The Flip-A-Coin trading strategy and lessons learned from it

Discussion in 'Psychology' started by NET, Dec 28, 2003.

  1. NET

    NET

    This post is for those traders who find themselves in a funk as I was surely in until recently. I'm sharing my experience and what I learned from it because there are those lurking these boards who may learn from my mistakes.

    The strategy: It was a crazy idea that popped into my head one day. After making 23 out of 25 losing trades in a row, it seemed I couldn't pick a winning trade if my life depended on it. With the Flip-A-Coin strategy, I figured I could pick an instrument (any liquid one will do) and just enter a trade on the flip a coin (i.e., heads for long and tails for short) and let money management take me out of the trade. Either that or stop trading. Something.... ANYTHING had to be better than what I was doing.

    Over time, I reasoned this strategy would give an overall 50% win-loss rate. That takes care of the entry. Now, all of the focus is on the exit--and that's where the money would be made. Exits would be determined by a two-to-one ratio, i.e., stop out at a 2% loss and take profits at 4% gain (substitute any ratio that suits your fancy).

    Then I thought, why not just enter a trailing profit stop once the 4% profit level is reached and let it run! Now there's an idea. Finally a plan to get out of losing trades quickly and let those winners run (that simple sounding strategy that seems so elusive). Hmmmm... looks like the beginning of an edge.

    How ridiculous! Maybe so. However, this silly little mental exercise broke my losing streak. Resorting to a strategy of flipping a coin caused me to step back and look in the mirror, and get back to the basics. This included re-reading some of my books, the most humbling of which is Trading in the Zone by Mark Douglas. After my first read, I thought I was prepared for the challenges and pitfalls. After my re-read, I found myself agreeing out loud with the author--scenario after scenario--as I recognized I fell into those traps for which I thought I was prepared.

    There were many mistakes that compounded over time. The progression developed as follows:

    Lack of commitment to a trading plan: I started out profitable with many winning trades early in my trading. I drifted away from what was working.

    Over confidence: Initial success caused me to hold losing positions. Worse yet, several of my losers turned into winners upon my exit. This was really damaging, as I changed my strategy with my losers from being a trader to long term investor (honor thy stop no matter what, right?).

    Being a relatively new trader, techniques that were learned in a bear market were carried into a bull market--i.e., failure to adapt to a changing market.

    Following beliefs instead of technical analysis: There's an argument to support any position in the market--at any time--long, short, or neutral. I had my bias and I looked for experts to confirm it. I was always able to do this. What's so shameful in retrospect is all of the missed opportunities by identifying pivot points, then not believing in them because they went against my preconceived market bias. The technicals were working; my deeply seated market bias was failing big time.

    Failure to accept probabilities in a trade, creating a quest for confirmation and certainty: What a vicious cycle! Identifying trade after trade and then sitting on one's hands as the train leaves the station--looking for confirmation. Then having confirmation create a poor risk-to-reward ratio... Finally entering bad trades in frustration.

    Money management: My gosh! How on earth could I find myself down $20.00 a share on a shorted stock trade! What were you thinking!! :eek: ahhh yes... those early trades that reversed time after time right after my untimely exit. :confused: What bad negative reinforcement that turned out to be. :mad: So I ended up a trader on winning positions and an investor on loosing positions. :(

    Fear of loosing: Prior to experiencing loss, I read about this phenomenon and frankly couldn't understand it; i.e., it seemed counter-intuitive. After all, wouldn't the fear of a loss help prevent one from happening? Lesson learned: Loosing trades create tunnel-vision, creating lost opportunity (gee... why not put that equity to work in a winning trade?).

    Failure to mitigate the loss: An extreme move will typically be retraced, so patience on an exit will reduce the loss--that part I mastered. However, if one believes the retrace is a resumption of the previous move (i.e., preconceived belief vs. technical message of the market) then the opportunity to mitigate can be fleeting. The retrace ends, and with the market's next impulse, your even deeper in the hole.

