The Fractal Nature of Technical Analysis

The Fractal Nature of Technical Analysis
A fractal is a geometric pattern whose general form is constructed out of smaller iterations of itself that repeat under increased magnification with infinite complexity. [18]  Financial markets have a fractal element to their price fluctuations, as the same types of patterns form on monthly charts, daily charts, and 1-minute and tick charts, and the larger patterns and trends are built out of the aggregation of compounded smaller patterns and trends. The micro scale influences the intermediate scale, which impacts the macro scale. If a trader can figure out what a market is doing right now, it may inform what happens for the rest of the day. If a trader understands today, that will give greater clarity to their view of next month.

Most technicians will ultimately spend the majority of their time on a chart resolution and study timeframe that works well in their market and for their methodology. It is important to look at the same product through a different lens from time to time, dropping down to a faster chart for intraday patterns or zooming out to a multi-year perspective to look for long-term trends. 

Tipping Points
The tendency of technical patterns to appear at all resolution levels of the data can lead to a circumstance where a small intraday pattern can have an outsized influence on the longer-term trend. Imagine a long-term downtrend experiencing a normal countertrend retracement to near the top of the downtrend channel, where on an intraday chart the market forms a bull flag. If the bull flag breaks out to the upside it may provide enough impetus to extend the countertrend and push the market outside of the downtrend channel, a neutral signal if not outright bullish. Conversely, if the bull flag fails then the countertrend movement is likely at an end and the long-term downtrend is intact.

Figure 4.13       Micro-level patterns that impact intermediate patterns that impact macro patterns. 

[18] The best-known example is the Mandelbrot Set, named after renowned mathematician (and sometime financial theorist) Benoit Mandelbrot.

From Chapter 4 - Technical Analysis, Pages 131-132.

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Excerpt from Trader Construction Kit Copyright © 2016 Joel Rubano. All rights reserved. No part may be reproduced in any form or by any electronic or mechanical means, including information storage and retrieval systems, without permission in writing from the publisher, except by reviewers, who may quote brief passages in a review.

Poker as a Whetstone

Poker As a Whetstone
Good poker players are extremely analytical, as success depends both on an advanced understanding of the underlying probabilities of the game and a feeling for the nuances of human nature. Professionals spend a great deal of time studying their opponents, and characterizing their playing style based on two attributes: the degree to which they are conservative or adventurous with their money, called being “tight” or “loose,” and their general inclination toward passivity or aggression. Mapped on intersecting axes, they yield the quadrants Loose/Passive, Loose/Aggressive, Tight/Passive, and Tight/Aggressive: [3]  

A Loose/Aggressive player, sometimes called a maniac, gambles wildly and without control. This player is a thrill-seeker, who plays to feel the rush and takes huge swings up and down, rarely having enough money to withstand the self-induced volatility and usually going broke as a result. 

A Loose/Passive player gets involved indiscriminately but gives up easily, squandering small amounts of money over and over as the game goes on. This person, derisively labeled a calling station, wants to be involved but lacks commitment, making him an easy mark for aggressive players.

A Tight/Passive player will sit at the table forever waiting for the perfect situation that never, ever materializes. She is frequently referred to as a rock, is not inclined to get involved, and doesn’t like to take any risk when she does. 

A Tight/Aggressive player will wait patiently until the odds are decisively in his favor, then act with maximum aggression to extract as much money as possible from opponents at the table.

Tight/Aggressive For The Win!
Most top poker professionals believe that Tight/Aggressive is the only winning behavior over the long run. More interestingly, elite players feel that a Tight/Aggressive approach to the game is not a naturally occurring set of traits. Very few people are intuitively disciplined enough to limit their participation to situations when they have a real statistical advantage and also willing to exert maximum pressure on their opponents. It is a learned behavior. A winning poker player has consciously, intentionally modified her decision making and approach to the game to be both more calculating and more aggressive in order to maximize the chances of success. This is exactly the right mindset for a professional trader, and the behavioral model maps perfectly.

A Loose/Aggressive trader is a thrill-seeking adrenaline junkie, swinging around in the market to satisfy a need for action, consequences be damned. 

A Loose/Passive trader will always have some sort of a position, but never anything significant, and will tend to give up at the first sign of a loss. 

