Derive pleasure from following your trading rules, not from profits

One of the most difficult things in trading is associating pain or pleasure with following (or not following) your trading rules, and not from your day-to-day trading results.

Trading results are random. That is a fact.

For example, let’s say you have an edge that results in you being profitable 60% of the time. This means that you will still lose money on 40% of your trades. Beating yourself up for these losses has zero benefit to you as a trader.

We are battling ourselves

The human psyche is fragile. We are battling our egos.

Sometimes in trading we get more concerned about being “right” than making money. This is why we sit on losing positions, hoping they come back in our favor. This is why we don’t take small losses, allowing them to turn into big ones.

I was stuck in a rut, which I’m working towards getting out of. Today has been a step in the right direction for me. Today my focus is on following my trading rules, not make a profit per se. This is really hard to do. Besides, isn’t the goal to make profits after all?

Associate positive feelings with following your trading rules, not the end results

Accepting that a trade is going against you and cutting it should be associated with positive feelings because you cut those losers early.

No one wants to lose money, and that’s why it’s so hard to associate a positive feeling with taking a loss. Taking losses sucks, and we all wish they were avoidable.

It’s difficult to do this. Losing money hurts. But, it’s important to reframe losses as a cost of running your trading business.

I have to remind myself to be impatient with losing trades. I can’t fear cutting a loser too soon. If trade doesn’t feel right and isn’t going the way I expect it to, it’s okay to cut it.

I have to remind myself to not look back at trades that have been cut loose. This look back bias makes me kick myself for not holding a trade longer. This is detrimental to my future trading performance, because I end up holding losers longer that should’ve been cut the moment they no longer felt like good trades.

I have to remind myself that I can always re-enter a trade if an attractive setup presents itself once again.

Dealing with randomness

Establishing a set of trading rules, and sticking to those trading rules has proved to me to result in more profitable trades rather than focusing on profits alone.

If you have a legitimate edge in the market, a set of good trading rules to follow, then profits will follow as result of disciplined trading.

This week was rough for me

I got my ass kicked this week by the market.

It started early in the week, when I bought WORK and SPCE call options, just before the market reversed course on Monday and sold off in the final hours of the day. Because the SPCE options expired on Friday of the same week, I had no choice to cut this loser. Only to see it rip higher Thursday and Friday.

I started the week in a hole, down $1,100.

I spent the rest of the week trying to climb out of the hole, only to make the situation worse. End result, down $4,000 on the week.

How did this happen?

Getting in a hole sucks. Spending the rest of the time trying to climb out of the hole led me to making sloppy trades, overtrading, and putting on trades that I wouldn’t normally make on SPY and IWM that I told myself were “hedges” in case the market sold again.

I forgot what was working.

I forgot how I made $12,000 in a matter of weeks from May 27th to June 19th.

Nothing seemed to work.

Every trade went against me as soon as I entered it. Or so I thought.

Either way, it doesn’t matter what they did.

What did matter was my mindset sucked. I was in a bad mental state, and desperately tried to “undo” my bad trades from the early part of the week, only to have even more bad trades to “undo”.

I wasn’t doing what works for me.

I started trading options expiring this week. I started day trading more even though I very much prefer swing trading a position for 1-2 weeks.

I cut winners too soon (primarily due to short-dated options being traded).

I let losers run on too long.

I added to losing positions.

I put on positions that were not favorable from the get go.

I spent too much time this week hoping for my positions to go in my favor.

Now is a time for reflection

It’s the weekend. My trading week sucked. But I still live to trade another day.

Goal #1 and always: DON’T LOSE ALL YOUR MONEY. When the money is gone, the game is over.

I’m going to take this weekend to reflect on my trades. I will review past trades further and understand what happened and why it happened. I will try to understand what my mental state was when I entered into those trades.

Trading is hard. It’s hard to tell by all the so-called experts all over social media. They’d have you believe they make profits all day. You rarely see is the hard part of trading. The part where it beats the shit out of you and makes you question why you started in the first place.

I share this for anyone else who had a bad day, week, month, or year. It’s not easy. It’s not supposed to be easy. I knew that. You know that. So take time to reflect, take care of yourself, and objectively review those trades and improve the process. It’s the only thing I know how to do.