    It's amazing how clear our thinking is when we observe others making trading errors. It's equally amazing when we're in a loosing scenario
    just how muddled our thinking becomes. Losses create tunnel-vision, and the more serious the loss, the more serious the tunnel-vision.

    I have a colleague and we talk daily about our trades. He told me he wanted to jump through the phone when I refused to dump my losers.

    Yet It's funny, because when he's in a loosing trade the first thing I ask him is where he'll get out (why couldn't I ask myself that same question). His most common answer: "I don't know...." or simply, "I'm not getting out."

    Unbelievable!

    It's also amazing to put this into writing and look back at it. It's why the majority of traders lose. The circumstances are surely different for each trader, but the bottom line is the same: Lack of discipline, poor trading plan, fear of loosing money (i.e, fear induced tunnel-vision), poor money management, failure to understand (really understand) probabilities, etc. etc. etc.

    The Flip-A-Coin trading strategy got me to address perhaps the two most important issues that completely disappeared from my trading: probability based trading and money management. By flipping a coin, it's absurdly clear that you're gambling on market direction for your selected instrument. That leaves only money management, i.e, an absolute and strict exit plan as the ONLY way to make money over time, whereby the percentage loss over time must absolutely be smaller (on a relative basis) and percentage win over time must absolutely be larger. This is accomplished with extreme impatience with losers, and substantial patience with winners (quite the opposite of what loosing traders tend to do).

    If we took a trade on a coin flip, how much confidence would there be in the position as soon as it moves away from us? I can tell you I would have no confidence whatsoever (after all, it's just a coin toss, right?) and would be very quick to escape the bad trade. It's a no brainer, because there is no emotional investment in a coin toss, so there's no emotional commitment to the position. Without that emotional commitment, escape is relief!

    Something happens when we use technical analysis to enter a trade. We become invested emotionally. The TA convinces us that we're right in our opinion, and therefore we develop a belief as to what the position should do. Based on this belief, we develop patience in a position that moves against us--exiting quickly is an admission that our TA was wrong! (Our ego doesn't like this kind of thing.) To make matters worse, the exit means taking a loss--kind of a financial penalty for making a TA entry mistake. And there it was--staring me in the face!! It was holding a trade because of a belief that started in technical analysis and then took on a life of it's own, along with a preconceived, outdated market bias that was causing an "over-committment" to positions that ended up losers, made worse by attempting to avoid a loss by avoiding closing, etc.

    When picking a trade, technical analysis only marginally improves the odds over that of a coin toss--and that's ONLY if the TA is nailed correctly (we don't want to believe this). Since the technicals only give one a slight improvement over the 50%-50% odds of a coin toss, we should be just as quick to escape from negative trades regardless of the method used for entry (coin flip or TA--doesn't matter). Ego should be rewarded for skillfully nailing an exit strategy--i.e., getting out rapidly or nursing the position into the protection of a profit stop, guarantying a win. Then, if the trade is favorable, trail it with a stop to insure exit as soon as the move ends (who knows when that will be-- 3% ... 50% or more... we just don't know). But for some dumb reason, a beautifully planned exit is not where we hang our hats; we like to do that on the entry--which by it's very nature--is not much more than a coin toss. Do we really want to admit that hours and hours of TA only adds up to such a small edge? Being right on that pick (after so much work) is soooo rewarding... could that possibly have anything to do with being patient with a losing trade?

    So what's the fix?

    The Flip-A-Coin strategy will only work with highly skilled exits, since there is no edge on the entry. Mastering trading with this strategy requires mastering skillful exits. This mandates extreme lack of patience with losing trades. Winning trades must be allowed to flourish, and never go negative once the trade is positive. Plenty of patience with the winners, using trailing stops for an exit so that the full profit potential of the trade can be realized.

    If so much effort is focused on the exit, then the entry can almost seem trivial. Yet, there's challenge and reward in finding the skillful entry. The trick is to find an entry spot, take the trade WITHOUT HESITATION, and THEN treat it like a coin toss. If it doesn't work right away, get out--fast!

