The process of building the system and the "pitfalls" encountered!


In my opinion, trading can be divided into three stages. There might be more stages beyond this, but I haven't reached that level yet. So, I'll only discuss these three stages, each addressing a specific problem encountered in trading.

The Establishment Process of the System and the "Pits" Stepped On!

In my view, trading can be divided into three stages. Perhaps there are more stages beyond this, which I haven't reached yet. So, I will only discuss these three, corresponding to the three problems faced in trading.

The first stage involves using various technical indicators or even naked K analysis. I call this the random phase of trading.

In this phase, you daily study various technical patterns, indicators: moving averages, RSI, Bollinger Bands, even wave theory, Gann, etc. You find a candlestick pattern or indicator, test it and think it works, only to find it fails later, then abandon it and switch to another, repeating the process. Eventually, you combine various indicators and find they still have loopholes while restricting your trades, repeating this process for several years, typically 2 to 5 years. This phase only addresses the problem of making a profit.

You may think solving profitability is enough since the ultimate goal of trading is profit. However, profitability is a very basic problem. Here, profitability has a very low bar. Li Dan once said anyone can do a five-minute stand-up, and anyone can profit for three days. But what about three months, three years? Perhaps you think you are looking for patterns, but you are not; you are looking for probabilities. Patterns are things that repeatedly cycle without change: the sun rising in the east and setting in the west is a pattern; birth, aging, illness, and death are patterns; the rise and fall of dynasties are patterns, unaffected by human will.

Patterns come in the third stage. However, you need to know that in trading, probability alone is not sufficient. There’s also risk-reward ratio and mindset, which are hard to juggle fully in this stage. Therefore, your trading results are random—profitable this month, profitable next month, potentially a blowup in the month after. Human nature is also a pattern. After you turn a profit for three consecutive months, this pattern typically starts setting in. Think carefully about this.

Most people will be eliminated at this stage because they always think their trading mistakes are due to insufficient analysis skills, thinking that learning the lesson will improve their performance next time. However, at this stage, new problems always slap the face of newly found solutions. Nonetheless, this phase is necessary, like needing five buns to feel full—you can’t say the first four buns were useless, right?

This stage is like the first bun; frequent assessments and analyses of the market will become your foundational knowledge and integrate into your consciousness. In future, easier trading stages will rely on this support, unseen but effective. If you are still trading in this stage, analyzing all market aspects thoroughly yet failing to achieve stability, it’s time to move to the next stage. If you continue to struggle here, you might never advance, eventually being eliminated.

If you’ve been trading for over two years and are still trying to get every market trend right, then something is probably off because nobody can get every market trend right. If you can’t accept the inevitability of losses, there’s no way to move to the next stage. In this stage, some profits and some losses are to be expected.

The second stage is what I call the mathematical model stage.

In this phase, you no longer obsess over getting every market trend right. You accept normal stop losses, understanding that they are part of trading. You introduce the concepts of probability, risk-reward ratio, and capital management. You use simple mathematical models to calculate if your found probabilities offer long-term positive expectancy. You continuously fine-tune these models to maximize positive expectancy and ensure stable operation. You no longer aim for perfection with every indicator because each tool has its pros and cons. You accept their flaws while leveraging their strengths and make balanced choices.

Ultimately, you settle on a straightforward model, then focus on execution, consistent waiting, and mechanical execution. This stage addresses the time issue. If you fine-tune your model and execute it properly, you can achieve sustained profitability gradually. In this phase, some models can be as simple as using one candlestick or one moving average. First-stage traders may not understand this simplicity and might think such traders lack proficiency due to their clean charts with few annotations.

In this stage, analysis takes a backseat. Mistakes are just mistakes. As an individual trader, this phase is most comfortable—you just need to repeat based on your model without psychological burden or high expectations, improving yourself internally while accepting all results. You enjoy freedom in both time and space, and the market becomes your personal cash machine. This phase solves both profit and time issues but not the scale issue, meaning your strategy works for your account with thousands or tens of thousands of dollars but may not handle larger fund sizes. Here, human nature and guiding principles play roles.

The third stage is what I call the pattern stage.

The pattern here is different from the first-stage pattern search. You can think of this pattern as a fundamental operating logic, an unchanging iron law that's effective at all times.