Been playing lotto calls on big movers…

This market is insane. For that reason, I’ve been playing short-term call options on those names getting bid the most recently.

Banks, airlines, cruise lines, oil, casinos, retailers, are all industries I’ve dipped into and out of recently. I’ve traded it on short-term call options about 3-7 weeks out.

My main focus is to take of 1/4 of a position at 10% profits, another 2/4 position at 20-30% profits, and then let the remainder of the position run. Taking profits is critical to setting up risk-free trades.

That’s the way it has to be played right now.

It’s very very very easy to adopt a bearish mindset right now.

The market is going insane.

But I’m thinking about it like the tech bubble.

My main focus is to keep my holdings short. I never held any of my lotto positions past 2 days unless it was the 1/4 winning position remaining.

It’s much much easier to let winners run when you booked 3/4 of your position at a profit. Those runners have ended up making up my big home runs in recent days.

My best trade was UAL last Friday, which I booked at 361% profit. F also netted me 192% profit.

I cut losers at around 20-40% drawdown on these positions without any regrets. It’s worked out well so far. But that can change very quickly.

Trading in the Zone – Book Notes

I recently finished reading Mark Douglas’s book, Trading in the Zone. This book found me at an opportune time, as I’ve been going through a rough patch with my trading and especially my mindset while trade.

If there is one book I highly recommend you read as a trader to get your state of mind right, it’s Trading in the Zone. Here are my book summary notes below. Note that my summary notes are not short. It’s over 2,500 words of the best wisdom I pulled out of the book.

Book Summary Notes

Have confidence in trades.

Focus on opportunities.

Fundamental analysis is the study of finding supply and demand of an investment based off fundamental information.

Technical analysis is based off patterns in an investments’ historical data.

Technical analysis is more “in the moment” than fundamental analysis. You react in the moment to changes in prices.

Good traders have rules for entry and exits.

Accept risk before putting on a position and never assume you are correct. Be quick to admit you’re wrong.

Accept the possibility that you will lose money so that you can objectively manage a position.

Good traders aren’t afraid because they have effective management strategies to enter and exit trades.

The four primary trading fears are:

Being wrong
Losing money
Missing out
Leaving money on the table

We blame the market for our losing money.

How you view the market affects the consistency of your results.

You can never know the myriad of ways the market can make you lose money.

Accept that the outcome of a trade is unknown, and that one trade is not a reflection on you as a trader. Failure to accept this leads to costly decisions.

Doing more market analysis will not make you a better trader. Acceptance of what the market is will.

Accept the risk you take on with every trade, and you will no longer be afraid.

Trade without fear, and have rules to prevent reckless behavior.

The market presents you with unlimited possibilities, and this can challenge those not equipped to deal with this fact.

Desires are generated internally, but must be fulfilled externally.

Once we identify a desire we are drawn to fill that desire externally. Denial of this opportunity to fulfill a desire leads to pain.

Accept that trades are a probabilistic outcome, and define how much risk you are willing to take on this probability.

Prices always move. Your entries and exits last as long as you want.

The market will not make you exit a trade. You must do that. Don’t be a passive loser. Actively lose by defining your risk.

Trading gives you ultimate freedom. This can be a curse because you have no structure to follow.

Most of those who get into trading initially struggle to create a set of rules to follow.

That which draws us to trading is the same thing that makes us resist creating trading rules.

Your impulses hinder your ability to trade well for psychological reasons.

You must keep yourself responsible for the way you take profits and take losses.

If you play probabilistic edges, you must be consistent in how you trade them and not get thrown off by a few losing trades.

Don’t get hung up on any single trade.

Adapt to your environment and create rules so that you can adapt appropriately.

Winning early as a trader can hurt your long-term performance.

Trying to “understand why” the markets do something can hurt you in the long run.

Your mental attitude will produce better results than analysis alone.

Trading can be a simple pursuit in which you don’t need a ton of skills, but rather a winning attitude.

Operate from the belief that trading losses are a natural part of trading and should be considered as your business expenses.

We feel pain when reality fails to meet our expectations, especially when they are unrealistic.

