Decision Tree Trade Management

Discussion in 'The 'On Professionalism' Thread Series' started by jack, Aug 25, 2013.

  1. jack

    jack Administrator Staff Member

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    This is the ninth installment of the On Professionalism thread series.

    The previous installment thread can be found here:
    Losers Average Losers, Averaging Down, and Grinding it Out

    The index and first installment can be found here:
    On Professionalism




    Managing your trade.

    When following a trade plan (and avoiding 'hope' mode,) having an exact plan of action in place for every possible outcome in price movement is a great way to help manage your trade (and make sure you're sticking to your initial trade idea.)

    It could be as simple as a stop loss and take profit order, or as complex as monitoring an indicator or volatility to give you a reason to execute on your trade, but it's essential to have a plan for each trade you take and be able to follow through on it.

    One method that works well is creating a decision tree for all possible outcomes.

    A decision tree is just structure of choices pre-made for each possible result of the previous choice. For example:

    This is a very basic example to better illustrate the point. If your trade style or plan is sensitive to factors like volatility, news, indicators, etc... then incorporate these as 'branches' to your decision making and expand on your tree.

    [​IMG]

    Here we see the decision process given possible outcomes of a trade. You don't have to do this on paper for every trade, and often the same decision process will apply to each trade taken in your trade plan, but simply having the guide already set can help remove any discretionary interference from mucking up your trade plan's performance. (How many times have you missed out on profits thanks to messing with your trade plan once the trade is put on?)

    Remember, we are following a plan for a reason: To exploit an edge we've discovered in the market! That edge quickly goes away once we stop following the plan. A decision tree is just way to help keep your execution choices within you trade plan and -- more importantly -- prevent you from freezing up should the market change drastically.

    As the cliche goes: Plan your trade; trade your plan.




    The next installment in the On Professionalism thread series can be found here:

    Points not Dollars, and Non-Monetary Trading Goals
     
  2. Skipper

    Skipper Demo trader - Learning everyday

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    I see how practical this decision plan is. It helps you calm down even those times when price just stays in place/flat.. tick, tick, and you wonder should you just close it. Straight and simple - unlike traders mind :durr:
     
  3. jack

    jack Administrator Staff Member

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    Yes.

    Eventually, traders can let their discretionary input change their trade plan on the fly when they see something in the market change that affects their trade.. BUT, doing this well is extremely hard for new or developing traders, and often they just end up bungling up their otherwise solid trades.

    So the decision tree helps people not get caught trying to just 'wing it' after the trade is already in place... and, it also serves as an exercise for the trader to go over all possible outcomes in their mind first (like visualization, only on paper) so they know how they will react to each possible outcome, and thus, react swiftly and properly when a given outcome takes place.

    You'd be surprised, but some people spend days and months coming up with a trading plan that actually has an edge (which is not an easy task, finding an edge on your own that is,) only to completely fail at putting that plan into practice in live markets. So any aid like this to keep them on track is a huge help.

    Glad you're liking the series. :)
     
  4. Adamant FX

    Adamant FX Member

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    this is so good, dont think I've come across something like that as it relates to trading.

    great suff, Jack!
     
  5. AusDoc

    AusDoc Well-Known Member

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    Yes, a decision tree is a great idea. Ideally, it should be kept so simple that it doesn't need to be written down to be followed. You should certainly write it down to document it of course, just know it so well it can be implemented without having to read it.

    While the decision tree idea is fine, I really do not like part of the example you have above Jack. This perpetuates one of the biggest errors to plague traders that ever was slipped into retail trading culture. "Allow it to get stopped out" is for losers who plan on staying that way. So many "trading educators" promote this idea one way or another that it seems to crop up just about any and everywhere. It's a shame to see it here.
     
  6. TopFroxx

    TopFroxx Well-Known Member

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    could you elaborate? what would be your advise? close early, adjust stop loss? depends? if so, on what?

    cheers
     
  7. jack

    jack Administrator Staff Member

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    Yeah, you're going to have to give more detail than that.... I hope you're NOT about to tell me that you think stop losses are for losers.

