Does fear dominate your trading rules?

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• 0:01Speaker 00

  Hi everybody, it's Michael Martin. So I got a great question. I wrote it down, I'm gonna read it to you. It says, "Michael, I'm having trouble overcoming the fear of pullbacks when I'm holding a high conviction swing trade." Okay, been there, done that. And so, what's the fear? The fear is that you're gonna mishandle the trade, look stupid, not make as much money. You know, you have to think, high conviction trades, you'll probably have, what? 100 of those over the course of the year? Maybe 50 of them? When you think of 250 trading days, so you have, I don't know, 20% of the time, maybe somewhere between 20, 40% of the time, you'll find a high conviction trade. Or something that's really worth your while.

• 0:46Speaker 00

  And so you really have to think of that, like, when we think about expected value, say you're right 40% of the time. And the other times, you're gonna risk 1%, lose it, the other ones, you're looking for at least 3, 4, 5 to 1 payoff, that asymmetry, and you're gonna be right, you know, the difference. You know, you'll be right 40%, say you're right 40% of the time, and you're wrong 60. And say you have 100 trades, and they all work out that way. Your winners are 3X, your losers, and your losers are all 1% losses, and that's that. Like, those are all good trades. We can't look at the losers and say, "Well, they're bad trades," or "I'm bad," or put any kind of negativity to it. Because when you run a system, or a systematized set of rules, even if you're a discretionary

• 1:31Speaker 00

  day trader, you have to take them all together, because it's those consistent small losses that you cauterize at small loss numbers, that make the winners all the more that valuable. Right? So, that's step number one. Step number two is inside those 40%. So say you did 100, 100 trades, 40 of them were winners, you might have 8 to 16 of them, or whatever, be really high conviction trades. So, to me, you just kinda take the thick with the thin. When you think of the high conviction trades, say, you know, you have 8 to 16 of them are

• 2:13Speaker 00

  super high conviction, maybe 4, 5, 6 of them are gonna really pay off. Because even the high conviction trades are the, that's the ex ante part, right? The ex ante expectation is that this is a high conviction trade. We don't really know that if it's gonna have a high conviction kind of payoff, what you're hoping for, until after. And to me, I don't think it's how you really handle the trade as much as it, you know, was it the instrument's destiny to move in the way that you thought, that gave you the high conviction in the first place? You see what I'm saying? We don't know that ahead of time. The best you can do is let the trades run. How else are you gonna get to that asymmetry?

• 2:57Speaker 00

  If you take your winners off too soon? You know, we'll talk about that tomorrow, because I don't wanna discuss and mix things up. I like to kinda keep these episodes segmented, so that, first of all, if it's not something that you care about, you don't have to sit and listen to it. Two, if we stay focused, you'll get, it's a little nugget that you'll get a lot out of. So to me, there shouldn't be any fear, because you should know, and you should have a rule, like, okay, if it's high conviction setup, you should know, here's my entry, here's my, well, here's my position size, here's my entry, here's my protective stop. Now, as the market activity unfolds, what are you prompted to do? Do you take a piece off at 1 ATR, or half an ATR, or at a specific dollar amount?

• 3:42Speaker 00

  At what point do you raise your protective stop to break even? Right? So all that should be done ahead of time, so there shouldn't be really any fear. Because there will be, just like in life, there'll be people who you think you can really count on, and one day, they might not show up and let you down. That's just the way it goes. And likewise, high conviction trades, sometimes they just don't manifest the way you want them to. They don't follow through the way you want them to. And it's a bit of a drag. You get high hopes, you count your money before it's actually in your account, that's just the way it goes, too. So I think, learning to deal with that uncertainty, I've always said that, the amount of money a person can make, really comes down to the amount of uncertainty that they can learn to live with.

• 4:27Speaker 00

  And not put themselves in a bad spot, where their mental health is going in the toilet because of it, right? You pay a big price for that. So, to me, what's the fear then? Because everything else becomes kind of random in the short run. Sometimes you catch a good string of luck, and the things never pull back to knock you out, and they just rip, and it's off to the races. And that's just the way that it goes. And good for you. Sometimes, they're gonna look perfect on paper, right? It's like dating. How many times did you look like you were gonna connect, and it just never amounted to anything? Just no chemistry at the end of the day, or meeting in person, and you didn't have the sparks flying? No butterflies, whatever it was for you. And that's okay, that's just the way it goes.

• 5:11Speaker 00

  You just have to get out there, it's a numbers game. So, I wouldn't, I wouldn't put so much emotional importance on my, you know, high conviction, you know, setups. They're just trades, they're a fraction of what I'm gonna see all year. When they show up, I'll affect my rules, and put them on accordingly. Where they go, it's kind of like, that's just the way God wanted it, right? Like, you know, it's the way it's gonna show up. And so, it is a bit of a drag when things don't work. Think, think too of all the earnings disappointments, right? Couple, couple months ago, you know, Micron printed amazing number, and then the stock sold off 33%.