Losing traders blame markets for their losses.

You blame markets for your results if you don’t accept the randomness of markets, have rules to protect you against this randomness, and take responsibility of your results.

Your goal is to extract money from the market, and the markets’ goal is to extract money from you.

Markets owe you nothing. Don’t blame them for your losses.

Take complete responsibility of your trading. Otherwise you will view the market as your adversary and you believe that your problems can be fixed by better analysis.

Every entry and exit on a trade is an opportunity for you to act in your own best interest.

You are never fighting the market, because it owes you nothing.

Learning about markets isn’t bad, but it can give you a false confidence that you know what will happen next and ignore the randomness inherent to markets.

Learning more about markets isn’t going to eliminate losing trades. Don’t take losing trades personally.

Accept your losses and you will no longer view market information as painful. You will view it as it is, information.

Our bias to avoid pain makes us ignore or alter information that the market provide us.

In sports there is a more discernible connection between one’s focus and results. It’s harder to see this connection in trading.

Leaving money on the table can be more painful than taking a loss because you know you missed out on a large profit.

Make winning and consistency are states of mind.

Make yourself available to what the market is offering you.

Our biases make us interpret information that is favorable to our own egos, even though it can hurt more in the long run.

Fear causes 95% of the errors you are likely to make.

Think about trading in a way that keeps fear at bay so that you can continue to focus on opportunities.

Let the market unfold and make yourself available to opportunities with a clear mind.

Accept risk and you won’t have anything to fear.

You see what you’ve learned to see, and miss that which you haven’t learned to see.

Every trade is an edge with a probable outcome. Know this to define your risk, and eliminate your fears.

Perceive the market objectively. Don’t project your own feelings on the market.

Your emotional mind links your current state to your most recent trading experiences, which can be painful and create a fearful state of mind.

The “secret” to trading well is four items:

Trade without fear OR overconfidence
Perceive what the market is offering clearly
Stay focused on the “now moment opportunity flow”
Enter the “zone” and believe in an uncertain outcome with an edge in your favor

Great traders don’t let emotions of recent trades influence their process.

To be a consistently successful trader one must learn adapt.

It can take years for most traders to figure out that consistency trumps picking the occasional winner.

The best traders cut their losses without hesitation if the market tells them it’s not working.

The three most costly trading errors you can make

Not predefining your risk
Not cutting your losses
Not systematically taking profits

Thinking that you “know” what will happen next is the cause of most trading errors you will make.

The most effective trading belief you can acquire is “anything can happen.”

Every trader acts on their own belief about what is high and what is low, and collective behavior pattern is displayed in the price at that moment.

Every trade you make is unique from every other trade you’ve made.

Train your mind to think in probabilities, and have actions that you take to deal with these unknown outcomes.

Don’t ever convince yourself you’re right when you enter into a trade. Instead, define the risk.

When you think you know what will happen, you are effectively thinking you know the future actions of every single individual and how they will move prices.

Markets are unique, anything is possible. To ignore this fact is foolish.

Your beliefs are shaped by your expectations. These beliefs cause you perceive market information that confirms your bias, and ignore market information that conflicts with your bias.

Market information that goes against our position is ignored when we find it too painful to acknowledge.

We focus on information that helps minimize our pain, which is destructive to our trading.

We lose out on opportunities when we choose to ignore what the market is telling us.

Our pain-avoidance mechanism shields us from seeing information that is not aligned with our beliefs.

Traders must learn to be rigid in our rules, and flexible in our expectations.

There are five fundamental truths you must accept to think probabilistically:

Anything can happen
You don’t need to know what will happen next to make money
Wins and losses are randomly distributed for any given edge
An edge is an indication of higher probability of one thing over another
Every moment in the market is unique

When you put on a trade, your only expectation is that something will happen. That’s it.

Define a stop loss for every trade. This should be some point where the odds of success are greatly diminished in relation to the potential profit.

Losses are the cost of doing business in the course of finding winning trades.

Each moment in the market is an opportunity to do something on your behalf. You always have an opportunity to:

Scratch a trade
Trade profits
Cut losses
Add or detract from a position

Expectations are beliefs projected into some future moment.

