Profitable ETF Trading Strategies: an extended reflection on risk management and mental toughness

Trader Quality Number  idea: if i want to trade AA today, and in the sideways mkt i have been using .1 iStop, maybe today i can use .4 as the iStop for position sizing, and acknowledge i will exit at -.5R or an adverse move of .2

if you are timid about pushing the button then your Risk level is too high.

So, make a bold correction on your risk level by cutting it by a factor of 4

can u trade 1 share of the target without worry? can you trade 2 shares?

there is some threshold where you believe you can trade it, but that if you got any larger, it would begin to be an issue.

we set that threshold using our most optimistic mind.

i say start with 1/4 of what you “think” you can safely trade.

i say that because we know that our fear is 3x larger than our greed in terms of importance.

so if i want to “win” 1000 on my 2:1 venture, i have to risk 500.  then i ask myself: can i risk 500 and manage the trade?

my optimistic mind says “sure”

so i actually risk 500 and i notice i am on pins and needles. why?

because my optimistic brain imagined i could handle 500 =R, when my stomach says “not so fast, thats 500!”

so i say , fark it, if you think you can handle 500 no problem, cut it in 1/4 and risk 125

and round that to 100 for math

if you feel you have to be successful then you are importing that stress to every trade, unless you make the trade so small that you can set aside the stress

i am giving you a technique to make it obvious to yourself that you can set aside the stress

you improve your stress management by desensitizing those excitement nodes in your brain

if you think you can handle 500 =R, then i say make R =100 and do it 30 times with no stress, then over the course of 2 weeks you will have enough data points to see if you can trade that risk level routinely.

i dont mean tweak the risk level a little, i mean make a bold correction.

my plan for a day like today would be to buy breakouts of targets that are stronger than SPY.

I dont need pullbacks on days when the market is melting up.

lets look at HD today: i would normally engineer a .1 stop, but it looks like a “slow grow and dont look back day”.

fark it, its going up, everything is going up, buy it with 1 bullet at 1/4 of the position size

I will do the bold correction, since I am changing methods. ie a .4 iStop, instead of .1

$250 bullet (ie 1R), thats 2500 shares with .1 initial stop (iStop), or 600 @.4iStop (conservative rounding error)

if it moves .2 in my favor (ie .5R) go to “no lose”, and there is all the trade improvement i need to be content in that trade.

my worst case contingency? what’s the worst thing that can happen?

right after i buy it it starts failing, and i say fark it, exit after an immediate -.2R adverse move, for a -.5R loss; there is my “.25R per trade improvement”

if your risk voice is interfering with TQN (your trader quality number), then by definition you are trading at too high a risk level and your gut knows it.

its your gut that dominates anyway.  your gut is your lizard brain

the lizard brain is “fight or flight” and is the oldest part of the evolutionary brain, the closest to direct sensory organs

the next brain is the emotional mammal brain that tries to improve its environment to allow for contentment and safety out into the future

it needs comfort and love

it is challenged by the fear feelings generated from the lizard brain

on top of all that is the so-called rational brain of the “economic man” which thinks it is in charge

be serious.

the rational brain is the last one to the party and has least  influence over our behaviors under conditions of stress

that’s the brain that works in the ivory tower of the best of all possible worlds

it is  out of touch with reality, yet that’s the brain we ask to calculate “the maximum ‘reasonable’ risk i should be able to manage on my best day with no distraction”

that brain calculates “$500” and we try to live up to that benchmark even though our mammal brain says “If I fail, i won’t be loved and i am jeopardizing the tribe” while the lizard brain is always looking for things to run away from

because he knows he can afford to be hungry a little longer, but if he gets caught, its the end

So the key is to desensitize the lizard then, with 30 trades of 1/4 of the rational risk, and this also means we never risk becoming “unloved”.

