Essence of Trading: The Three Pillars of Critical Thinking (Part 3)


… continue from part 2

"Being ignorant is not so much a shame, as being unwilling to learn"

– Benjamin Franklin

Stop Associating Common Terms With Market Conditions Until You Can Understand What They Really Mean

The first most common mistake I have seen is that someone telling everybody that a stock (or whatever that thing is) is very cheap to buy and will go much higher. Yet, the word cheap is not defined clearly in the statement, nor the projection of going much higher is defined. The words cheap and  going much higher is used casually without substance. At best they are just comforting sound bites.

Further investigations into this kind of claims usually result in the discovery that the person has already bought the stock. Digging deeper you will find out there is no proper money management (What? What is stop loss? Cheaper the better and I will buy more!) This risk of losing all the money throw at the stock may not be acceptable to that person but the possibility is never part of the consideration in the first place when the stock was bought.

Trading is not gambling if you choose wisely. If you like buying "cheap" stocks, figure out exactly what conditions are necessary to make a stock "cheap", something that will give you positive expectancies should you bet on that consistently. I use the word bet very carefully here. Bet in this context means you are not sure if the outcome will be in your favour but you know that because the exact conditions are met, you are likely going to make money off the bet. In another words, it is not gambling. You are similar to those people who count cards and (in the words of the casinos) loot the casinos consistently.

The big difference here is that casinos can ban you from placing your bets with them (usually after you extracted significant amount of money from their operations) while the regulated financial markets around the world cannot (most of the time).

Like Learning A New Language

Learn to stop speaking jargons to yourself until you have acceptable meanings for them. It is the very first step you can transform yourself to become more objective in evaluating the market conditions you are facing. Every time you find that you do not have an exact meaning to a term you use to describe the market, you have homework to do – write it down and investigate. All these accepted terminology without clear definition in your mind is an obstacle to your ability in handling the market you want to make money from.

This process of relearning the language you use on the markets is not easy. It is also not straightforward as you are filling in the gaps of your understanding of the markets, you will keep finding more holes in your knowledge of trading. It is normal that you feel overwhelmed in the beginning.

Remember that it is alright to not understand something because there may be nothing important to understand.

During your quest for clarification of your knowledge, some terms is simpler to learn because they are just definitions you have not heard of while some other ones will require your use of logic and statistic inference to define the concepts. It is the same as learning a foreign language. As your set of clarified concepts keep growing, you will be able to define and understand the more difficult ideas over time.

Clarity Comes From Rigorous Study

Some people will simply give up the approach as they could not do it without feeling uncomfortable. It is as if they are strip naked. It is exposing yourself to your own ignorant side. There is no need to resent this. Everyone have something they do not understand. No one is an expert in everything. Trading is very likely not your domain of knowledge or expertise because there is no such training from standardized education. There is no shame to accept this fact.

During this discovery (knowledge acquisition) period of the vague concepts in your mind, there are two common techniques to achieve the goal – direct and indirect approach to learning.

You can focus on using statistics on historical data and events to guide you. The collection of statistics and analysis through the lens of  statistical method is an indirect learning experience, meaning that it requires acceptance of statistics as your ultimate decision making tool which is often difficult to do.

Knowing the subject of statistical analysis well has nothing to do with the ability to use it as a tool to acquire new knowledge. That is the reason why we see a lot of programmers and engineers who try their hands on trading and writing all these codes to study the markets, failed miserably in trading. They are just not the type of people who can accept new knowledge from indirect learning experience.

Personally I cannot solely rely on statistics results either. I always confirm the findings from both visual inspection of the new biases I obtained and also tracking them in real-time until I am comfortable to integrate them into my trading.

Direct learning experience means using hands on approach to learn new things. If it works better for you in the past, or it is how you learned your best skills, it is likely the better choice for you. For the purpose of trading, it translates into learning by rigorous visual inspection. First, you print out your charts, mark them with the important events, price patterns, etc. and then examine the charts or raw data closely. Bar by bar, one chart after another, you will start to feel natural with your interpretation of the information for each specific concept you have doubts about.

The clarification achieved through direct learning often cannot be quantified or explained exactly in words. You are just trained. It is very similar to our experience in learning to ride a bicycle or drive a car. We cannot explain how to do what we do exactly but we can do it.

There is no good or bad method to clarify your understanding of price actions in markets. Both methods I described above get the job done. Several of my mentors who highly specialized in specific trading methods (first techniques popped into my mind – point and figure, channel drawing) learned their chart reading methods the direct way. They have every single trading day of the markets they trade printed out with all kinds of notes, marking, etc. on their charts. When you treat trading seriously and understand your learning of chart reading is an important step towards your success in trading, you would do the same.

Notes: The discussion on Objective Evaluation went a bit longer than I expected as I have to cover various topics related to the mechanisms of learning. Hopefully I have explained the concepts clearly.

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