Discussion of article "Time Series Forecasting Using Exponential Smoothing"
Becoming a Fearless Forex Trader
- Must You Know What Will Happen Next?
- Is There a Better Way?
- Strategies When You Know That You Don’t Know
-Michael Steinhardt
"95% of the trading errors you are likely to make will stem from your attitudes about being wrong, losing money, missing out, and leaving money on the table – the four trading fears"
-Mark Douglas, Trading In the Zone
Many traders become enamored with the idea of forecasting. The need for forecasting seems to be inherent to successful trading. After all, you reason, I must know what will happen next in order to make money, right? Thankfully, that’s not right and this article will break down how you can trade well without knowing what will happen next.
Must You Know What Will Happen Next?
While knowing what would happen next would be helpful, no one can know for sure. The reason that insider trading is a crime that is often tested in equity markets can help you see that some traders are so desperate to know the future that their willing to cheat and pay a stiff fine when caught. In short, it’s dangerous to think in terms of a certain future when your money is on the line and best to think of edges over certainties when taking a trade.
The problem with thinking that you must know what the future holds for your trade, is that when something adverse happens to your trade from your expectations, fear sets in. Fear in and of itself isn’t bad. However, most traders with their money on the line, will often freeze and fail to close out the trade.
If you don’t need to know what will happen next, what do you need? The list is surprisingly short and simple but what’s more important is that you don’t think you know what will happen because if you do, you’ll likely overleverage and downplay the risks which are ever-present in the world of trading.
- A Clean Edge That You’re Comfortable Entering A Trade On
- A Well Defined Invalidation Point Where Your Trade Set-Up No Longer
- A Potential Reversal Entry Point
- An Appropriate Trade Size / Money Management
Yesterday, the European Central Bank decided to cut their refi rate and deposit rate. Many traders went into this meeting short, yet EURUSD covered ~250% of its daily ATR range and closed near the highs, indicating EURUSD strength. Simply put, the outcome was outside of most trader’s realm of possibility and if you went short and were struck by fear, you likely did not close out that short and were another “victim of the market”, which is another way of saying a victim of your own fears of losing.
So what is the better way? Believe it or not, it’s to approach the market, understanding how emotional markets can be and that it is best not to get tied up in the direction the market “has to go”. Many traders will hold on to a losing trade, not to the benefit of their account, but rather to protect their ego. Of course, the better path to trading is to focus on protecting your account equity and leaving your ego at the door of your trading room so that it does not affect your trading negatively.
Strategies When You Know That You Don’t Know
There is one commonality with traders who can trade without fear. They build losing trades into their approach. It’s similar to a gambit in chess and it takes away the edge and strong-hold that fear has on many traders. For those non-chess players, a gambit is a play in which you sacrifice a low-value piece, like a pawn, for the sake of gaining an advantage. In trading, the gambit could be your first trade that allows you to get a better taste of the edge you’re sensing at the moment the trade is entered.
James Stanley’s USD Hedge is a great example of a strategy that works
under the assumption that one trade will be a loser. What’s the
significance of this? It pre-assumes the loss and will allow you to
trade without the fear that plagues so many traders. Another tool that
you can use to help you define if the trend is staying in your favor or
going against you is a fractal.
If you look outside of the world of trading and chess, there are other
businesses that presume a loss and therefore are able to act with a
clear head when a loss comes. Those businesses are casinos and insurance
companies. Both of these businesses presume a loss and work only in
line with a calculated risk, they operate free of fear and you can as
well if you presume small losses as part of your strategy.
Another great Mark Douglas quote:
“The less I cared about whether or not I was wrong, the clearer things
became, making it much easier to move in and out of positions, cutting
my losses short to make myself mentally available to take the next
opportunity.” -Mark Douglas
Happy Trading!
The source
Becoming a Fearless Forex Trader
- Must You Know What Will Happen Next?
- Is There a Better Way?
- Strategies When You Know That You Don’t Know
-Michael Steinhardt
"95% of the trading errors you are likely to make will stem from your attitudes about being wrong, losing money, missing out, and leaving money on the table – the four trading fears"
-Mark Douglas, Trading In the Zone
Many traders become enamored with the idea of forecasting. The need for forecasting seems to be inherent to successful trading. After all, you reason, I must know what will happen next in order to make money, right? Thankfully, that’s not right and this article will break down how you can trade well without knowing what will happen next.
Must You Know What Will Happen Next?
While knowing what would happen next would be helpful, no one can know for sure. The reason that insider trading is a crime that is often tested in equity markets can help you see that some traders are so desperate to know the future that their willing to cheat and pay a stiff fine when caught. In short, it’s dangerous to think in terms of a certain future when your money is on the line and best to think of edges over certainties when taking a trade.