• 5:54Speaker 00

  Like, who could figure that kind of stuff out? So, to me, to overcome the fear is, it might mean that you don't have a rule for the situation that you're in. Generally speaking, the longer you hold on to your winners, the more money you can make. Now, that might scare some of you from not wanting to take risk home overnight. To me, if I've had any success, it's because I took risks home overnight. Sure, you can make a lot of money intraday, if you're trading size, but when you're newer, to me, I knew the money was, because it was more uncertainty, more risk, more emotional uncertainty, more financial risk as well. So you have emotional risk, in having to deal with the uncertainty, what's gonna happen

• 6:38Speaker 00

  tomorrow. But generally speaking, I can't say that I ever woke up to a complete disaster. I had, you know, limit moves happened to me a few times in the futures markets, but that happened during the day. That wasn't like I opened, opened my trading screen. You know, I had a mad cow thing happen, I wrote about in the book, and that was, that was an intraday announcement, there wasn't anything I could do with it, it just went all for limit down, on some report, there was nothing I could do about it. And I got, I had my trailing stop, I was able to get out of some, but it moved so

• 7:22Speaker 00

  fast, that I was still stuck with some of my position. So again, the protective stop did help me. In the end, I think I lost like, 3/4 of a percent. Because by the time it came back, everyone realized that things weren't bad, so then the market ripped the other way. Generally speaking, they say, "Your first loss is your best loss." And yeah, it would've been better to get taken out of the entire trade, but the markets move so damn fast, it's oftentimes harder. But I survived, I didn't blow up my account. So I think in overcoming the fear, is to process your feelings again, if you do it in the simulator. You're never gonna know, is the one thing I wanna absolve you here, I'm absolving you

• 8:06Speaker 00

  right now of any of your worry. You're never gonna know ahead of time, there's no way to plan for that. Now, if you're a person who worries about stuff, and that's a different story, you'd need a therapist, but it's nothing I can help you with, I'm not there. So I would just say, like, okay, you're gonna see, you know, maybe once a month, you'll see like a high conviction trade. And the best you can do is affect what your rules are, at that given time. You don't wanna start overthinking things, and start to freak out. You wanna stay cool. You know what your rules are. Market moves 1 ATR, adjust your stop, or whatever, whatever it is, if it's a half an ATR, full ATR, whatever.

• 8:50Speaker 00

  You know, as far as taking profits, you can do the same thing. Thing rips, 1 or 2 ATRs, 3 ATRs, you can take, take your profit off. If it gets, you know, far extended, 2 or 3 standard deviations away from the mean, you can offset some, or maybe all of your position, and then look to kinda get back in on a continuation pattern. There's a million ways to do that, but that's where the simulator can help, is that you can pick one and act on it, and then evolve over time. It's okay to evolve. You don't wanna be all over the place, though, because you can't evolve every day, and be running a different system. Right? You have to be, you know, stick to your rules, and run that one model all the time.

• 9:35Speaker 00

  It will evolve over time, but, you know, not in a material way. Your entry rules, your position sizing, your tolerance for risk, that, it doesn't stay static, but it doesn't waver all that much as, as you grow up. When you make more money, you can obviously change your bet sizes and diversify better, for sure. But I think the best way to overcome the fear is, you know, stay calm. What I've done, you know, obviously, I've done a lot of yoga, I've meditated, you can do breath work, to try to stay calm in the moment. But to me, like, you shouldn't be making these decisions on the fly, I think you should

• 10:17Speaker 00

  know ahead of time, what you're gonna do, and how you're gonna manage the risk. And then, you know, in the simulator, you can experiment. Just kinda see, like, okay, what, if I did it this way? Because you can do the playback, right? So you can backtest and see, like, okay, here's 10 different trades that were my ultimate setup. Here's how it would've played out, if I sold a piece, and then held a runner. Here's how it would've played out, if I just kept everything. And not just look at the P&L, but think about how would you have felt? Right? You know, think about how you would've felt, if there is a small pullback in an otherwise uptrend move.

• 11:00Speaker 00

  Because things can pull back without breaking the trend. Can you stomach those? You know, because then you start saying, "Okay, now I gotta talk position size, because I like it when it runs up, but I, you know, 5 or 10 bucks, but I don't like it when it comes back 3 bucks on me with that same position." Right? That's something that you have to work out ahead of time. All right? All right, folks? Anyway, thanks for being here, I'll see you tomorrow.