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The process of establishing my trading system and the "pit" I stepped on!

2024-04-05

Today, I write this article to summarize the past decade of trading. In my view, trading is divided into three stages. Perhaps there are more stages beyond these, but I have not yet reached that level. So, I can only talk about these three stages, which correspond to solving three problems faced in trading.

The first stage is what I call the random stage of trading, where you use various technical indicators and even naked K-line analysis. In this stage, you study various technical patterns and indicators every day: moving averages, MACD, RSI, Bollinger Bands, and even wave theory, Gann, and so on. You catch a K-line pattern or indicator, test it and feel it's okay, only to find it fails when it's critical, so you give up and switch to another one, repeating the above process. In the end, you start using combinations of various indicators and find that while they limit your orders, there are still loopholes. This process may take several years, about 2 to 5 years. This stage can only solve the problem of trading profits.

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You might say that solving the profit problem is enough, isn't the ultimate goal of trading to make a profit? No, the profit problem is a very basic issue. The profit here is of a very low requirement. Li Dan said that everyone can do five minutes of stand-up comedy, and everyone can make a profit for three days. But what about three months, three years? Perhaps you will say, no, I am looking for the law, but you are wrong again. You are not looking for the law, you are looking for the probability. The law is something that is always circulating and unchanging: the sun rises in the east and sets in the west every day is a law; people's birth, aging, sickness, and death are laws; the rise and fall of dynasties are also laws. It does not change according to people's will.

The law part is in the third stage. But you have to know that in trading, relying solely on the factor of probability is completely insufficient. There are also odds and mentality. At this stage, it is difficult for you to take care of everything. So it leads to the randomness of your trading results. You make a profit this month, make a profit next month, and may blow up the next month. Human nature is also a part of the law. When you have made a profit for three consecutive months, this law has almost started to take effect. You should think about it carefully.

Most people will be eliminated in this stage because they always think that it is because my analysis level is not high, and the trading mistake is because I was careless this time, and I will learn from the lesson next time. But at this stage, new problems are always slapping the solution you just found. Then the cycle repeats. But the content of this stage is also necessary, because just like when a person eats the fifth bun and is full, you can't say that the first four buns are useless, right.

This stage is the first bun, and the countless research and analysis of the plate will become your underlying knowledge, integrated into your consciousness. It is inseparable from the support of this part in the later stage when you can trade easily, invisible but effective. If you are still trading at this stage: you have studied all the content on the plate thoroughly but still cannot stabilize.Then I suggest you pack up and move on to the next stage. Because if you can't get out of it, you might not be able to get out for a very long time, until you are eliminated. If you have been trading for more than two years and are still trying to analyze and do all the market conditions correctly, this should be a bit wrong, because no one can analyze all the market conditions correctly. If you can't accept the objectivity of losses, then you can't move on to the next stage. At this stage, you will have losses and gains.

The second stage I call the mathematical model stage.

At this stage, you are no longer obsessed with doing every market condition correctly. You start to accept normal stop losses and understand that stop losses are also a part of trading. You introduce the concepts of probability, odds, and capital management. You use simple mathematical models to calculate whether the probability you find is expected to be positive in the long run, and then continuously fine-tune to expand this positive value and run stably. You no longer worry about using every indicator perfectly, because you know that each tool has its strengths and weaknesses. Use its strengths, accept its shortcomings, and then weigh and choose.

In the end, you use a very simple combination to fix your model, and the rest is execution, boring waiting, and mechanical execution. This stage solves the problem of time. If you polish the model well and implement it, you can slowly achieve continuous and stable profits. At this stage, some people's models are as simple as a K-line, a moving average line, and this is something that people in the first stage cannot understand, and then they think this person is not good, his screen is too clean, he won't draw any lines, and he probably won't analyze.

In fact, at this stage, the analysis has become secondary. Since I don't insist on doing every order correctly, if it's wrong, it's wrong. At this stage, if you are an individual trader, it is the most comfortable stage. Holding your own account and repeating according to the model is enough, without psychological burden, without great expectations, striving to improve yourself inwardly, and accepting all good and bad results. Time and space are free enough, and the market is your small ATM. This stage solves the problem of profit and time, but it has not yet solved the scale problem, which means you can do your own account, tens of thousands of US dollars can be done. But the same strategy may not be able to control a larger scale of funds. There are issues of human nature and so-called guiding ideology.

The third stage I call the law stage.

This law is different from the law sought in the first stage. Here, if you are willing to understand it as Tao, it is the underlying logic that is always effective.