We can’t know what to expect from the market because other traders are always there to enter and exit trades based off their own beliefs about the future.

The only thing you should “know” in trading is what an edge looks like, how much you need to risk, and a plan for taking profits or losses on a trade. You can never know if any one trade will work out.

Don’t have an agenda when you trade. Make yourself available to the opportunities the market makes available to you with a clear mind.

Emotional pain is a response we have when the world expresses itself in a manner opposite of our beliefs.

Don’t expect the market to make you “right” or “wrong”.

Don’t expect to market to go in your favor forever. Establish rules for taking profits.

Gathering more information to predict if a coin will flip heads or tails is silly. Why would you expect it to work in the markets? Remember that every trade is probabilistic.

Every moment is unique, and therefore you will never “know” what will happen next.

Don’t try to change your beliefs. Remove the energy behind that belief, and channel it towards better beliefs.

It’s hard to make new discoveries when your internal beliefs conflict with those discoveries.

The underlying cause of fear in trading is interpreting market information as threatening.

You must believe that every edge has a unique outcome in order to trade without fear.

You must believe you don’t know what is going to happen next.

Train your mind to expect a unique outcome in order to see market information objectively.

Believe that each moment is unique in order to achieve mental freedom while trading.

Trading is a pattern recognition numbers game. Identify patterns for some edge, define your risk, and take profits consistently. Some trades work and some don’t. Don’t take it personally.

Trading is one of the hardest things to do because the more you think you know, the less successful you’ll be.

Manage your expectations as a trader and align your mental environment with the five fundamental truths.

Trust yourself to operate in an unlimited environment
Focus on flawlessly executing a trading system
Think in probabilities – the five fundamental truths
Create a strong belief in your consistency as a trader

Your primary objective as a trade should be to produce consistent results. The way you do that is by following your trading rules with unshakeable confidence.

Consistency should be your primary reason for trading.

Making mistakes will happen until your beliefs are in harmony with your desires and your beliefs are consistent with what works from an environment’s perspective.

Don’t think less of yourself when you make mistakes.

Mistakes should not hold negatively charged energy for you.

Beliefs must be in alignment with goals and desires to eliminate any conflicting energy.

You must create the belief that you are a consistently successful trader.

Don’t make it a goal to guess correctly. Make it a goal to be consistent with your techniques.

Tell yourself, I am a consistent winner because:

I objectively identify my edges
I predefine the risk of every trade
I accept risk and am willing to let go of trades
I act on my edge without hesitation
I pay myself as the markets make profits available to me
I monitor myself for my susceptibility to make errors
I never violate these principles above

To be an objective observer, think from the market’s perspective. There are always unknown forces waiting to act on price movement so that every moment is truly unique.

The typical trading errors are:

Hesitating
Jumping the gun
Not predefining risk
Defining risk but not taking a loss
Exiting a winning trade too soon
Not taking profits on a winning trade
Letting a winning trade turn into a loser
Moving stop too close to your entry point
Trading too large a position in relation to your equity

You can change your identity by changing your desires.

Losses call for larger % returns in order to be profitable. A 50% loss requires a 100% return to become profitable again.

Divide your position into thirds or quarters, and scale out of the position when taking profits.

Take off a portion of a winning position whenever the market presents you with the opportunity to do so.

In a three contract trade, establish a stop loss, and take profits by scaling out of the position one contract at a time.

Scale out of positions to create “risk-free opportunities”. These are positions where you have taken profits to the extent of max loss allowable on the remainder of the position, therefore guaranteeing a break-even trade at a minimum.

Try to achieve a risk to reward ratio of 3:1, which means you risk one dollar for every three dollars of profit potential.

Success or failure of a strategy should be based off a sample size of 20 trades or more.

An edge is merely a snapshot which captures a limited portion of all probabilities.

Be willing to make 20 trades on a strategy before making a judgement of its effectiveness.

Follow your trading rules and focus on the five fundamental truths in trading.

If you can go through 20 trades without allowing your emotions to influence you adherence to rules and probabilities, then you discover that thinking in probabilities is a functioning part of your identity.

Conclusion

Again, if there is one book I highly recommend you read as a trader to get your state of mind right, it’s Trading in the Zone.

