The Probabilistic Mindset of Successful Traders | Mark Douglas

How can someone produce consistent results from an event that has an uncertain probabilistic outcome? To answer this question, all we have to do is look to the gambling industry. Casinos make consistent profits day after day and year after year, facilitating an event that has a purely random outcome. Shouldn't a consistent, nonrandom outcome produce consistent results, and a random outcome produce random, inconsistent results? 

 

"I just wait until there is money lying in the corner,
and all I have to do is go over there and pick it up.
I do nothing in the meantime."
Jim Rogers

What casino owners, experienced gamblers, and the best traders understand that the typical trader finds difficult to grasp is: events that have probable outcomes can produce consistent results, if you can get the odds in your favor and there is a large enough sample size. The best traders treat trading like a numbers game, similar to the way in which casinos and professional gamblers approach gambling. It's the ability to believe in the unpredictability of the game at the micro level and simultaneously believe in the predictability of the game at the macro level that makes the casino and the professional gambler effective and successful at what they do. 

 

 

Their belief prevents them from engaging in the pointless endeavor of trying to predict each individual outcome. They have learned and completely accepted the fact that they don't know what's going to happen next. More important, they don't need to know in order to make money consistently. Because they don't have to know what's going to happen next, they don't place any special significance, emotional or otherwise, on each individual hand, spin of the wheel, or roll of the dice. In other words, they're not encumbered by unrealistic expectations about what is going to happen, nor are their egos involved in a way that makes them have to be right. As a result, it's easier to stay focused on keeping the odds in their favor and executing flawlessly, which in turn makes them less susceptible to making costly mistakes.

A probabilistic mindset pertaining to trading consists of five fundamental truths:

1. Anything can happen.  
2. You don't need to know what is going to happen next in order to make money.  
3. There is a random distribution between wins and losses for any given set of variables that define an edge.  
4. An edge is nothing more than an indication of a higher probability of one thing happening over another.  
5. Every moment in the market is unique.

Quoted from:
Mark Douglas (2000) - Trading in the Zone: Master the Market with Confidence, Discipline and a Winning Attitude.

 

See also:

James B. Rogers Jr. in Jack D. Schwager (1992) - The New Market Wizards: Conversations with America's Top Traders.
Nassim Nicholas Taleb (2001) - On Randomness, Uncertainty, and Probability.

Tom Hougaard (2022) - Best Loser Wins: Why Normal Thinking Never Wins the Trading Game. 

The Funded Trader (Jan 15, 2023) - Paladin: 21 year old ICT Trader Makes a $28,000 Withdrawal | TFT Interview. 

Paladin (Feb 15, 2023) - How I Earned $250K At the Age of 21 from Trading.

The Inner Circle Trader (Mar 10, 2023) - Real Money, Real People - ICT Student Paladin.

Trading Tips from the Front Office | Tom Hougaard

In 2007 I visited the oil pit in New York. I got some rather unusual trading advice from a 20-year veteran of the pits. The floor traders seem to have a unique take on the market, probably because they are so close to the forces of demand and supply unleashed in the pit. Here is what the trader told me:

 

1. The First Cut Is The Cheapest

‘The first cut is usually the cheapest. I see so many of the new traders who are unable to take a loss. They hold on to their position for too long. They don’t understand that I too am wrong more times that I am right, but I cut the trade the moment I am in doubt. That first cut has kept me alive in the pit for 20 years.’

 

15 Minute Bar Chart of Crude Oil with red Simple Moving Average of 60 bars:
Price goes where the Other Time Frame Traders have their Stop (Loss) or Limit (Buy or Sell) Orders: Around Highs and Lows of previous
1 Hour and 4 Hour Bars, Sessions, Days, Weeks, Months, Quarters, Years, 3 Years.
Look for Peak Formations a.k.a. Reversal Patterns around these Levels (QM Patterns, V-, M-, W Formations).
Dotted blue horizontals = Yesterday's High and Low
Blue solid horizontals = Last Week's High and Low
Red Solid Horizontal = Last Months High and Low.
See also HERE

2. The Market is Efficient

He also told me about the nature of the market: ‘The market is efficient. It wants to go where the orders are. These orders can be stop (loss) orders or limit (buy or sell) orders.’ I asked him to elaborate and he said: ‘often the market will go to a certain price just to make sure as many people are filled as possible, and then it reverses. We say in the pit that they push them up to take them down.’