The problem with thinking that you must know what the future holds for your trade, is that when something adverse happens to your trade from your expectations, fear sets in. Fear in and of itself isn’t bad. However, most traders with their money on the line, will often freeze and fail to close out the trade.
If you don’t need to know what will happen next, what do you need? The list is surprisingly short and simple but what’s more important is that you don’t think you know what will happen because if you do, you’ll likely overleverage and downplay the risks which are ever-present in the world of trading.
- A Clean Edge That You’re Comfortable Entering A Trade On
- A Well Defined Invalidation Point Where Your Trade Set-Up No Longer
- A Potential Reversal Entry Point
- An Appropriate Trade Size / Money Management
Yesterday, the European Central Bank decided to cut their refi rate and deposit rate. Many traders went into this meeting short, yet EURUSD covered ~250% of its daily ATR range and closed near the highs, indicating EURUSD strength. Simply put, the outcome was outside of most trader’s realm of possibility and if you went short and were struck by fear, you likely did not close out that short and were another “victim of the market”, which is another way of saying a victim of your own fears of losing.
So what is the better way? Believe it or not, it’s to approach the market, understanding how emotional markets can be and that it is best not to get tied up in the direction the market “has to go”. Many traders will hold on to a losing trade, not to the benefit of their account, but rather to protect their ego. Of course, the better path to trading is to focus on protecting your account equity and leaving your ego at the door of your trading room so that it does not affect your trading negatively.
Strategies When You Know That You Don’t Know
There is one commonality with traders who can trade without fear. They build losing trades into their approach. It’s similar to a gambit in chess and it takes away the edge and strong-hold that fear has on many traders. For those non-chess players, a gambit is a play in which you sacrifice a low-value piece, like a pawn, for the sake of gaining an advantage. In trading, the gambit could be your first trade that allows you to get a better taste of the edge you’re sensing at the moment the trade is entered.
James Stanley’s USD Hedge is a great example of a strategy that works
under the assumption that one trade will be a loser. What’s the
significance of this? It pre-assumes the loss and will allow you to
trade without the fear that plagues so many traders. Another tool that
you can use to help you define if the trend is staying in your favor or
going against you is a fractal.
If you look outside of the world of trading and chess, there are other
businesses that presume a loss and therefore are able to act with a
clear head when a loss comes. Those businesses are casinos and insurance
companies. Both of these businesses presume a loss and work only in
line with a calculated risk, they operate free of fear and you can as
well if you presume small losses as part of your strategy.
Another great Mark Douglas quote:
“The less I cared about whether or not I was wrong, the clearer things
became, making it much easier to move in and out of positions, cutting
my losses short to make myself mentally available to take the next
opportunity.” -Mark Douglas
Happy Trading!
The source
I agree that one does not need to know what will happen next in order to profit, but the question seems to be in defining an edge. Casinos define their edge using predefined probabilities, e.g., there's a 1/52 chance of drawing an Ace of Spades from a complete standard deck of cards, or a 1/6 chance of rolling a 5 using a fair dice. Insurance companies use aggregate histories to compile actuarial tables from which to make assumptions regarding populations, but cannot (much like traders) make assumptions regarding any particular individual without knowing some facts regarding behavioral habits of the individual to compare to the attributes of the population. 20 year old males tend to be aggressive, somewhat reckless drivers; John is a 20 year old male, he "may" be an aggressive, somewhat reckless driver, but there is also a chance that he may not be. The insurance company will then look at John's driving record for any history of risky behavior, very much like a trader looks at price history to determine exploitable "behaviors."
So as a trader, much more like insurance companies than casinos, we gather information regarding the past to attempt to make assumptions about the future when defining our edge. Combining the entry/exit conditions with risk management to make assertions regarding unknowable probabilities (because one cannot assert that there is a 1/6 chance that the EURUSD will increase by 20 pips with 100% confidence) is the essence of trading. So it all boils down to making the most of the time available to an individual trader, finding the most advantageous setups/exits using assumptions regarding price histories and profit/loss expectancies should the future be similar to the past, which is uncertain at best.
Using an exponentially smoothed time series forecast as a setup/exit together with risk management is no different really than using a consolidation/breakout strategy in that one creates rules for the trade based on how the strategy worked in the past, and then follows the rules with as few assumptions regarding the future as possible.
Will price go up, or will it go down? I don't know, but this is what I'll do in either case.
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New article Time Series Forecasting Using Exponential Smoothing is published:
The article familiarizes the reader with exponential smoothing models used for short-term forecasting of time series. In addition, it touches upon the issues related to optimization and estimation of the forecast results and provides a few examples of scripts and indicators. This article will be useful as a first acquaintance with principles of forecasting on the basis of exponential smoothing models.
Author: Victor