A Tight/Passive trader is waiting, always waiting, for the perfect opportunity that just never quite seems to appear. 

The Tight/Aggressive trader waits for the conditions to be favorable, and then commits to a strategy with a meaningful position managed in a tactical, controlled fashion.

The first thing strong poker players do when sitting down at a table full of opponents is, surprisingly, nothing at all. They will sit and watch the ebb and flow of the game for a half hour, an hour, or as long as it takes to preliminarily classify their opponents and to see how the game is playing at the moment. They will study the betting, the aggression level of the participants, and the quality of cards being played. They will listen to the players talk about how they played previous hands to gain insight into their thought processes, style, and skill level. They will see how much money is in play, and by whom, as an indicator of how much profit there is to be made. Finally, they will make a candid assessment of themselves relative to what they have learned about the game, its participants, requirements, and profit potentials relative to the risks involved. As the saying goes, “if you can’t spot a sucker at the poker table, then you are the sucker.” Smart players know when to stand up and walk away from a game that is too tough or that does not suit their style, even without playing a single hand. They also know when to settle in for the long haul if they find a situation that seems profitable.

Here is the previous paragraph again, with replacements in italics.

The first thing strong traders do when entering a market full of counterparties is, surprisingly, nothing at all. They sit and watch the ebb and flow of the market for a half hour, an hour, or as long as it takes to preliminarily classify their counterparties and to see how the market is trading at the moment. They will study the prices, the aggression level of the traders, and the fundamental information. They will listen to the traders talk about how they put on previous positions to gain insight into their thought processes, style, and skill level. They will see how much money is in play, and by whom, as an indicator of how much profit there is to be made. Finally, they will make a candid assessment of themselves relative to what they have learned about the market, its participants, requirements, and profit potential relative to the risks involved. As the saying goes, if you can’t spot the sucker in the market, then you are the sucker. Smart traders know when to stand up and walk away from a market that is too tough or that does not suit their style, even without doing a single trade. They also know when to settle in for the long haul if they find a situation that seems profitable.

[3] This common model for categorizing player behavior may have originated from Alan N. Schoonmaker’s grid-based system seen in The Psychology of Poker (Henderson: Two Plus Two Publishing LLC, 2000), 71-79.

From Chapter 1 - Know Yourself, Pages 11-13.

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Excerpt from Trader Construction Kit Copyright © 2016 Joel Rubano. All rights reserved. No part may be reproduced in any form or by any electronic or mechanical means, including information storage and retrieval systems, without permission in writing from the publisher, except by reviewers, who may quote brief passages in a review.

Traits of Bad Traders

Traits of Bad Traders

1.    Not admitting that they are wrong.
2.    Not taking responsibility for poor decisions.
3.    Making the same mistakes again and again.
4.    Trading too much.
5.    Engaging in thrill-seeking behavior.
6.    Making simple things complicated.
7.    Ignoring their limitations.

Bad Traders Do Not Admit They Are Wrong
A trader holding a losing position faces a painful decision: suffer the losses in the short term in the hopes that things get better and not worse, or exit the position and move on to other opportunities. Some traders allow their ego to become part of the decision making process, refusing to remove negative positions because they cannot accept booking a loss. In other cases, particularly with an inexperienced trader, they may fear that the losing position will be a referendum on their capabilities as a risk taker. Regardless of the underlying reason, if the trader is unable to admit that a position is not working and proactively rectify the situation, then he has stopped managing risk and has become a passive spectator, riding the exposure wherever it may go. 

Bad Traders Do Not Take Responsibility for Poor Decisions
This is a classic symptom of a weak, undisciplined trader. Every good trade is a product of her unique and singular genius, planned with the calculating tactical brilliance of Sun Tzu and executed with the effortless virtuosity of Paganini. Any losing trades are obviously the fault of the stupid analyst, the stupider weatherman, the insipidly stupid salesman, the buffoonishly stupid quant group, or the toxically stupid management, all of whom are conspiring to bring down the One True Hero of the markets. This distancing from any sort of negative outcome prevents productive self-critique and impedes refinement of a trader’s technique and methodology. 

