Adventures in being wrong

Direct Theory of Probability
All problems commonly met within this branch turn on counting the number of ways in which events can occur.
For example, what is the probability that three coins being tossed will all show heads?

There are 8 possible results; the probability of three heads is p=⅛
In trading, the number of ways events can occur is often too numerous to count. This is even further complicated when myriad technical indicators and strategies are thrown into the mix. Still, perhaps we can use the direct theory of probability on ourselves, on our behaviour - what is the probability that we will cut our losing trades whilst they are still small? If we don’t care too much about being wrong = always.
To succeed at this game, we must ensure that we are winning more than we are losing over the set of all trades. I don’t think the answer to this problem is correctly identifying the next coin flip; the answer is to make sure that our winning trades are bigger, much bigger, than our losing trades, and we can achieve this through the understanding and practical application of combinations and permutations.

Combinations and Permutations.
When a problem concerns groups without any reference to order within the group, it is a problem in combinations.
When a problem asks us to take arrangements into account, it is a problem in permutations.
Permutations are more numerous than combinations, for each combination can be permuted.
The letters ABC make a single combination, which can be permuted in six ways.
The problem for most traders is that they add to losing positions, creating a combination of losers with devastating permutations. Perhaps they start with a 10 pip losing position and add another position; then the trade runs to a 10-30 pip loss with 2 positions. This might happen repeatedly, but one day, they are convinced the market will turn around, or they cannot accept the loss, so they let it run and add another position and another.. combined together these losing positions then permute to create a huge loss. Sooner or later, such a trader will blow their account.

Adding to losers (never do this!)



On the other hand, if we flip this logic and add to winners, our winning trades will, on average, be much bigger than our losing trades.


Occasionally, some winners will be huge. On trend days price can run hundreds of pips. Days like these are when you want to get out of losing positions quickly and join the party. Keep adding as you go and trailing stops on each position until the market is about to close. Every day, it should be the case that losers are smaller than winners, and this way, across the set of all trades, you will win more than you lose. Being wrong will mean very little to you. Note this has nothing to do with correctly predicting the next movement; you do not need to know with any degree of certainty what the market will do next. In this respect, being right will also mean little.

Why Being Wrong Feels Right

Cognitive Dissonance comes from a tendency to seek consistency among attitudes, thoughts, and beliefs.
When beliefs agree, there is consonance and a state of comfort results.

When all the conditions for a trade are met there is consonance. The signal is there and it feels right to enter.
The price is in a trend, it pulls back a few bars, we wait for a new bar to close in the direction of the trend, and better still if it engulfs some of the previous bars, this is what happens, and then we enter placing a stop order above the signal bar and a stop loss behind the signal bar. Price moves in the direction we want activating the order. Wonderful. We have consonance.

But then the price moves against us.

People alleviate cognitive dissonance in one of three ways:
Reducing the importance of dissonant cognitions
Adding consonant conditions
Removing or changing dissonant conditions

When a situation involves incentives, to win or avoid loss, people may reduce dissonance by changing the dissonant condition (usually when the incentive is small) or by adding a consonant cognition (usually when the incentive is large)

Changing the way you think and feel about a dissonant situation that involves incentives is very dangerous when trading.

When price moves against our hypothetical trade we should just accept it and move on. There is always another trade. However, if we cannot accept being wrong about the trade we may try to reduce the importance of the dissonant move against us and increase the distance to our stop, believing the trend will hold in the end. Or maybe add a consonant condition - this could mean clutching to any indicator at all that shows a chance of being right - but more often than not it will mean adding another position ‘at a better price.’ In the previous post you can see that adding to losing trades can get very ugly as losing positions begin to combine and permute into big losses.

Never, ever, justify risky behaviour when it is not wise to do so. Before you enter you must know exactly what would contradict or otherwise invalidate your trade and accept the loss. Allow your stop loss to take care of things.