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What are Federal Reserve repo operations?

Repo operations (within the context of the Federal Reserve) are Repurchase agreements and are conducted only with primary dealers.

The Fed purchases Treasury, agency debt, or agency mortgage-backed securities from a counterparty, subject to an agreement to resell the securities at a later time.

It’s similar to having a loan that is collateralized with assets. These assets from the banks have a higher value than the loan to protect the Fed against market and credit risk.

Repo transaction temporarily increase the quantity of reserves in the banking system.

The New York Fed began conducting repo operations in September 2019 to ensure supply of reserves is ample and to mitigate risks of money market pressures near year-end that could affect policy implementation of interest rates.

What is a repo?

Repo is a generic name for repurchase transactions (which can include buying or selling). It is a transaction in which one party sells an asset (such as Treasury Bonds) to another party at a set price and commits to repurchase the same assets from the same party at some future date.

If the seller defaults, the buyer is free to sell that asset to a third party to offset their loss. This is what makes a repo very similar to a collateralized or secured deposit.

How is repo rate determined?

The difference between the price paid by the buyer at the start of the repo and the price received at the end is effectively the lending rate on the repo. This is known as the repo rate or repo interest.

Why are repurchase agreements (repos) used?

Repurchase agreements can serve four different functions for various market participants:

They are a safe investment
Borrowing costs on repos are very cheap
Yields can be enhanced for those holding a large amount of safer assets
They provides a means for short-selling and short-covering

It’s safe because the cash is secured by collateral, which is generally safe assets. Makes it easy for seller of repo to make money back by selling those secured assets.

Yields are enhanced because a party could lend out a high demand asset to the market, and in return they receive cash for cheap which can be used for funding or reinvesting profits.

Why do banks use repos?

Banks will use repurchase agreements (repos) for short-term borrowing. They do this to raise short-term capital and generally use agreements which are very short-term, generally overnight or 48 hours.

The implicit interest rates on these agreements is known as the repo rate, and is a proxy for the overnight risk-free rate.

Repo can be used for many purposes. One such purpose would be as an efficient source of short-term funding

It also allows institutional investors to meet liquidity requirements without having to liquidate long-term investments. The repo market has become an important source of cash for non-banks to meet Basel regulatory requirements.

Who and What are primary dealers?

Primary dealers are trading counterparties of the New York Fed in the implementation of monetary policy. The make markets for the NY Fed as needed, and bid on a pro-rate basis in all Treasury auctions at reasonably competitive prices.

There are 24 banks designated as primary dealers. Well known banks that are primary dealers include JP Morgan, Wells Fargo, Bank of America, Citi Group, Deutsche Bank, just to name a few.

Why do we have primary dealers?

Primary dealers are counterparties who buy government securities and resell them to the overall market. These are banks that have an inside track to buy US Treasuries.

Primary dealers purchase the vast majority of the U.S. Treasury securities (T-bills, T-notes, and T-bonds) sold at auction. They will then resell those securities to the public. Their activities extend well beyond the Treasury market.

Arguably, this group’s members are the most influential and powerful non-governmental institutions in global financial markets.

Where are primary dealers located?

Many dealers are in the US. There are also dealers across the globe, including Japan and Europe that distribute US Treasuries to those geographical areas of the world.

What are the requirements for primary dealers?

Firms must meet specific capital requirements before it can become a primary dealer.

The capital requirements for broker-dealers that are not affiliated with a bank is $50 million. Banks acting as primary dealers need to have $1 billion of Tier 1 capital (equity capital and disclosed reserves).

Prospective primary dealers need to show they made markets consistently in Treasuries for at least a year before their application.

You are your own worst enemy

It’s easy to blame others.

It’s hard to blame yourself.

It’s easy to blame things out of your control.

It’s hard to blame those things that are within your control.

Rules can help you make better decisions. Your goal should be to follow your rules. Not making money. Making money should be a product of following your rules.

Don’t think of yourself as a gamblin’ man. Think of yourself as a risk manager.

Make smarter bets through time. Don’t trade too big in any one position or in any one day. When you place your bets is just as important as where you place your bets.