Bad Traders Make the Same Mistakes Over And Over Again
Poker players refer to any persistent problem in their life or their game that causes them to lose money as a leak. Visualize water leaking out of a hole in a bucket. Whenever a trader says “I always lose money when I do this or that trade,” the obvious question is, “Why do you keep doing it?” There are allowances for suboptimal performance when learning a new market, instrument, affecting a stylistic change or implementing a new methodology. Beyond some point, however, consistently unprofitable behavior cannot be tolerated and the trader will have to revise his approach or cease activity. This can be tremendously difficult, particularly for historically high achievers unaccustomed to failure. 

Bad Traders Trade Too Much
It can be very frustrating for a trader to not be able to find any positions that seem worth taking, particularly early in the year when all of her colleagues are off and running or late in the year when they are desperately trying to meet a goal. If a trader cannot find anything that meets the normally exacting criteria, the easiest remedy is to simply lower the standards a bit and start re-considering previously discarded ideas. Eventually, with a low enough hurdle to clear, something has to seem worth doing, even if it is a 50/50 coin flip or worse. “At least I’ve got a position! I’m in the game!”

Having tasted the sweet nectar of bad decision making, professional over-traders rarely stop there. With newly lenient standards they become transactional dervishes, executing every trade not patently awful, buying and selling and buying again with reckless abandon.

Bad Traders Engage in Thrill-Seeking Trading
Overtrading is a good impulse warped by desperation and desire. Thrill-seeking trading is a manifestation of boredom and an unhealthy, destructive attitude toward risk taking. Thrill seekers trade to feel the rush, to be in the action, and are generally poor stewards of the firm’s capital as a result.

Bad Traders Make Simple Things Complicated
A close cousin to both the desire to overtrade and a desire to not take responsibility for losing positions is the tendency to take a bad position and, instead of cleanly exiting and taking the pain, attempting to fix things by putting on some sort of semi-equivalent off-setting trade to hedge the exposure. When the new trade inevitably exhibits some unwelcome performance characteristics, the trader tacks on a third deal to correct that, and a fourth to compensate for flaws in the third. The end result is a giant knot of positions that wobbles inexplicably back and forth with every tremor in the market, but that allows the trader to brag on any particular day that he has something that is working. 

Bad Traders Ignore Their Limitations
There is a saying: “a good trader can trade anything.” Given time to learn the structure of a market, assimilate the applicable fundamentals, and discover the unique nuances, any trader with a disciplined, rigorous methodology should have a better-than-even chance of finding a way to be profitable. Many traders take the success they have worked so hard to achieve in one market and simply assume that the underlying methodology is universally applicable, without bothering to understand how the unique characteristics of a different market will influence their approach. This is particularly common in young traders who, caught up in the excitement of mastering a market assume that they have mastered all markets. This can be a particularly expensive delusion.

From Chapter 1 - Know Yourself, Pages 18-19.

To read more, click here. To purchase Trader Construction Kit, click here.

Excerpt from Trader Construction Kit Copyright © 2016 Joel Rubano. All rights reserved. No part may be reproduced in any form or by any electronic or mechanical means, including information storage and retrieval systems, without permission in writing from the publisher, except by reviewers, who may quote brief passages in a review.

Traits of Successful Traders

Traits of Successful Traders:

1.    Disciplined.
2.    Self-analytical.
3.    Intellectually honest.
4.    Rationally accepting of failure.
5.    Have an ability to suffer.
6.    Learn from their mistakes.
7.    Hyper-competitive, driven.
8.    Have a strong work ethic.
9.    Positive.
10.    Prepared.
11.    Ethical.

Good Traders are Disciplined
It is easy to wonder what is right, somewhat more challenging to figure out what is right, more difficult still to understand why something is right, but very hard indeed to do what is right, particularly when the course of action may be unpopular, unpleasant, and involve personal or professional costs. It is very easy for anyone to say what she is going to do; it is much more rare to find someone who consistently does what she says. The other ten traits are important; discipline is mandatory. Discipline enables all of the other traits to be expressed, and allows a strong analytical process to be translated into thorough trade selection, rock-solid execution, and effective position management. This is one major reason why former athletes and ex-military are so highly prized by trading firms, often above more highly intellectually pedigreed individuals. If an ex-Marine or Navy SEAL says they’re buying here and selling there, you had better believe things are getting bought here and sold there. 

