ago when discussing this topic…

-within a range only a few minutes, you saw around 4-5 buy or sell “signals” (if you follow common wisdom on these types of things)

-the first gave up zero ticks, the second, 1, the third, 8, the fourth, 1, etc.

-your probability of achieving perfect execution on these does not even exist, I wont even bother tossing numbers at this

-the only way to achieve profitability on this would be to execute at the BBO on the other side of the trade. As a retail daytrader, you will be waiting in line less time for every ride at Disney World than you would before this happened. Everyone is beating you to the queue.

Well what about the long term for a footprint? Sure, but then you're looking at very fragmented data. If that's the case you mine as well just plot total executions and block out all of the noise. Same thing, but up to you obviously.

So a more simple way to state this is that it boils down to realizing what is achievable vs. what is not. For people looking to trade in a relatively short term nature, don't try to become a genius gray box competing with HFTs. Ain't gonna happen.

I see tons of people realize something is not achievable within 5 minutes but refuse to take action on it for 5 years. Not uncommon. That's our animal instincts trying to take down the bull with our bare hands, I suppose. Whatever it is, it requires change faster than what most people put up with it.

Anyone I have ever seen trade well, and use the DOM or tape, is not widely relying to on this tool to generate their buy or sell triggers. It might be a component, albeit typically a small one. And while it is all that is seen while people are actually executing, it gives off the illusion that this is, indeed the only method of analysis being employed.

And as ridiculous as this statement sounds on the surface level, I no longer worry so much about forecasting these days. I take it one step at a time, based on the information I have in front of me. I have seen too many things at this point to realize that there is such a thing as overforecasting, and getting married to an idea that ultimately proves incorrect.

It should be a given that there's nothing wrong with this, so long as your risk is managed thoughtfully and appropriately, but this something people have an extremely hard time doing, especially on individual positions minus any hedging.

Pattern Recognition and Confirmation Bias

Analysts are notoriously mediocre to poor price forecasters. We are taught in general academia to follow a prescription of macroeconomic principles and other themes which lead us to believe that A+B = C in a very static sense. What we all learn very quickly, however, is that other elements outside of this realm come into play, refuting a material portion of that which we are taught.

Some people are vehemently against topics like technical analysis. I have found over the years that this has more to do with their general systems of belief as opposed to working knowledge. But then they open a chart, and what is the first thing they do? They start to visualize sequences, patterns, etc. and essentially repeat the very thing they most defiantly offend in the public space.

We are literally hardwired to seek out patterns in charts and other forms of financial data in the same way get off the couch and go to the fridge. It is nearly impossible for us not to do this when entering the same situation, every day.

All I am saying here is that it is very natural for us to want to find patterns in just about anything, whether it be that price chart or a string of economic or market driven data, and there's nothing wrong with that. All trading strategies are ultimately built to seek out a series of repeatable events.

But what is disconcerting is the weight on which people place such “surface level” patterns, because, at the end of the day, many traditional price patterns, in and of themselves, don't lend themselves to favorable outcomes.

What always varies is context. Two people will look at the same chart/data, have completely different biases, and be able to frame an argument based on their own past experiences.  Instead of letting the information speak to them, they speak to the information, and reinforce their initial bias by continuously adding layers that support their argument, and dismissing those which don't (confirmation bias).

Obviously, this is only possible because the underlying “system” is the same and allows them to do this in the first place. Therefore, this loose “system” needs to go, and confirmation bias made simply impossible.

The biggest issue with conventional price action as a standalone is that it allows confirmation bias to spread like a virus. Again, it is not the input, its the method, and this seems to be one of the bigger misconceptions out there. So if you're solely relying on price action for your strategy you are 100% reactive. Fine, but realize that basic math behind your risk will take precedence over your forward-looking price movements.

And this is not something which is easily defeated. Catch phrases like “having discipline” is not the answer. Perhaps in the moment, but certainly not long term. You need more info.

We have a natural tendency to want to forecast. In many ways you could say this, too, is in our nature. But when it comes to forecasting by way of prices in and of themselves, we are reacting, not forecasting. That's all there is to it. Note: to reiterate what was written above, there is nothing “wrong” with selecting either a proactive or reactive approach, so long as it is implemented properly.