Trading should feel comfortable, which is a result of consonance between your trading plan, market conditions, and actual behaviour and results.
The feeling of being wrong is one to respect, and not run away from - it is your best and most sophisticated indicator.

Sometimes being wrong can be such a shock to the system that we feel overwhelmed or dislodged if we cannot close the gate on our experience. Trying to control ourselves by acting against our best interest, moving stops and adding to losers, is a desperate defence against the pain of loss, yet resisting the pain also prevents us from experiencing freedom and adventure.

“An architect designing a house is designing a real house. Yet, the architect brings a lot of imagination to bear in visualising the house, imagining how people might use it, and matching it with some aesthetic concepts she has in mind. It is reasonable to say that the architect builds a pretend house, in her mind and on paper, before it becomes real… In all of us, the capacity for abstract, hypothetical thinking depends on our ability to imagine situations we haven’t experienced and to reason logically based on those imagined situations. This is a skill every normal child exercises regularly in play.“
- Peter Gray, Free to Learn.

Imagine cutting losers repeatedly until it becomes real in your mind, and play with the idea that you can have big winners by imagining situations where you add to winners and run with them, until that also becomes real in your mind.

SUMMARY OF POSTS TO DATE:
So far I have made a case for why we should accept being wrong as quickly as possible without feeling bad about it. The sooner we can get out of losing trades the better, and if we are never tempted to manipulate dissonant conditions to avoid feeling cognitive dissonance we should never stay in a bad trade for longer than necessary or rack up a huge loss in consequence. In this respect, being wrong is pretty awesome! Likewise, I hope it is clear that one way we can make money from trading is by allowing combinations and permutations to work in our favour by adding to winning positions when we are right. Going forward I will post from time to time about the experience of being wrong, of course, the objective is to make money and do things right, but getting things wrong is unavoidable and the more we understand about how to recognize when we are wrong, and why we get things wrong, then we can better anticipate the things that are likely to trip is up and avoid them. When we cannot avoid them, whether by mistake or chance, I hope these insights will help us react maturely and minimise any damage to our accounts.

Excellent stuff. Are there any stats where scalpers have profitably reversed direction to turn a wrong decision into a profitable one?

I'd be interested in reading such a report, but I'm not sure if anything like it exists. I experimented once where I opened a position (0.01 lots) with a 10 pip stop loss and minimised the chart to look at the P/L display; as soon as the P/L went negative I'd reverse it; if it went positive, I'd watch it, and when the numbers started to go down I'd reverse again.

-1 -2 -3 (reverse) +1 +2 +3 +4 +5 +6 +5 +4 (reverse) +1 +2 +1 0 -1 -2 (reverse) +1 +2 +3 +4 +5 +4 +3 (reverse) ETC

After 30 minutes I was at break even, but I've been wondering how it would work over a longer trial and more practice with the timing. When I tried this the price was moving sideways, not ideal, but it could have had a very different result in a trending market.

Post 3 is an example of reversing a trade profitably; however, it's important to note that the decision to reverse was based on price action and not because the first trade failed. The candle that broke through the support level showed strength, and it was clear price was likely to target the next support level. Normally I'd just take the loss but in this case there was a compelling reason to reverse the trade based on PA.

I agree - price action - a much more compelling reason to reverse

Mind the gap.
When I look at a chart like this of today's trading, I can see that many of my entries and exits are far from perfect. I often get in too soon or too late, and often I get out too soon or too late. Sometimes, I add to winning trades aggressively, and other times I do not. But for the most part I'm good at following my plan, at the moment this is to buy support and sell resistance until the range gets broken. I don't obsess over these mistakes or care too much when I'm wrong. I trust that I will win more often than I lose, and the winning trades will, on average, be bigger than the losing trades.

"The perfect is the enemy of the good" - Voltaire.