    If it turns positive, treat it as a challenge to make the most skilled exit possible, i.e., a stop that trails, never letting a positive trade turn negative, etc. Fun challenges on entry AND exit! Geesh is seems so simple....
     
    K-Pia likes this.
  2. ig0r

    ig0r

    excellent :) On our way to riches, are we?
     
  3. How about a rhetorical question: If you are unable to determine a proper entrance other than by coin flip, what makes you so sure you can execute a "beautifully timed exit"?

    While you're pondering that, allow me to point out a simple fact. Yes, technical analysis may only provide slightly better odds than a coin flip. BUT, what you miss here is that through properly used TA you may be able to enter at times where the odds of maximum gain exist, while the risk of minimum loss is present. In other words, let's assume that the trade will be little more successful than a coin toss, but when successful, it will be VERY successful because of the nature of the entry.

    Is this true of an entry based upon coin toss? We don't know. And therein lies the problem with this 'new' method of yours.

    The real solution to your original problem lies in simply developing some discipline to take your entries, and then couple them with the "beautifully timed exits" that you supposedly know how to do. Flipping a coin to correct your trading problems reminds me of all the phoney diet solutions to overweight, phoney solution to stop smoking, etc. Learn some discipline....it will help your trading, along with the rest of your life.

    OldTrader
     
  4. Pabst

    Pabst

    Net: Oldtrader is part of this old school of philosophy that thinks you need to know whats going to happen if you want to make money. Since reading Flipping Your Way to Financial Freedom two years ago I've changed my life. The dirty little secret: Everyone from Soros on down is using coin tossing entries. Some of the more sophisticated funds are working on exit strats with both coins and decks of cards. I don't want to get into some of the more esoteric derivatives trades involving dice throwing but I will say, if you see me roll snake eyes, cover your short options premium! I'm trying to cut down on my trading and the number of signals generated by flipping. I'm now taking an average of 13 flips with a 34 flip crossover. MUCH smoother equity line. GOOD LUCK NET!!
     
  5. maxpi

    maxpi

    Here's a thought: it is psychology you are dealing with here so why not fool yourself after entering every trade as follows: Enter the best way you know how but at the moment you are in it start pretenting you entered on a coin toss. That might help to shuck off all the baggage you described.
     
  6. Turok

    Turok

    >Enter the best way you know how but at the
    >moment you are in it start pretending you
    >entered on a coin toss.

    Don't know if I've ever heard better advice. It's yet another way of saying "manage the trade as you see it and not as you think it".

    Nice

    JB
     
  7. Wow, amazing. If only the previous posts represent all different schools of thoughts that lead to financial freedom then please bring the bowl, I need to vomit.

    One guy suggests that even flipping coins can be over the long-term profitable if exercised with strict money management and entry/exit strategies. (You should know this is wrong and has been proven empirically and statistically; please include commission cost and slippage in your equation).

    Another guy states that its best to trade, knowing what is going to happen. Dude, if we could all know what is going to happen by working hard, there would be no functioning financial markets. Markets work because its a gathering place for people with different views of the future, willing to invest their funds with the expectation of yielding a positive return.

    Finally, Pabst suggests that many huge funds including Soros follow some esoteric and coin flipping strategy: What a relief to human kind, its not knowledge, not skills, but its pure luck and statistics!!! I cant wait to invest all my funds with such managers. Pabst(=pope in German): You are an old man and do not seem to have learned a single lesson from the market. What we need is not "small dirty secrets" but an honest and critical view of the markets. Could it be you are a seller of those neuronal network or esoteric software?

    Fortunately markets are way more sophisticated and structured and if you have not learned your lesson now you will do so for sure in the near future. Reading such posts, I understand better and better where all the money comes from, those 1% or 2% top make out of the majority.
     
  8. NET: I think u'll make it now.

    bundlemaker: Could u comment on NET's story? And possibly help him change his map?
    Thanx.
     
  9. NET

    NET

    Maxpi and Turok...

    You got it exactly! I made the same conclusion at the end of the post (last two paragraphs).