    For the simplicity of making an example tree for this post, I used rather basic but easy to follow trade logic, but even so, stops of some kind -- or, more specifically, where you are 'wrong' on a trade -- are paramount as far as I'm concerned.

    EDIT: I accidentally a word.
     
  8. AusDoc

    AusDoc Well-Known Member

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    It's really simple: actively manage.

    "Allow it to get stopped out" is passive and borders on abrogation of any real position management at all. Setting a stop loss and watching while the market goes against you right to the point where you are stopped out usually means one of two things: plain stupidity or trader incompetence.

    I grant you that occasionally a flash move comes out of the blue, not a news item you overlooked but a real shocker. That's why you must have stop losses in place. But stops are not put there to be routinely left in place and allowed to be hit. That's part of where we get the term dumb money.
     
  9. jack

    jack Administrator Staff Member

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    Oh..**few**.. for a moment there, I was afraid you'd turn out to be a "no stop loss, ever" person who thinks that the simple act of placing a stop at all is ensuring terminal losses...

    There are a lot of trading methods (mostly discretionary, as opposed to systematic) that allow for 'actively managed' risk, yes... but please don't take the overly simplified trade logic I used to populate an illustration/example as an attack on any other risk management method. The idea was that the reader would build out their own as a framework, after all..

    --

    That aside, I can't say I'm 100% with you on "allow to get stopped out" being a totally bad thing. The context of how you're letting your stop get hit is everything... In some systematic styles, a hard stop that's observed or adjusted based on set rules is not only required, but part of what defines said strategy's edge (mind you, this isn't as simple as 'just wait to be stopped', and often these rule sets can be complex enough that it near mimics active discretionary management, but of course when I'm giving examples I'm trying to keep things simple.)
     
  10. AusDoc

    AusDoc Well-Known Member

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    Are you kidding Jack? Stop losses are not for losers. People who think they don't need stop losses are very interesting. I'm not that interesting, I always place stops.

    Yes, I understand the keeping it simple argument. I have no problem with that, just the unfortunate choice of phrase I've highlighted. I have seen this concept bandied around very widely for decades.

    You're absolutely right about using protection. I agree completely.

    What I hate to see is new traders lapping up what they think is trading wisdom that is nothing more than old folly. I have heard traders bragging about their courage as they stood their ground and watched the market gradually turn against their position and move towards their stop. They talk tough about handling the stress and then shrugging the loss off while they look for their next entry.

    Some, of course, tell it differently and lament the dreadful anxiety they experienced. They talk about their misery and look for comfort only to have self-professed more experienced traders tell war stories about the many times they have stood their ground and then just moved on. They drag out old favourites like "losses are just a part of the trading business" and "you have to get used to taking losses". Incredibly helpful stuff eh? Inspirational! What crap.

    When traders enter a position and then spend significant amounts of time in the red it just means they haven't learned how to trade with precision. For them success is going to be more about luck than skill. They have little choice but to accept their suffering or toughen up and develop good loser skills. Yes, let's be clear, that's what many traders spend time developing, loser skills. There are plenty of poor traders who are well qualified to teach these.

    If you want to develop winner skills you must start with accepting responsibility. That means for the level and timing of your entries, your management of open positions and your decision to close and manner of doing so. If a trade goes against your position then you know immediately that you got something wrong. Hopefully not wrong enough to matter but the parameters matter and each individual trader needs to know exactly what they are for every trade and what actions should be taken in response.

    In my own trades I set stop losses at, in most cases, 20 or 30 pips. I do not worry too much about looking for levels to "hide" my stops behind and I don't care at all if it happens to align with a round number or any of the other equally feeble ideas floating around about "protecting" stops from the market. The stops only exist as emergency exits. I haven't had a full stop loss hit for many years.

    On entry I fully anticipate that the market will move quickly in a profitable direction. If it doesn't it usually means I have made a poor entry. Sometimes it just means I need to be a tad more patient. If it moves five or so pips against me I become concerned and usually am out before it hits 10 pips. I will very quickly re-enter if I see that I was just a little bit out and the trade setup remains valid but I will not sit around stewing and hoping while it moves further against me. I certainly would never sit back and allow my position to get stopped out.