Good Traders are Self-Analytical
All machines break down from time to time, and every motor needs the occasional tune up. Flaws can creep into any (or all) aspects of a trader’s methodology, and if left undiscovered or unchecked will destroy even the most robust process. While honest, objective feedback should always be welcomed, a trader cannot rely on others to diagnose the flaws in his technique. A trader’s peers may be unwilling or unable to offer productive critique, and even if they are, the trader may not be able to process and use the information. A professional trader must be both willing and able to forensically examine the decision-making process and all aspects of the methodology to determine if there are flaws that need to be addressed. Debugging a trader’s methodology will be discussed in greater detail in Chapter 16 – Navigating the Corporate Culture.

Good Traders are Intellectually Honest
Most people find it extremely easy to lie to themselves about the underlying motivation for their actions. This prevents personal growth by denying them opportunity to learn from their mistakes. 

Taking a significant amount of risk is a very committing exercise, requiring a great deal of forethought and no small amount of emotional stress. Once invested (in both senses of the word), it can be difficult to hear counter-arguments or process incremental new information, regardless of how critical, timely, or obvious. In extreme cases, traders will go to elaborate lengths to convince themselves the market is acting “irrationally” or “stupidly,” that the shift in fundamentals was “bad data,” and that devastating information is “just noise.” It is difficult to believe how fully intelligent, perceptive individuals can deceive themselves under stress.

Intellectual honesty allows traders to self-police their actions. Traders must be able to step back and ask themselves “why am I doing this?” If they don’t have an answer, (or it isn’t a good one) they need to check themselves before they wreck themselves. 

Good Traders are Rationally Accepting of Failure
Poker players sometimes say, “A real gambler doesn’t need anything.” It does not take any self-actualizing philosophy to imagine that desires can, and do, influence the decision-making process. Wanting to win too badly can muddy up what needs to be a clinical assessment of the risks and rewards inherent in any proposition. Needing a particular result makes it paradoxically more difficult to achieve. 

This behavior is on display every weekend on television as highly compensated professional athletes miss short putts, drop easy catches, and brick free-throws that they could make with their eyes closed at practice or with nothing at stake. The sudden pressure of having to do something completely ordinary (and the associated consequences of failure) can transform any task from routine to impossible. Losing traders who approach their maximum allowable loss for the year almost inevitably explode violently shortly thereafter. The combined pressure of wanting desperately to succeed but being unable to fail is too much, leading to poor decisions and, ultimately, the exact circumstances the trader was seeking to avoid. 

A trader must put himself in a space where, given what is at risk and what he hopes to gain, he is completely comfortable with either outcome, that is, the potential profit is worth the probable risks involved. A trader needs to learn to think that a particular trade could work, given the probabilities, not that it should work or that it will work. It must never need to work. Trading ideas that don’t work are an unpleasant yet inevitable byproduct of the process. A trader must accept that losing is part of the game and move on with the minimum of psychological damage, because there will be a lot of losing over a career. Traders are not in the perfection business. The name of the game is batting for average and controlling the risk, so that the trader can afford to play again tomorrow. Traders need to learn to trust in themselves and trust in their process. Poker, with its reduced probability set and defined outcomes, is a perfect laboratory for developing this kind of self-confidence. 

Poker also teaches the difficult-to-grasp concept of divorcing the short-run outcomes from the quality of the decision-making process that created them. This may seem counterintuitive, particularly when applied to a results-centric endeavor. “Isn’t the point to win, to make money? Isn’t it a good decision if it makes money, and a bad decision if it does not?” Sometimes good decisions lose, and poor decisions win. If offered a chance to bet $1.00 to win $1.00 on the flip a coin that comes up heads 99% of the time and tails 1% of the time, any trader would be insane not to bet on heads. If, when flipped one time, the coin comes up tails, it was not a bad bet, just a bad probabilistic outcome. There will always be exogenous events and instances of random chance. Bad luck happens.

For many high achievers, not succeeding immediately as a trader may be the first significant failure in life. Athletes with experience losing have more likely developed productive coping/compensation behaviors. When I studied karate as a boy the first thing I was taught was how to fall so that I did not injure myself. Every trader must learn how to fail so that he does not hurt himself.