How to download S&P 500 data from Yahoo Finance using Python

Make sure you have the yfinance package installed first. If you don’t, you can run the following command in your Jupyter notebook:

!pip install yfinance

Input:

import pandas as pd
import numpy as np
import yfinance as yf

Input:

spy_ohlc_df = yf.download('SPY', start='1993-02-01', end='2019-12-01')

Output:

[*********************100%***********************]  1 of 1 downloaded

Input:

spy_ohlc_df.head()

Output:

Conclusion

This is a very brief summary of how you can download stock data information for the S&P 500 from Yahoo Finance, using the Python programming language. If there is something you want to learn about, please let me know in the comments below and I can cover it in a future blog post.

It’s not if, but rather when will a market pullback happen

We’ve had an extremely long run up in the market over the past month and a half.

The S&P 500 is up 8.8% since October 8. The market has barely had much of a pullback since this rally started. It feels like the market won’t pullback at any point soon. But it will happen.

There are a lot of questions to think about though when it comes to timing a pullback in prices:

How much long will markets run higher before the market pulls back?
What will the depth of the pullback be when it does happen?
What is the likely magnitude of the pullback?

These are all impossible to know, but are at least worth considering.

My prediction is that we experience a pullback sometime after December 20, 2019. Why that date? It’s the infamous quad witching date. What’s that?

What Is Quadruple Witching?

Quadruple witching refers to a date on which stock index futures, stock index options, stock options, and single stock futures expire simultaneously. While stock options contracts and index options expire on the third Friday of every month, all four asset classes expire simultaneously on the third Friday of March, June, September, and December.

Source

There is large gamma exposure coming off the books on this date. To the order of $2.7 billion. Source

There are the potential risks that could be a tipping point as well. If any catalysts materialize, a pullback is likely.

Possible risks include:

No trade deal with China, or worse, a more tense U.S.-China relationship.
Issues in the short-term funding market where the Fed can no longer control short-term interest rates
Bad guidance on future earnings
Declining GDP becoming more known

I believe a pullback could see much of gains up to this point being wiped out. $2900 isn’t out of the question of being tested at some point in mid-December to mid-January. That’d be down 7.7% from where we are currently at.

A deeper decline is possible, but would need to be closer before any thoughts about it happening.

I think a pullback could be very quick, 3-4 days like August and May pullbacks. Some even say it could be like February 2018 pullback, but I’m not so sure that the magnitude would reach that level.

With that being said, my predictions are usually wrong. Follow Murphy’s Law: Whatever can go wrong will go wrong. So make sure you hedge your bets and spread them out intelligently over some specified time frame.

Just because you see risks…doesn’t mean the market will price it in (yet)

I used to believe that risks to the market get priced into the market.

This is based off the efficient markets hypothesis. Once information is known it immediately gets priced into the market.

However, risks don’t always get priced in (right away) for one reason or another. Perhaps those risks are further off the horizon than believed. Perhaps those risks are going to dissipate soon. Perhaps those risks are not as significant as I believed they were.

Whatever the case may be, the market doesn’t always price in risks to the market right away.

Lesson learned

In October, I saw numerous risks to the market and strongly believed we would move down another leg lower in the S&P 500. I placed my bets accordingly, and it did not work out at all.

What risks did I see? A hiccup in the overnight repo market, beginning in mid-September. Hong Kong protests taking place every weekend, and U.S. Government officials denouncing China and supporting Hong Kong protestors. No signs of a real trade deal of significance. Slowing economic growth across the globe. A collaterialized loan market that’s looking more and more frothy.

I saw all of the risks, and here we are with the S&P 500 up 8.8% since October 8th, when the Fed made it known they would begin expanding their balance sheet with the purchase of Treasury Bills.

Markets are not efficient

Information can be priced in right away. Information can be ignored for days, weeks, months, or even years.

Risks can be priced in one week, and completely ignored the next week.

Markets are manipulated. No doubt about it.

But blaming my poor performance this month on market manipulation is irresponsible and definitely not a recipe for success.

I must learn how to trade around uncertainty and market manipulation caused by institutions and central banks across the world.

Trade the market you have, not the market you want.