    OldTrader, you are absolutely correct, and you also missed my point. May I respond to each of your comments:

    How about a rhetorical question: If you are unable to determine a proper entrance other than by coin flip, what makes you so sure you can execute a "beautifully timed exit"?

    Therein lies the challenge. If this post helps traders in a funk start paying attention to exits instead of living and dying by the entry, then mission accomplished.

    While you're pondering that, allow me to point out a simple fact. Yes, technical analysis may only provide slightly better odds than a coin flip. BUT, what you miss here is that through properly used TA you may be able to enter at times where the odds of maximum gain exist, while the risk of minimum loss is present. In other words, let's assume that the trade will be little more successful than a coin toss, but when successful, it will be VERY successful because of the nature of the entry.

    You are absolutely correct! My post affirms--repeatedly--that TA works, and works well. The point is, don't get "married" to a well placed entry, because no one can predict what will happen. Did you read the last two paragraphs? (I know the post was pretty long.)

    Is this true of an entry based upon coin toss? We don't know. And therein lies the problem with this 'new' method of yours.

    This is a board on psychology, not trading technique.

    You've missed my point, entirely! The Flip-A-Coin strategy was a "mental" exercise that helped me get back to "probability based" trading. I was expecting too much certainty (i.e., confirmation) with my TA picks, which frequently caused me to enter late or miss the trade entirely. Back to your previous point, TA is superior to a coin toss--I absolutely agree! But one MUST PULL THE TRIGGER without waiting for confirmation. That means one must take the trade based on a probability of success--and nothing more--instead of waiting for the sure thing. Take the trade, then immediately shift focus to the most profitable exit possible.

    The real solution to your original problem lies in simply developing some discipline to take your entries, and then couple them with the "beautifully timed exits" that you supposedly know how to do. Flipping a coin to correct your trading problems reminds me of all the phoney diet solutions to overweight, phoney solution to stop smoking, etc. Learn some discipline....it will help your trading, along with the rest of your life.

    We disagree on this point, at least partially. Let's distinguish what we mean by discipline.

    You cannot compare discipline in life with discipline in trading. If they were related, then very smart and disciplined professionals such as doctors, lawyers, etc., would comprise the bulk of winning traders. My studies suggest the opposite is true. Discipline in life does not translate to discipline in trading.

    As a former flight instructor, a better comparison is with a student learning to fly by instruments. The most difficult part of learning instrument flying, is training your mind to ignore what your body is telling you (ask any instrument pilot about this phenomenon). The physical sensation of "which way is up" is so powerful and deceiving, that many private pilots lose their lives when they lose visual reference to the horizon. Instrument pilots must learn to ignore these very, very powerful feelings and trust the instruments.

    Similarly, when one spends considerable effort finding a trade and then backs it up with money, an emotional attachment, i.e., belief about the correctness of the position is made.

    Discipline in trading is the ability to ignore--actually defy one's "beliefs" about a position, the technical analisys that lead to that position, belief about market direction, etc., i.e., ignore everything that identified why the trade was good to take--once you're ALREADY in the position. The challenge is to disregard strongly held beliefs about the position so that one can abandon the trade when the price--and nothing else--tells you to do so. This... frankly, is easier said than done because you are going against yourself, (which has nothing to do with discipline in life).

    Pabst, Coffeezoo, thank you. I'll know in a year. The last two months have been very positive!
     
  10. I found that I was able to turn the corner to consistent profitability when I finally had a system that I BELIEVED had an edge.

    It didn't have to be a big one, just one that I believed would play itself out over time. The reason I feel this is important is that when I finally had it, Istopped hesitating. I now pull the trigger every time when my edge appears.

    Before this I was trying to cherry pick which set ups would work. A trader who has it together (which means a WRITTEN trading plan), can avoid prolonged slumps because they take every trade and let the probabilities play out.

    Newer traders will jump from method to method as soon as it shows a drawdown. There is nothing wrong with that while you are learning, but you must eventually pick a style to be consistent.

    DTP
     
    #10     Dec 29, 2003