Good Traders Have an Ability to Suffer, or to Displace Suffering
One key survival mechanism involves having or developing a larger than normal ability to tolerate suffering or the intellectual capability to compartmentalize it. The trader must find ways of dealing with the pressure and discomfort such that it does not degrade the decision-making process. If the trader has structured and sized trades correctly and adopted a good gambler’s mindset, it is possible to not care too much about any one particular outcome, trusting that in the long run there will be more gains than losses. Sooner or later, however, every trader will misjudge the market and find out what he is made of under the worst possible circumstances. 

Good Traders Learn From Their Mistakes
In any given day, month, or year, a trader’s approach to the market will be a success or a failure. It is easier to learn from failure where it is possible to start from the logical premise that the method may be flawed and forensically examine it for defects. Adapting to a changing environment while still generating productive results is vastly more difficult, and will require a visionary sense that the underlying conditions are either eroding or are vulnerable to a seismic shift. Observant traders will look for clues like a decreasing winning percentage, greater difficulty finding good trades, greater execution slippage, and thinner margins. Profitable traders are like snakes, shedding their methodologies like so much dead skin when they are no longer productive. 

Making mistakes is part of the evolution of a trader, but there is no excuse for making the same mistake twice (let alone multiple times). Whenever possible, it is far better to learn from other people’s mistakes by studying other markets and trading styles and observing what does (and more importantly) does not work.

Good Traders are Hypercompetitive, Driven
Traders must first be profitable (or they will not be traders for long), and then distinguish themselves relative to their peers. Traders will be compared to their desks, to traders in other products at the firm, and to standardized industry benchmarks. They will be graded on total dollars earned relative to the cost of the resources utilized, and on the amount of risk taken. At most firms, management will start to look askance at the minimally productive trader, and will usually manufacture some reason to shuffle an underperformer into a different role (or out the door) to make room for a shiny new up-and-comer with potential.

Good Traders Work Very Hard
Good traders work much harder than average traders, and do so throughout their careers. A strong work ethic helps a trainee outlearn peers and get a shot at the desk. Junior traders must claw their way up to competency as fast as possible to keep their seats. Traders must continually out-work their peers in the market to remain profitable and be compensated for their production. Senior traders must remain current while at the same time always pushing to find the next product, market, or strategy that will expand or extend their career. 

Good Traders Prepare
Good traders do vast amounts of research to minimize the chances of being surprised by a data item, research report, or economic indicator that they should have factored into their decisions. Traders are in the anticipation and reaction business. The more time spent pre-planning for contingencies, the faster and the more precise the reactions. Doing the homework allows the trader to spend the critical time period after any market event executing a plan, not pondering the possible ramifications as the market moves.

Good Traders are Positive
Good traders believe that they can accomplish what they set out to do, that through hard work and skill that they can find profitable opportunities, design and execute a trading plan, and make money for their firm and themselves over time. Part of this is having rational expectations, but most of it is fairly straightforward psychology. A baseball player who thinks he can’t hit the ball will never step up to the plate. There is no point adding artificial barriers, there will be plenty of real ones there already.

Good Traders are Ethical
Most traders are ethical because they acknowledge and accept the carrot and stick implicit in their job description. A good trader at an aggressive firm can make so much money that there is no justifiable, logical reason for them to break the law or do anything else that could jeopardize their extremely lucrative career. Being ethical is also is good for their business. Once established, a trader’s reputation becomes well known and difficult to shake. Behaving unethically eventually becomes extremely counterproductive, and failure to honor a transaction or live up to the terms of a deal will lead to an immediate cessation of business with the offending party. A trader cannot expect to get better treatment in the market than she is willing to give, and in a fast-paced environment the shoe will be on the other foot very quickly. Within the rules rough play is allowed, however, and should be expected.

For those that, for some unknown reason, do not value the tremendous privilege their position implies, there are substantial penalties for transgression, including severely punitive fines and the very real threat of significant jail time. 

From Chapter 1 - Know Yourself, Pages 13-17.

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Excerpt from Trader Construction Kit Copyright © 2016 Joel Rubano. All rights reserved. No part may be reproduced in any form or by any electronic or mechanical means, including information storage and retrieval systems, without permission in writing from the publisher, except by reviewers, who may quote brief passages in a review.

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