Not knowing what is going to happen next, or being outright incorrect in a forecast is not an uncommon occurrence. In trading, this is par for the course and you need to accept these circumstances, as they are.

Worry about high risk growth / wealth is what tends to sink most people. 

These days, I see it in crypto.  Ask me 12 years ago, and I would have said FX. For every one long term guy who is willing to hold onto his bitcoin for 20 years there are 1,000 other people (usually younger) thinking they will strike it rich in the next year as an early adopter. Hate to tell you this, but the 16% train has already left the building on this one. And I realize I am speaking against “the gospel” when I write things like this, but running away from reality has never helped me personally. If you want to think otherwise, that's fine too.

Daytrading is commonly viewed as an alternative mechanism to achieve otherwise nonviable goals. Technical analysis as a tool is structural to me.  That's why when you come on here I describe it as a framework. It gives you a GPS position. Builds your confidence so you're not scrambling to understand the most basic of common movements.

But I think one of the reasons it has become so popular is the pure surface layer simplicity of it all. Anyone can look at a chart and draw a trendline or identify a pattern within 5 minutes of “training”.  But understanding how prices evolve, how one item leads to the next, where true, material flips in prices are likely to occur (and why, behind the scenes), is another topic, one which requires substantial depth. This is all very important context for a short term trader, much less so for someone utilizing an intermediate timeframe.

It is also one of the reasons I don't update this blog like I used to. At risk of sounding like a Debbie Downer here, it does get a bit tiring explaining these things, much of which I am just defecting against myths people have been trained to believe over time. I would be lying if I said it was a load of fun. But for anyone willing to put in the work and make a concerted, serious effort, that's another story.

I like people to challenge themselves. It is what makes us who we are. True character doesn't come from sitting on a couch, remote in one hand, iPhone in the other.

People want to short term daytrade. I get that. But in doing so you need to realize a few different things:

  • you need yield. Discretionary “scalping” for a couple ticks at a time using single timeframe data, is barely achievable, if at all over the long term. So therefore:
  • be very specific about the timeframes you're observing, and what they mean to your trading. I still use a top down approach and marry longer term analysis into the intraday.
  • any patterns you build will be based on the data you're observing, so find a methodology with proof of concept. Strategy hopping never works because the trader is executing on a void of observed knowledge on whatever new “thing” he or she is using
  • you can use a convergent or divergent strategy, it doesn't matter, but be very well aware of what it is you are doing
  • it is one of the hardest forms of investing you can do. I tell beginners these days to take advantage of the thousands autoinvesting apps and websites to get rid of the itch of gaining market exposure, and leave the real money out of the short term accounts until he/she has developed a high intermediate to advanced proficiency particularly when it comes to controlling your downside. Best I can recommend in many cases. Per the demo vs. live psychology thing, all I will say is this: I have never seen an algo written and then automatically put to work on real money without testing. “Common” sense.

Wealth managers call themselves “wealth managers” and not “wealth generators” for a reason. Imagine walking into an RIA's office, managing 2 billion dollars, and telling them you want to take $1,000 and run it up to $10,000,000.


So as usual, no free lunch. You're going to have to work for it.

Come to grips with the type of strategy you intend on using: proactive (convergent) or reactive (divergent)? See past the surface layer. Rising wedges are characterized as bearish, yet if you sold into that last few rising wedges on the S&P 500 you would have gotten your face ripped off 3-4X now (hint: they're one of the worst performing price patterns). Prices are result of any number of things, and reactive low volume levels is just one of them.

Having a demonstrative framework/template to navigate such circumstances will help you remain on track, control your level of risk taking and enhance your ability to take action when favorable events present themselves. This template will vary greatly based on the products you trade, as well as the timeline for doing so.

So just kind of a rant here today. Next article coming in 9 months, probably :).

I would like to thank the crypto community for reigniting my need to rewrite the “Trader's Guide to Mythological Constructs“. But we all need to start somewhere, and there's absolutely nothing wrong with that either.

And to you guys specifically, I say, Godspeed.

Best of luck, but better to use your head instead. Thanks for reading.