The more fundamental a pattern is, the stronger and more effective it becomes. If you say prices drop when they hit the upper Bollinger band and rise when they hit the lower band, its effectiveness is about half. But if I say prices always fluctuate, that's unrefutable. This fluctuation is one of the market's most basic patterns, born to guide prices. While this may seem like stating the obvious, it reveals its power through another perspective: If you build your trading system on this principle, you can profit as long as prices fluctuate. However, achieving this is difficult.

So, let’s compromise a bit and build a model around segments of this principle: prices either oscillate or trend, which is indisputable. The remaining task is to build a model around this logic. This requires filtering, calculation, and utilizing first and second-stage learnings. Establish a model on this logic, adjust until the system consistently performs positively. Whether you choose an oscillation or trend strategy, you must accept that you’ll profit from one side and lose on the other, aiming for an overall positive result.

Your confidence comes from the fact that as long as the market alternates between oscillation and trend, your system remains effective, resulting in predictable, non-random outcomes. When your trend strategy hits consecutive stop losses during oscillation, or your oscillation strategy hits consecutive stop losses during trend, you remain calm. You understand that it won’t always oscillate or always trend. Often, failed oscillation strategies result from forgetting this basic logic and becoming overconfident.

If your trading model is built on these fundamental principles, you can break through scale limitations. Trading no longer falls prey to human weaknesses. Greed and fear do not affect how patterns operate; you simply execute them, possibly even through automated programs.

We can also find more patterns on this theoretical basis, such as prices either rising or falling—which sounds like another obvious statement but reveals deeper logic: prices won’t always rise or fall. I haven't built a model on this, but I speculate it closely resembles Martingale logic. Some say Martingale strategies lead to blowouts, but that’s typically due to insufficient understanding of Martingale principles.

If you had unlimited bullets, would you still blow out? Since bullets are limited, the key is to operate within bounded prices. If you design a model based on gold prices dropping to zero, your risk would be minimal. Though your profit might be low, this illustrates what low risk really means. Proper use of Martingale involves calculating and accepting extremes beforehand. If your model can endure a 300-dollar trend, you won't complain about bad luck when a 400-dollar trend blows you out.

Building your system on these foundational principles ensures a solid base. From there, refine, adjust probabilities, and manage risk and capital, leveraging content from stages one and two.

The reason I list so many points is to introduce the theme: there are no secrets in trading.

Once you go through this journey, you’ll realize trading returns to its simplest form. On an incredibly simple model, you mechanically repeat the process. Midway, profit and stop losses, going long or short, account size, or fundamental news no longer matter. Trading involves no analysis, no predictions, indifferent to wars, inventories, or economic data, all of which hold random elements. I only seek a large sample size for overall probabilities. By focusing on large samples and stability, you can standardize your trading results—doing 50% last year, 50% this year, and likely 50% next year.

This is what trading looks like after solving profit, time, and scale problems. You might have heard others say simplicity is the way, and trading becomes straightforward eventually, but maybe not understood why. If this helps you a bit, then it has served its purpose.

My thought is, if a trader follows the correct path—from technical indicators in the first stage to becoming a mature trader—it is a long process. But thinking in reverse, if you recognize the logic, starting from the final state of mechanical repetition of a simple model and working backwards might be easier. Starting with an understanding that trading ultimately involves mechanical repetition and long waits, aim for the third stage from the start. Accept this result and work backwards to refine the process, similar to knowing the answer and understanding the steps later. This way, trading becomes a regular job with deliberate practice.

During this process, ensure your model functions well and has a long-term positive expectancy while constructing and refining it. Whether it is an oscillation or trend strategy, ensure the risk-reward ratio compensates appropriately: losing five or six trades but one winning trade covers it for trend strategies, or ensuring one stop-loss does not wipe out previous gains for oscillation strategies.

The Turtle trading philosophy aligns with this approach: traders can be deliberately trained and nurtured. Repeat simple models mechanically. While this line of thinking is feasible and suggests there is no need for identical models, creating simple models leaves room for individuality. The real challenge lies in the refining and executing phases. Define boundaries, focus on your part, and ignore the rest. Continue battling human nature with a clear final goal, avoiding internal conflicts.

For more related financial knowledge, please contact CWG Ahai; ahaidanshenkeliao


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The market carries risks, and investment should be cautious. This article does not constitute personal investment advice and has not taken into account individual users' specific investment goals, financial situations, or needs. Users should consider whether any opinions, viewpoints, or conclusions in this article are suitable for their particular circumstances. Investing based on this is at one's own responsibility.

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