Friday, July 6, 2007

A Bit About IF and THEN

The idea of IF-THEN scenarios in trading is often misconstrued one. I often see it being interpreted in a sense of predicting stock's action. A trader trying to apply it in this sense tries to think in terms 'If a stock does this, it's going to do that". This approach is more acceptable if a trader thinks in terms of probability instead of certainty in which case the above sentence becomes "If a stock does this, it's likely to do that". Nothing's wrong with that as long as a trader realizes that probability is just that - a probability that is going to work in a statistically valid number of samples but will not predict the outcome of each given case.

I, however, apply IF-THENs in a slightly different manner. For me it's about defining my own action in response to market fluctuations. My IF-THEN is a scenario where IF is what market does and THEN is what I do in response. My intepretation thus becomes 'If a stock does this, I do that".

Certainly, it's a derivation of the version above - you can arrive to it from "if a stock does this then it's likely to do that, so I am going to react in such and such way". My version is just more cut and dry.

What are the advantages of this aproach and why do we need to build a set of such scenarios?

First, it takes guessing and predicting out of the equation. Our trading becomes more systematic as we look for recognizable situation for which we have a pre-canned response.

Second, it takes emotions out of the equation. Since our actions are pre-determined, we simply apply them to what happens. Stock does this - we do that. No room for emotions, no room for surprize (well, almost - market has ways to offer something unseen before even when you think you have seen it all, LOL).

Third, it takes ego out of the equation. Since you are not trying to predict future events, there is no ego involvement in case if a stock does something unexpected. You didn't expect anything, right? You were simply waiting for it to do something in order to react in that pre-canned way. Since ego is not there to make you feel hurt, you have no problem with taking your stop - it's just one of the prepared scenarios. You don't feel as if you were proven wrong - you didn't commit to any prediction, so you can't be right or wrong.

All above makes you kind of trading robot. See setup - take setup, see action - apply reaction. Eyes to finger, no brain inbetween. Sounds boring? Great. I trade for profit, not for excitement. No brain involvement is a side benefit, you feel fresh and rested when the trading day is over.

I can assure you, it's a very liberating state of mind. Once you experience it, you never want to go back to old "highly-strung overthinking it" ways.
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