The more fundamental the law, the more powerful it is, and the more basic it is, the more effective it is. If you say that the price falls when it is on the upper track of the Bollinger Bands and rises when it is on the lower track, is this law effective? Anyone who has a little understanding of Bollinger Bands will know that the effectiveness is about half. But if I say that the price always fluctuates, it cannot be refuted. This should be the most basic law of the market, and it is born for the indication of the price. But you must say that I said a correct nonsense, which is indeed correct but not necessarily nonsense. I will explain it to you from another angle, and you will understand its power: if you build your trading system on this logic, it means that as long as there is price fluctuation, you can make a profit. But I'm sorry, I haven't done it yet.Then we take a step back and opt for a second-best approach, not basing the model on the fluctuations every minute and every second, but on the patterns in segments: the price is either volatile or trending, which is also indisputable. The remaining issue is how to build a model on this logic. It requires screening and calculation, which involves the content of the first and second stages. You build a model on this logic, run and adjust it until the expected value of your system is positive over the long term. Whether you choose a volatility strategy or a trending strategy, you need to accept the result of making money on one side and losing on the other, and then let the overall result be positive.

Then your confidence comes from the fact that as long as the market still follows the alternating operation of volatility and trend, your system is effective. The result is predictable. It is not random. When you choose a trending strategy and continuously stop losses in volatility, you are not panicked, and when you choose a volatility strategy and decisively stop losses when the trend starts, it is because you know it will not always be volatile and it will not always be volatile. The first "always volatile" is that you will not always lose in a trending strategy, and the second "always volatile" is that you will not always profit in a volatility strategy. Most of the results of volatility strategies are not very good because you have inflated and forgotten this logic.

If the trading model is built on this rule, then it can break free from the limitations of scale. Because trading is no longer limited by my human weaknesses. Whether I am greedy or fearful does not affect the operation of the rule. I am just an executor, and even say that you can write a program to execute.

We can find more rules on this theoretical basis, such as the price is either rising or falling. Here comes another correct nonsense, but I will interpret it for you in another way: the price is not rising or falling, which means the price will not rise forever or fall forever. I have not done this logic, but I boldly guess that the model built from this rule should be close to Martingale. Some people say that the end of Martingale is to blow up the position, which is because you don't understand Martingale enough.

If you have unlimited bullets, will you still blow up the position? If you don't have unlimited bullets, then if the bullets are limited, go for a limited price. I give an extreme example, if you design your model with the bottom line of the gold price falling to 0, I believe the risk will be extremely low, and you will say that my profit will be very small, so do you understand what is called extremely low risk. The correct use of Martingale lies in the fact that you need to calculate your extreme value in advance and accept this bottom line. You have designed a model that can withstand a 300-dollar one-way market, and once the market goes for a 400-dollar one-way pull and blows you up, you will not complain about your bad luck.

All these basic but unchanging rules serve as your underlying support to build your system, at least your foundation is solid, and on this basis, polish the details, adjust the probability and profit and loss ratio, and fund management. Use the content of the first and second stages mentioned above.

The reason I list so many is to lead to the theme: there are no secrets in trading.

After going through this process, you will find that trading has returned to the simplest appearance at the beginning. Mechanically repeating on an extremely simple model. There is no profit-taking or stop-loss in the middle, no matter whether it is long or short, no matter whether the account is big or small, and no matter whether the fundamentals are good or bad. Trading does not analyze, predict, or care about wars and inventories, nor does it care about economic data. Those all have random components. I only seek the overall probability of a large sample. Execute large samples and stability in a probability event. This is the only way to fix your trading results as much as possible. If you did 50% last year and 50% this year, then I can probably guess that you can also achieve 50% next year.

This is the appearance after solving the problem of profit, time, and scale. Before this, you must have heard others tell you that the great way is simple, and trading is very simple in the end, but you probably can't understand why. If these can help you understand a little, then I also feel very useful.Then my thought is that if a trader follows the positive route, starting from the first stage of candlestick analysis of technical indicators, to the final stage of becoming a mature trader, it should be a somewhat lengthy process. However, if we think about it from a different perspective, assuming you agree with this logic, wouldn't it be easier to work backwards? Knowing from the start that the ultimate state of trading is to mechanically repeat and wait for a long time on a simple model, then refine this model first, and aim for the third stage from the first stage. You need to accept this result first, and then work backwards to strive and refine the process. It's a bit like already knowing the answer and then understanding the steps involved. In this way, trading can be turned into an ordinary job, a result of deliberate training. Just like ordinary technical professions, as long as the correct ideas and paths are given, a difficult thing can be simplified as much as possible.

In this process, one thing you need to do is to ensure that your model can run through and has a positive long-term expected value when you build and refine it later. It doesn't matter whether it's a range strategy or a one-way strategy. For a one-way strategy, you need to focus on the odds, ensuring that after losing five orders, one order can make up for it. For a range strategy, focus on the win rate, ensuring that after making a profit on five or six orders, a stop loss in a broken market will not wipe out the previous losses.

The concept of the Turtle Trading is also similar to this approach: traders can be deliberately trained and cultivated. Mechanically repeat on a simple model. While I believe this approach is feasible, I also think there is no need for everyone to use the same model. There are many ways to build an extremely simple model. Everyone can build a model that suits themselves. The real difficulty lies in the refinement and execution process. Define the boundaries and only take your own part. Don't covet any part beyond it. In this process, you still have to struggle with human nature, the difference is that you have a clear final goal in your heart, no longer internal consumption.