    Traders need excellent decision-making skills and your simple decision tree is a useful tool for learning such skills. But traders need to remain fully engaged and very active while accepting full responsibility for their trading outcomes.
     
  11. AusDoc

    AusDoc Well-Known Member

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    Yes Jack, I'm referring to discretionary trading.
     
  12. jack

    jack Administrator Staff Member

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    Ugg.. where to begin..

    Firstly, and before anything else, I'm really glad you're both passionate about trading as a craft, as well as sure of your trading methods. :) I's always good to see that in others.

    I missed a word in the line you quoted of me, and you'll find it edited in the post itself from long ago. "I hope you're NOT about to tell me..."

    I've battled such people on the net for some time now, who harbor the idea that trading naked without a stop (or even a clue where they're wrong on a trade) is the best way to go. Often, these people will express a feeling that if they place a stop, they'll just get taken out by virtue of it being placed, and then subsequently watch as price moves in their intended direction afterward. I feel, as you put it yourself, their problem is a lack of precision with their entry... but I digress... I'm just glad you're not one of these people.


    I do think you're reading too much into my material though... I'm mostly a scalper, so the example I gave was off the top of my 'tight stop, quick profit' mindset... I'm used to employing stops that are set tight enough that the first signs of "something's wrong" usually includes taking a small loss via said stop. No real room for manual stop management unless you're ultra fast and can read the noise of a few pips of oscillation can provide. So yes, I do stress the 'context' issue I brought up earlier. I'm going to get back to this thought later**

    For you, setting a disaster stop, but manually (and mentally) keeping your stop tight, works. However, that's just one way of slicing it, and there are many, many (profitable) methods of trading. If the "allow to get stopped out"' was a stop placed 5 pips in the red, what active management between 0 and -5 could the trader realistically expect to do? No where was my example advocating for a 30+pip stop and just watching it as the market chewed straight through such a wide range of price.. the stop distance was left out, because, again, it was just an illustrative example.

    As the trader builds out such a decision tree process, they'd be filling in for more branches of possibilities based on their trading strategy and methods, and should they have a wide stop set, then there's a lot of room (and nothing stopping them--geddit? Stopping them? >.>) to work in tree branches that limit losses to less than the full initial stop amount.


    ... ok, I get what you're trying to say, but before I dig into the details, I should point out that this thread series was not written to just rehash junk I once read in some failed trader's attempt to make money from selling books or courses. Everything I've written was based off my experiences trading prop and on my own for many years, it's what worked for me, or helped me get past plateaus in my own trading.

    Yes, some of it reflects what others have already said (and at the beginning of the thread series, I state that I'm not reinventing the wheel here,) but if I've made mention of it in this thread series, it's because I've personally benefited from viewing the markets or my trading this way... and I refuse to push advice that I haven't vetted myself in my trading career.

    That being said, there's a lot to be gained from learning how to take a loss in stride. No matter how good you are, you're going to have losses. Letting anxiety or emotions mix you up about them will only serve to hinder such things as discretionary trading.

    This is NOT saying it's ok to just sit there and continually take losses without caring... this is about not letting losses break your ability (and mental fortitude) to follow your trading method and appropriate risk.

    Your level of trading -- and do understand that many traders who are still striving for consistency are not trading with the discipline and experience your posts convey -- where an active risk management approach can yield a net benefit to your P/L, is not realistic to someone who still gets worked up and anxious over a trade that goes a bit south enough that they start violating their rules or mismanaging the trade.

    Also, alleviating anxiety and emotional distress by seeking out others to tell them it's "ok" and 'losses are part of the game'... is not the reason why traders like myself advocate learning to shrug off losers. The idea is to mute the emotional side and be able to remain objective.. with that, the active management that you're talking can start to be a net benefit, but while the trader is consumed with emotions such active management might yield poor execution/risk decisions.

    Again, I do feel you're reading into this material too much and filling in between the lines as if you're expecting to read the common dribble found around the net and in books that miss the mark on a trader's development.


    To some extent I agree and I think the market tends to teach bad habits every chance it can... but no where was my material suggesting it was ok to enter a trade and just sit in it, in the red, for long periods of time.. I didn't touch upon system development in this sense, and remarks like this is what keeps me asserting that you're reading too much into the material.


