Reactive versus Predictive Trading

Everyone knows the thrill of a winning trade. There’s that moment of uncertainty where you’re watching your position go into the red and depending on the type of trade it is, that red blip is there for minutes, even hours. But you’re holding on tight and you’re sure that your convictions will pay off. When it seems like you can’t take it anymore – BOOM – the market moves and you are victoriously in the green. Money is raining down on you like a gentle spring shower. You are now crowned emperor of Wall Street.

It’s trades like these that make traders love the market. Especially in these unique times where there’s so much turmoil going on. If it isn’t subprime, it’s oil demand, if it isn’t oil demand, then it’s the ADP report, etc. etc. At these points, everyone is working to find the theory: “which direction will oil go?”, “where is the swissy headed?”, “are we in for a move in the Hang Seng?”. Many traders will be committing their capital to their theories and of course, many traders will have their theories invalidated – and often times, not because they were wrong, but because they did not have the capital to sustain their theories.

Too many times, we put on these trades during periods where the possibility of the market stopping us out is great. The theory is there, but there’s no entry point, exit point, and position sizing. I call this a Predictive position, one where; it’s just out there and that’s that. Many traders have lost vast amounts of capital this way – some have lost fortunes. The reason is because if the market just isn’t ready to move towards that anticipated value, it’s simply not going to. There’s no amount of hoping you can do for that to happen. The only thing that you can do is hope that you don’t get stopped out or margin-called before your theory is validated. Often times, this is not the case and as you stand there without trading capital a few days later, the market then skips off pleasantly to where you thought it was going to go.

What’s needed here is a point where you will say: “Aha! The market has reached this price which is confirming my theory and so, I’m going to get in.” Until then, you have to wait for this point and when it does, you have to – you guessed it – react. When you trade this way, you now know the three things that have to be known before placing a trade: the entry point, the exit point, and how much you’re going to risk. Not only that, but I can almost guarantee that this is a less stressful way of trading. Being reactive forces you to become a more patient trader. Sure you might miss the 3 point move in AAPL or the 500 pip move in the Yen but in the end, there will still be opportunities. Getting the theory is the easy thing for traders. It’s the timing that is the hardest to nail down, and even if you wait for that right time, the chance still exists that you can still be stopped-out. Take heart, it’s just the nature of the game - it’s called Trading. But over the long haul, if you learn how to be patient, you will be protecting your most valuable resource: your capital.

Remember, there are a million trading opportunities so long as you’re in the game. If you’ve burnt up your capital, there are none. Patiently waiting for that price action that gives your theory its statistical edge will keep you in the game for the long term.

Then you can be like those old men that are revered on Wall Street desks who smoke cigars and give sagely advice to scared newcomers. If you want to keep making predictions, then you’ll more than likely end up working at another type of desk – one with a crystal ball on it - if you’re lucky.

Happy profits!

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