the lizard brain is activated when it sees what might be a threat inside its field of vision and sees how it can go wrong; it bases that on physical size

it interprets size as threat

we interpret “dollars at risk” as a threat the same way lizards view “size” as the threat

we say we can engineer a stop of .1 but we are seized with the image of a .4 adverse move in a sudden shock and interpret that, properly, as a potential -4R loss

so don’t figure out your R based on the best possible contingency case, ie an orderly set of losses that degrade a penny at at time in a smooth step function which lets you easily exit

ask the lizard what he’s really afraid of, his worst fear, and say “well, at least we know what our R really is”

based on cognitive science which puts fear at 3x more powerful than greed, you can be more psychologically balanced by estimating that your initial “best case” comfort level of R is at least 3x too large in reality, which is why i would say cut your R by 4 or 5

to make a bold correction

if your first estimate is that you can handle R = 100, i’d say, well start at 25 then , ie dinner for 2 in kansas, and demonstrate proficiency at that risk level first then build up

now this will establish whether or not it was risk level causing you grief; you can eliminate that as the issue

you might find its a deep seated need to be right: in order to please a parent? to validate the little kid who was ostracized as a youth? the shy new kid who needs acceptance? to have the respect of those you respect? to help the teen boy trying to be a man? to feel like you are a man who can provide for his family?

we get all sorts of “help” like this from the emotional mammal brain

we get a lot of standards to meet, which are connected to our emotional center, provided by our emotional connections to family and from society

all of these things stand between us and a state of mind which is pure, of “just trading”

that’s the zero state, defined in a new way; prepared to “just trade”, then trade. a pure zen moment

our organic brain has been conditioned by the 10 million years of the era of evolutionary adaptation to behave in certain ways based on chemical reactions, that are optimized for something quite removed from “just trading”

and filling out some checklists once, and doing an exercise now and then in the comfort of a seminar classroom is only tenuously connected to the act of trading everyday

those are preconditions, and potentially fast tracks to improved performance

but the truth comes from entering the ring everyday

and having the persistence to prepare properly every day

and then do it, rain or shine

the difference comes from the willingness to endure the pain, and to be able to keep going back

into it, that’s what separates Lance Armstrong for example

you think he doesnt feel the pain like other guys?

he does, he just is willing to endure it

the great ones hate the pain of practice, but they persist

our emotional brains do not operate as straight line functions

try this exercise  suggested by Robert:

If you really want to see how much stress you can handle, plan out a trade tonight and a position size to risk 10x the normal risk….$5000 lets say.

Now widen your stops and lower the size

Maybe the trade is 2000 shares( we can all buy 2000 right) with a 5 point stop. R=10k. See how it feels, see how you react that position. Now if you want to move out of your comfort zone, put on the trade.

Now sit with that 10K position for an hour or a day or a week.

this morning i observed KO breakthrough 50, and said that was massively important, psychologically.

in the meantime it has moved to 50.54

i think it has every potential for being better than SPY for the next 2 weeks because there is no resistance

it made a 6 month new hi; there is no resistance in sight

it stays on my watch list

i will buy it with tactical momentum each and everyday until otherwise noted

but acknowledging my lizard and mammal brain issues

relentless attention to the lizard and rat brain

listen to the guy in the ivory tower, but remember he isnt getting his ass kicked potentially on every trade

acknowledge he can see things from his height, but  remember that life is lived on the ground

Robert reminded us of “The man in the ring”  when he said:

Good thoughts KL…nothing take the place of the man of action. That’s been my experience in every part of life.

“It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.”

Robert also reminds us of the challenge to play to our potential when he said:

“I also tell anybody to play small as KL suggested. But there comes a moment where you have to see if its “possible” to play up to your potential. Play from tips, take on the big boys so you know what if feels like.

When you put on a big position for the first time wide stops, we have the time to comtemplate the responsibility of trading the counter part of the freedome of trading

Tips”= On a golf course, if you play every hole from the back of the championship tees its the hardest setup for that course. (Never done in tournaments even)

It take a mental toll on your game b/c the course, any course becomes much more intimidating and the designers true intentions become apparent.”

Now get out there and trade.

Lombardi said: everyone wants to win, but not everyone will do the things it takes to prepare to win.