There is always a gap between our own mind and the rest of the world. When we are wrong, this gap reveals itself. It is for this reason that being wrong can be so unsettling. Chasing perfection, aiming to have no gaps and see things as they are, is a denial of our human limitations and basic vulnerability to error. Our mistakes reveal the gaps, sure, but they also create opportunities to see the world in a new light. I don't mind the gap; when I see it, I am grateful to know it is there, and sometimes I won't see it until I get hurt by falling into it. However, I know it is always there and obsessing about it just gets in the way.

Okay, so today began with a loss. The entry wasn't too bad; however, in hindsight, I could have cut it earlier; even so, I stuck to to the plan and prefer not to micro-manage trades as, in my experience, this doesn't help long-term. The stop loss was placed below support and I'm okay with the 20 pips it cost to see if the trade would work out. I didn't add to the losing trade. Soon after the price began to move away from support (for context, DOW is in a super-aggressive bull trend), so I took another long position and added to it. In hindsight, I could have added more, but as discussed in the previous post, I don't obsess over perfection or minor mistakes. Combined, the winning trades made over 70 pips which I'm very happy with.


A few traders have expressed concern that this thread will focus too much on being wrong; I hope to maintain a journal for a while that provides examples of trades where things haven't gone to plan, tying together the ideas discussed in previous posts with practical examples to demonstrate the core idea that being wrong is an acceptable part of trading and often just a stepping stone to being right. With some basic knowledge of how combinations and permutations can harm or help us, we can ensure that our winners are consistently bigger than our losers and actually profit from this endeavour.

Hi All,

As long as a trade has been made following your entry criteria it shouldn't ever be considered 'wrong' even if it loses - it should simply be seen as a business cost.

Similarly, if a trade wins or profits it shouldn't be celebrated, it's just another day at the office

If trades are being made incorrectly, against your rules or criteria, then these can be considered wrong, and then improvements can and should be made.

I missed a perfect trade on Monday (Ger30) because I didn't re-enter after my first entry got dumped for -20, if I had re-entered I would currently be up 100 pips, giving me a nice cushion fpr FOMC tonight. But what if I had re-entered again, and again, and again and kept getting my stop loss hit? It can and does happen, so you just have to let it go and wait for the next perfect set-up which might still be a losing trade.

Just my thoughts.

Good points! I agree

Reactions
Our intellectual activity is driven by emotions. Emotions are based on logic. Emotion and logic are like two sides of the same coin. When we attempt to define or describe something, we may feel satisfied or frustrated with the definition, and this feeling is emotion attached to the logic. As humans, our emotional reaction to knowledge is always present, although not always obvious. It is important to understand that when we say that 1+1=2, it is not just a robotic calculation; an emotion is also attached. We ‘know’ that it is correct. If someone said 1+1=5, we would not only know that this is wrong logically, but we would also feel an emotional understanding of this.
Cognitive dissonance involves both logic and emotion, the cognition and the feeling of dissonance. In his book ConCom, Rory Miller likens escalation in conflict to a hierarchy, inspired by Maslow’s Hierarchy of Needs. When trading, it is essential to understand our emotional reaction to the information we are dealing with, so that we can anticipate, recognise, and de-escalate conflict before it becomes a problem. If a trade is working out, you know both intellectually and emotionally, when it goes wrong, you know this too. Keeping a clear head and being able to respond to changing conditions makes trading much easier, as opposed to being so outcome driven we do not readily accept new information and our reactions are frozen.
Level 1 is the base level, where we should be 95% of the time, we may occasionally stray into levels 2 and 3, but we should never go beyond them.


Level 1 - acceptance
Most of the time we accept what is happening. In our perception of things there is little distortion and misinterpretation. We are seeing the whole picture in balance and we can solve problems without stress. All dichotomies can be resolved under a superordinate whole. Everything can be seen in itself, not in competition with anything else. The price action is seen in its own right, independent of any needs and preferences. Our perception is organised around the object as a centering point, so much so that the self disappears, and our conception of the market is as fluid as water. We are flexible to the extreme. There is no conflict or opposition to the market. There is no right or wrong. Everything that exists belongs. When our trading plan and behavior are organised around the price action, as it is, we feel consonance. Our view of the price action is positive.

