This is going to be one of those posts that you want to bookmark and read over and over because there is so much wisdom here from Mark Douglas and these concepts really need to sink in. The majority of this post are my notes from a recorded seminar that I watched within the INO TV library, which has an enormous amount of resources available on the following topics: options, psychology, trading systems, futures, and much more.

I personally don’t watch much tv and it’s nice to have all these resources available in one place that I can just turn on whenever I want. If you’d like to gain access to this same trading library for free, click here.

Why Mindset is so Important

The professions that correlates with trading the best is a gambler because the focus on money management and continuously calculates probabilities.

Most people understand the nature of probabilities, but what they don’t know is that they have not integrated what they understand at a functional level inside their mental environment.

Traders may understand probabilities, but that doesn’t mean they can function in probabilities. You must have a key belief in a random outcome for each trade. This is a problem for traders because they see consistent patterns everywhere that produce similar outcomes over time, but the statistical reliability causes them to only focus on the consistency and not the randomness. This happens over and over because we don’t want to deal with the uncertainty.
The outcome to each individual pattern is random in relationship (in other words statically independent)  to the outcome the last time it showed up. There is a random distribution between wins and losses. You must believe this to the core in your trading personality. When you grasp these concepts you will be taking trading out of a right/wrong context and more in a system based trading structure.

Do you get worked up when you flip a coin and it comes up heads when you thought it would be tails? Does it tap you into the accumulated pain of every time you’ve been wrong in your life if it comes up a side you didn’t expect? Of course you don’t because it’s a random outcome.

It’s when you believe it isn’t that you put trading into a right/wrong context that creates the potential to tap you into pain, that then starts narrowing your focus of attention, to where you end up attracting the very thing you’re trying to avoid.

Whatever your edge (higher probability of one thing happening over another) is, it will never be exactly the same as the previous scenario because unless every single person who created the pattern in the past, would have to be present in this now moment, interacting exactly the same way with everyone else…so that the two patterns are exactly identical.

All it takes in one person to change what appears to be the same…and turn it into something that is similar, but not identical. But our minds don’t treat it this way. And you should not try to decide which edges are going to work and which ones won’t, once you’ve tested and decided that your edge is valid.

The best traders are not concerned with each individual event and focus on their edge’s performance over a series of trades over a sample size of trades. Thinking about trading in this way allows them to do exactly what they need to do, every single time, without thinking and without hesitation.

In other words…if I don’t know what’s going to happen next and I believe there’s a random distribution between wins and losses….then what would prevent you from determining my risk in advance? This way it has nothing to do with you being wrong.

The best traders know how much they are going to risk (down to the dollar value) of how much distance they are going to give the market to tell them if their edge is working or not. They expect something to happen, and nothing more. That’s a world of difference between most traders.

So how do you go about creating an edge?

Forward test (in real time, not back-testing) a sample size (say 20 trades) with a rigid set of variables and take every single trade when your edge triggers. And the reason this is so important is because the underlying characteristics that drive a market are consistently changing. Meaning…whatever behavior pattern you identified in the past, does not mean it’s going to continue to exist in the future. There are always new people coming into the market causing the market to behave differently because of their interaction.

These minute changes in the way all other traders are interacting creates differences in the underlying fabric of this collective behavior.

This must be taken into account by:
forward testing for 20 trades
and if you like these results…take 20 more
and if you like those results…take 20 more
and if you don’t like these results
stop and take a look at your variables.

Continuity combined with a systematic approach gives you a clear idea of what works and what doesn’t. Anything else is a random trading plan. And you must be committed to testing this for all 20 trades even if you lose 19 in a row (so trade small) because that 20th trade could make up all your losses.

In conclusion, it’s going to take some time to develop your own system, and the mental fortitude to actually test it in real time, but if you want to achieve consistency in the markets this is one of the few ways one can work towards that goal. Your system is going to be just that…your system and that in itself is a huge edge in trading.

If I spelled out everything I did on a daily basis…all my buy/sell trigger points, there is a possibility they would become ineffective over time. It’s possible that wouldn’t occur, but I’m not willing to take that risk. Besides, there is no guarantee that another person would even be willing to trade exactly as I do. Their psychological makeup may not allow it.

Focus more on the journey of developing your trading system and not so much on the end result.

Related Posts:

Trading in Your Zone

Trading Psychology

The Path to Greatness

2 Responses to “How to Create Your Trading Edge”

  1. derek Says:

    excellent post, Jeff…forward testing is time-consuming but such a critical part of really “feeling” the edge(or lack of edge) at work

  2. Defining Our Market Edge StockTwits U Says:

    […] December 9th, 2010 I love this post from zentrader, in which he references a key passage from “Trading In the Zone” by Mark […]

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