The Journal - Why Bother if the Market is Random?
The following is some great email Q&A which occurred recently, which I'd like to share with all readers...
Question:
Hello Lance,
There's another question that recently popped up in my head after reading "Trading in the Zone". As both you and many other successful traders say, it's very important to have a trading journal, so we're able to find out what's working and what's not working. The journal also tells us about our strengths and weaknesses and the things we need to improve, both in ourselves and in our strategy. It's obvious that keeping a journal is a very logical thing to do but now that I've read Trading in the Zone and hopefully absorbed the message I must question this essential factor.
Why do we try to find out what's working and what's not when every new opportunity in the market really is a new and unique one?
Why do we even bother and try to analyze when our edge is stronger or weaker if every opportunity really has a random outcome?
As Mark Douglas explains in the book,
"You can't expect that whatever you did that worked the last time will work again the next time,
even though the situation may look, sound, or feel exactly the same."
This information simply got my head thinking, I would really appreciate if you could explain to me why keeping a journal has made you a successful trader.
Is it to identify these small atomic things around the edge that can give that edge a higher probability to work?
Really looking forward to hear your opinion about this. Take care,
Emil
Answer:
Wow... you ask great questions.
My thoughts on this in a couple of paragraphs (although a full book is probably warranted if I were to do this subject justice)...
Markets are not random if you define random as being an equal probability of all possible outcomes (I'm not a statistician so that may not be a text book definition, but it's the one I use). The nature of markets is uncertainty. There is a probability of each outcome occurring and it will never be 0 or 100% but always somewhere in between. And the exact probability cannot be known, as each individual opportunity is certainly unique (the exact context for each setup will never be repeated).
However it is possible to gain an edge (in my opinion anyway).
Price movement occurs due to buying and selling decisions of individual market participants. While individual decisions are essentially unknown, herd behavior is somewhat more predictable at times of stress. For example, consider the random movement of people in a busy shopping centre. Individual paths of movement would be difficult to predict. Now what if a fire alarm activated? It's a little more predictable in this case, as most (hopefully all) shoppers would be preceding to one of the emergency exits. Human behavior, at times of stress (whether through acting out of fear or in seeking opportunity) is still probabilistic in that there is no certainty, however the odds of particular outcomes are reliably greater than other outcomes.
Same in the markets. An edge exists at those areas of the market at which other participants either perceive opportunity or perceive fear and are compelled to act in a certain direction. By identifying these areas in advance we are able to position ourselves to profit from the increased order flow.
Is it always correct. No. But it can provide a small edge. And if we can consistently identify these areas, position ourselves well enough through wholesale trade entry (to borrow a great term from Don Miller), manage the opportunity in order to exit when the edge is gone, either through minimising losses when wrong or taking profits into the retail buying/selling, then the small edge will be allowed to work over a larger sample of trade opportunities. The intent is not to seek 100% certainty, but to seek an edge over a longer term. Individual trade results don't matter.
Is it a valid theory for the nature of markets and profiting from trading opportunities? Who knows? Is it the only useful theory of market movement? Probably not. But it seems to work for me.
Certainly, if the markets were totally random, or even if fixed odds such as a casino game like roulette, then there's no need to keep a journal. Just play, and be happy with losing over time. However if we accept that the market is not random, and can provide a small edge for those who know how to find it, then a journal becomes an essential tool in developing our trading ability:
(1) Seeing areas of opportunity is simple in hindsight. Seeing them at the right hand edge of the screen is much harder. Experience needs to be gained in reading the flow of the markets. A journal recording your analysis of price movement as it happens live, later compared to the chart with the benefit of hindsight, can reveal insights into the nature of price action and how you perceive it to be unfolding, thereby accelerating your learning and the building of a mental model of how price and markets work.
(2) Consistency in your own performance is essential. Once again a journal is a useful tool in identifying patterns of thought or behavior. This allows us to enhance what works, and improve what doesn't or at least mitigate the risk if it's something which can't be improved.
End result.. keep a journal if you want to win at this game. A journal won't guarantee you win. But the odds of making it without one are probably very, very small.
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