Level 2 - manipulation
When we take a position, our needs and preferences may interfere with our perception of the market, which may be dominated by emotionalised positions and values. If we expect the price to move in our favour, but instead it moves against us, cognitive dissonance leads us to distort and manipulate the information presented to us, and we are no longer in a flow state with the market. Our emotions become harsh and destructive. If we start to alleviate dissonant conditions and add consonant conditions, we are involved in manipulation.

Level 3 - assertion
Sometimes we must assert the truth. We must include the market in our plans and soften the harshness of our emotions and cognitions. Deal with manipulation by accepting new information. If the market is moving against us, we must accept that we got it wrong and close losing trades. On the other hand, we may assert that we are right no matter what, and double down on our manipulations, which will bring no good.

Level 4 - force
If we do not accept or assert the truth, we force our distortions and manipulations onto reality. If acceptance is characterised by the inclusion of what the market is doing, conflict is characterised by rejection. We become adversaries with the market. Forcing trades is something we should never do, by following our emotional reaction to being wrong, we get into conflict with the reality of the market. We act without reference to the market but in competition with the market. Or we blindly hope that eventually, the price will do what we want it to do. Hope can be a destructive force in trading. When everything becomes centered around our needs and our desire to be right, pressured by our ego’s demand to be in control, we must de-escalate by recognising our freedom of choice. We always have agency and can act to surrender losing positions willingly. Much price action is arbitrary; anything can happen, and recognising this, our logical positions lose most of their emotional pressure. We don’t hate the water when it is rough; we learn not to go swimming. If getting the fruit involves a perilous climb, go find an orchard. If our fishing spot is empty of fish, we don't throw out all our bait but find a better spot or return another day. When conditions change, so do we.

Level 5 - lethal force
If we do not recognise and assert the truth, then the use of force will continue to escalate. At this level, we use force that can do serious damage to our accounts—increasing position sizes and adding to losers. Something I’ve noticed about many great traders is their sense of humour. When we think we can beat the market, we should laugh at ourselves. When wrong, we should react with an “Oops!” or “Oh, shit!” and then carry on, if we must react at all. Expect to be wrong. Accepting our mistakes brings peace and humility. It is foolish to inflate ourselves and pump up our positions going against the market, blaming the market makers and going on the offensive. If we get it wrong then really we should just shrug our shoulders, accept it and occasionally laugh at the rigidity of our behaviour - learn to be like water.

Today's result is a good example of combinations and permutations in action; the first attempt to buy Dow was too early and got stopped out for a 67 pip loss. In hindsight, I can see that a) I could have cut the loser earlier, b) if the stop was just a few pips further away it wouldn't have been triggered, and c) the entry was definitely premature. I screwed it up, and yet it really doesn't matter. It's just one trade. I followed my plan, respected the gap, and didn't add to the loser. On the second attempt to get in long, I bought more aggressively; I expected the bearish corrective move into support to be followed by a swift bullish impulse move, or at least a rally, since Dow is in such a strong bull trend at present. It worked, and as the bullish move took hold I added more. In the end, the combination of winning trades permuted to give a total of 816 pips. 749 total for the day. Not bad. Combinations and permutations can be very powerful when the price is trending, so long as you make them work for you and never add to losing positions.

Hi @Bainbrito

How does one accept and embrace the fact that he's wrong and learn valuable lessons from it.

And also how does one avoid the negative impacts and euphoria of winning trades, so as to stay consistent in the markets.

