Trading is not really about prediction or being right or wrong. It is really about how much are you willing to risk to find out. It’s easy to take the approach of, ‘is this trade going to work or not’, and in reality, we can’t help but think that way on a certain level. But because we will never know before hand, and because protecting capital is rule number one, we must attend to risk management and have flexible expectations instead of thinking in terms of ‘prediction’.
As I wrote elsewhere, a set-up with a 60% win rate does not mean that the next 6 out of 10 trades will be winners . An objective market statistic based upon the past can not become a market probability about the future unless the same exact market participants are present and continue to act in the same way. Each trade, and each moment in the market, is unique for this reason.
The main point here is that although entry location is important, its how much we are willing to risk that determines our account equity and consistency over time.
If the primary focus is on whether the trade is going to be right or wrong, the trader is beginning to go down the slippery slope of market prediction. Trading is not a business of predicting, it is a business that involves hypothesizing and risk management. The biggest and best traders understand the distinction between predicting versus hypothesizing and also understand that risk management is critical. The job of a short-term trader is to be prepared to act in your own best interest when price approaches a level that you have determined to be important for some reason.
In the final analysis, it could be said that good traders develop appropriate or realistic hypotheses and are good risk managers. Whereas, ‘predicting’ is what the typical unprofitable trader tries to do.
[…] This post was mentioned on Twitter by SMB Capital, jotuk6771 and SB, Andrew Menaker. Andrew Menaker said: 2 Many traders tumble down the slippery slope of prediction. Trding is about hypothesizing & risk mgt, not predicting. http://bit.ly/bgWULm […]
This is a fantastic comment that has really made me reevaluate my whole approach to trade entry. As any trader with limited funds you try to predict the outcome before entering. Now based on what you say, my expectation is flexible as to the outcome but I accept the trade on the basis of my risk and let what happens flow from there.
Stewart,
This is something that prevents many traders from performing better. As traders we must define our risk, and accept it (emotionally accept the loss of money and being wrong without the need for revenge or anger), but our expectations regarding our target must be flexible. The majority of traders are caught up in predicting, which contributes to the need to be right. When we manage our risk and let go of the need for a certain outcome, trading improves dramatically.
Andrew
Your perspective on predictions seems like it would take a lot of pressure off the need to be right. I love this line of thinking. It also seems like your emphasis on risk management seems wise….I look forward to reading more about this.
David
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[…] I’ve previously written about how trading is not about predicting. Trading is about creating a hy… Entries are important, but what really determines our consistency in the long run is a function of how much we are willing to risk. An excellent way to measure this is an important but often ignored trading statistic, the average win size and average lose size. That statistic will tell you a lot about your trading, much more than the winning/losing percentage. It’s also a required component of the formula for positive expectancy. But that’s not what I want to write about here. […]
[…] you’ve read my other blogs you know about the dirty little secret in trading, and that it’s not the entries, but the exits that makes a tra…And that goes a long way in understanding why struggling traders spend so much time searching for […]
hello i have found your website just yesterday and have spent a good amount of time reading your articles.
you have very good articles here thank you for that, i’ll be sure to check in every day to see if you came up with a new post
anywyas, just wanted to drop my 2cents on this particular post
entries…. yes a lot of people are obsessed with this, and there seem to be equal amount of “professionals” who seem to brush this aspect of trading off to the side to the point of almost “discrediting” its importance
i am not saying you are necessarily doing this, but nonethess you seem to belong to the latter group (ie. exit and management is more important than entries)
well for me personally, especially during my earlier days in trading, i was obsessed with entries as any other new comers
why did price turn here, how did this trader short here, how does he know he will buy there, etc etc
my analysis and effort was 100% focused about finding the right methodology to gaining the right entry
my trading instrument of choice is the s&p futures
and as most people, i prefer to get an entry which will allow me to set a stop no greater than 2pts
and at this stage of my career, i am usually able to get out of losers usually 3 to 4 ticks against my entry, or worst cases 1.5pts
when i am right on my entries, my MAE tends to be within a point usually
so i would say my entries are quite precise
needless to say, i still do beileive a skilled entry is a VERY necessary part of trading
when a trader is able to get into a movement with less than 2 points of adverse movement, the management of the trade becomes THAT MUCH easier
however, if a trader emphasizes more on exits, how and when would a trader know to cut his loser or determine if his trade will be a winner or a loser?
that is the part i seem to have hard time grasping when people say entries are not as important as exits
in my opinion, entries are even more important to new comers since it builds them emotional capital and makes trade management very smooth
the only problem is, gaining that skilled entry does not come easy
which is why everyone focuses on that very skill
anyways, that was just my 2cents
i enjoyed your blog immensely so far and plan to catch up on your old posts
thx for your work
@Timothy
Timothy,
I agree, trade location (entry) is very important, can’t be consistent without it. My point is that once you have set-ups, the bigger challenge for most traders is how to manage the trade and where to exit. Many traders have back-tested good set-ups but are still unable to make money, the reason is usually the exit, not the entry.
Andrew Menaker
[…] I’ve previously written about how trading is not about predicting. Trading is about creating a hyp… Entries are important, but what really determines our consistency in the long run is a function of how much we are willing to risk. An excellent way to measure this is an important but often ignored trading statistic, the average win size and average loss size. That statistic will tell you a lot about your trading, much more than the winning/losing percentage. It’s also a required component of the formula for positive expectancy. But that’s not what I want to write about here. […]
[…] you’ve read my other blogs you know about the dirty little secret in trading, and that it’s not the entries, but the exits that makes a tra…And that goes a long way in understanding why struggling traders spend so much time searching for […]
[…] for perfection. With so much noise in the media, blogs, and forums about calling tops and bottoms, one would think it’s a trader’s job to predict such things. Expecting to nail the top or bottom is a recipe for frustration and inconsistent […]
Andrew,
I like the term ‘hypothesis’ which you use when explaining why traders should hypothesize rather than predict.
When we predict, ‘we believe’, and when we believe we know where the market will go, we’re stepping out onto that slippery slope you wrote about.
Keep the articles coming!
Rob
@Rob
Thanks Rob.
Andrew
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