3. Trend Days Are The Best

I asked him about intraday trends. He told me he had the advantage of being able to see the orders from the brokers. His best days were ‘trend days’, where the market continues in one direction all day. This point was aired by others I met in the pit. If a good trend was developing intraday, these guys would press it for all it was worth, irrespective of who was on the other side of the trade. They were never concerned about whether the market technicals were overbought or oversold. The only thing they had in mind was to press it as high or as low as they could before the bell rang.

Quoted from:
Tom Hougaard (2011) - Trading at the Top: Trading Tips and Strategies from a Professional Trader.

See also:

Tom Hougaard (2011) - The Lost Momentum Trend Following Strategy.

Tom Hougaard - YouTube Channel.

The Lost Momentum Trend Following Strategy | Tom Hougaard

A dear child has many names. The strategy below is called ‘lost momentum’ in my vocabulary, but it no doubt has other names too. It is in essence a form of trend-following strategy.

 

Ingredient No. 1: Define the Trend

I recommend using a simple or exponential moving average (MA) of more than 50 bars. Some have reported good results with the 62 period MA. I don’t want you to get too bogged down with rigid definitions. You are looking for a trending market, which trades above your chosen MA, and the MA is pointing up (for long positions – reverse the instructions below for short positions).

Ingredient No. 2: Define your Time Frame

You can use this technique on any time frame. I find it lends itself very well to day trading on the 15-minute chart, and swing trading on the four-hour chart.

Set-Up for 'Buy Signal'

Your chosen market is trading above your MA indicator and the MA is pointing up. If you observe that the market is taking out a previous low (that previous low must be at least 8 bars prior to the current bar), you now wait until the market closes back above the price point of the previous low. That is your buy signal.

 

[...] The technique stems from the observation that even in a trending market you will often find that price dips below a previous low, only to immediately resume its trend higher. All I attempt to do is to trade in the direction of the trend defined by the moving average. I reverse the instruction above for selling. 

 

[...] In the morning, around 8 am, I look at what the high over the overnight range is. I then wait for the market to take out either the high or the low of the range. If, and only if, the market then trades back into the range, after having taking out the high or the low of the range, I prepare an order to enter the market at the 62 per cent retracement over the range. This order comes complete with a stop and a target too. It doesn’t trigger every day though.

Quoted from:
Tom Hougaard (2011) - Trading at the Top: Trading Tips and Strategies from a Professional Trader.

 

 See also:
Tom Hougaard (2011) - Trading Tips from the Front Office.

W.D. Gann's Personal Daily Bread & Butter Trading Strategy | Tom Hougaard

I want to tell you about a world famous trader named W. D. Gann. He wrote many courses on trading, some of which were exceptionally esoteric in content. Gann was supposedly a very clever man, so it came as no surprise to me that the man who made his millions selling forecasts to people actually made his money from a remarkably simple trading method.

 

My friend and trading partner David Paul once spent a whole summer at the British Library, researching past wheat and beans prices, and tracking Gann’s trades to get to the nitty gritty of his actual trading strategy. His conclusion was startling. He told me that ‘Gann simply traded double tops and lows in the direction of the daily trend, nothing more, nothing less’. After eight weeks in the archives of the library he was adamant that what Gann wrote in his courses and what he traded were two very different things. Maybe the lesson for all of us is to keep things as simple as possible.

Quoted from:
Tom Hougaard (2011) - Trading at the Top: Trading Tips and Strategies from a Professional Trader.