Hi sthukzin,
To accept and embrace being wrong starts with having a more positive view of being wrong in the first place. I think that socially we are conditioned to have an extremely negative view of getting things wrong. Not only do we associate being wrong with humiliation, defeat, embarrassment and stupidity, implying a loss of social status, being a loser and an idiot, but there is also a moral dimension to being wrong, meaning that when you are wrong you are a bad person, too. Similarly, being right makes you righteous, a winner, and someone to respect and admire, it is associated with pride, intelligence and excellence. I think the answer to your question is somewhere in recognising that in trading and in life, being wrong is not the terrible thing we make it out to be, at least it is nowhere near as damaging as our fear of being wrong and the arrogance that often comes from thinking you are right.

Consider more deeply what it means to predict the next price movement correctly.

“Instead of speaking of the possibility of an event occurring, we might speak, more precisely, of an inherent propensity to produce, upon repetition, a certain statistical average. These tendencies and propensities have led to the emergence of life. And they have led to the unfolding of life, the evolution of life. And the evolution of life has led to better conditions for life on earth, and thus to new possibilities and propensities; and to new forms of life that differ utterly. All this means that possibilities – even possibilities that have not yet realized themselves – have a kind of reality; a kind of, as yet, conditional reality. The numerical propensities that attach to the possibilities can be interpreted as a measure of this status of a not yet fully realized reality – a reality in the making. And in so far as these possibilities can, and partly will, realize themselves in time, in the future, the open future is, almost as a promise, as a temptation, as a lure, present; indeed, actively present, at every moment. The old world picture that puts before us a mechanism operating with causes that are all in the past – the past kicking and driving us with kicks into the future – the past that is gone – is no longer adequate to our indeterministic world. Causation is just a special case of propensity and a comparatively rare case: the case of a propensity equal to 1, a determining demand, or force, for realization. It is not the kicks from the back, from the past, that impel us, but the attraction, the lure of the future and its attractive possibilities that entice us: this is what keeps life – and, indeed, the world – unfolding.”
- Karl Popper

Even if it were possible to identify all the factors that played a part in the market at any one time, all the kicks from the past and lures of the future, it would take months, perhaps years, to measure them accurately, and by then different factors would be in play.

To be right (or wrong) about the next move is almost entirely by chance, we think the forces that move price are linear, and therefore predictable, when in fact they exist as a multidimensional net spreading far and wide. Anything can happen at any time and considering this ought to temper the excitement and euphoria of being right as well as the disappointment of being wrong. The trade works or it doesn't. Any individual trade, win or lose, is of no importance at all.

“Listen, business is easy. If you’ve got a low downside and a big upside, you go do it. If you’ve got a big downside and a small upside, you run away. The only time you have any work to do is when you have a big downside and a big upside.” —SAM ZELL, NEW YORKER, 2007

To be consistent focus on large sets of trades and try not to concern yourself with whether the next trade wins or loses. If you have a well-defined exit strategy with a small downside and you stick to it when a trade doesn't work out, you shouldn't be too concerned about losing trades. The main thing is to minimise damage when the price moves against you and let it do its thing when it moves in your favour - landing those trades with a big upside is key. It can be difficult to determine if a failed trade was due to chance or an error on your part, but if you know you made a mistake, try writing about the experience. Keeping a journal is an excellent way to extract any lessons that could improve your trading process. It's also a good idea to write about your best trades, even if you accept that chance has a big part to play in them you can still learn a lot about the process that works best for you. I warmly suggest reading Best Loser Wins by Tom Hougaard as he has a very interesting and practical method for this as well as tonnes of great insights into the mind and process of a super successful trader.

Thank you for your reply. Our social upbringing have a huge impact in our trading and as traders we ought to udjust our mindset and beliefs about being right and being wrong. Being wrong isn't a bad thing, personally I think if you associate being wrong in the markets with the social norms of what it means to be wrong, then you just created a recipe of emotional and mental disaster and it will be hard for you to understand how the market is not responsible for your decisions and that will probably lead to a mental breakdown.

Thanks for your insights and I'm looking forward to learning more from your experience.

Thank you for your comments sthukzin, I completely agree.