    Yes, personal responsibility is huge. I agree with this entire statement.

    Ok, I suspected a bit, but now I'm more sure... you've written a prescription based on your own ailments, not the patient's. :p

    You are right, if you anticipate the market will move quickly, and your resulting position just sits there slightly against you... something is wrong. Get out. But that's in the context of that specific style of trading (and that's actually exactly what I teach people when it comes to momentum trading in equities.)

    My first manager at my the first firm I traded for used to say: "The market should just 'go!' If it sits there, almost telling you 'are you sure you don't want more shares? I'm about to run, you can buy more cheap now." ...then it's probably a bad trade. For momentum trading, I've held this idea close to heart and consistently find that it helps me keep out of trouble even to this day.

    But all that being said, keeping a tight hard stop (say the -5-10 pip or less that you like to manually take yourself out at) and re-entering should the trade still be valid, isn't much different from how you manage it... it's just a bit more mechanical. I tend to advocate for removing the discretionary element of someone's trading should that person be stuck making impulsive and emotional execution choices.. after enough screen time and consistency/discipline is achieved, then a reintroduction of discretionary input based on objective experience can be applied for a net benefit. This is how I approach helping people, and it's how I developed myself when I struggled to get over "emo" trading while I was working to gain consistency when I first started out..

    Re-read the introduction of this thread series if you have to, but the aim here isn't to teach people from the ground up, nor is it to direct already consistent and pro traders... my goal was to take someone who's spinning their wheels, force them to take a step back, work on discipline (directly and indirectly when it comes to trading) and then have them re-approach the market from a better reference point. It's still going to be up to them. I'm not teaching a method here. I just hope they might be in the right mindset after reading all this to give trading a fair shot, regardless of the trading method they take on. (I mean, really, the only specific things I speak out against, method wise, is not to average a loser simply to avoid a loss, and other loss aversion enablers.)

    ** Remember when I said I'd get back to an earlier thought at the end? Ok, here it is: I have homework for you! :D I do not disagree with your ideas and sentiment, but I do feel you've jumped the gun a bit in judging this material. So instead of being all offended and defensive about it, I'd rather we be constructive. If you feel you could make a better moc-up example of a decision tree that includes your specific methods of active management, please create one and post it here. Don't forget to explain your reasons behind the logic statements on the chart.

    This way other readers can benefit from seeing a more hands on and practical example from another source, as it might help them also create one of their own.

    Sound good? :)
     
  13. AusDoc

    AusDoc Well-Known Member

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    LOL, way to go Jack! :)

    You seem to have taken my criticism of one small, but important, concept very personally. That's fine. I am always happy to press people's hot buttons to get them to think. If you don't ruffle a few feathers water just runs straight off a duck's back. But this was never an attack on you Jack.

    Take a look back now. What do you see? You should notice a thread that has been greatly enriched by your new posts. Now new traders who happen upon this thread have something more useful to chew on, there is more meat. The concept to which I took exception has been exposed and elaborated upon so it is hopefully less likely to be taken as a perpetuation of the poor teaching one can find almost anywhere.

    When you say I have written a prescription for my own ailments, you're quite right, even if you're wrong. I didn't do so unknowingly, which you may be implying. I don't suffer a one-eyed perspective that prevents me from stepping into others' shoes. I do not see merely the world according to AusDoc and fail to consider that other views exist. But I did learn from experience. I have made all the trader mistakes in the book, and then some. Fortunately I was able to think independently and critically and had the self-knowledge, personal qualities and the funds to survive long enough to find my way.

    I won't go through your post in the detailed way you have developed it. There's no need, we're on the same page. I am a little amused by your homework assignment though.

    You must think I'm easy. ;) I think there is more than enough material here now for people to recognise the importance of thinking a bit more deeply about that graphic. Hopefully they will be able to:

    • re-examine their entries if they are finding themselves worrying a lot about being stopped out
    • grasp the concept of actively managing positions from open to close and not just "allowing" themselves to be stopped out if they can avoid it
    • generally give more thought to what they consume about trading because they may not realise that they are not getting the whole story

    Best wishes to all for your decision trees.
     
  14. rod178

    rod178 Well-Known Member

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