Trading Psychology · Lesson 6 · Beginner
The Five Truths
You internalize the five truths and distinguish the uncertainty of each single trade from the predictability across a series.
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The Five Truths
First: anything can happen. Second: you do not need to know what comes next to make money. Third: wins and losses are randomly distributed. Fourth: an edge is just a higher probability. Fifth: every moment is unique.
Micro and Macro
On the single trade you believe in the uncertainty, across the series in the predictability. Like a casino: a small edge plus a large sample produces consistent profit out of random single events.
Simulate many trades with a slim edge and watch the losing streaks despite a positive overall curve.
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Test yourself
You have five losers in a row with your edge. What does that mean?
- Nothing special, losses are randomly distributed
- Your edge is broken, stop
How does a pro react to a single loss?
- Like a lost coin flip
- Like a life crisis
Sign up free for the answers with an explanation for each option.
The key points at a glance
- Anything can happen, a single whale breaks through any support.
- Wins and losses are randomly distributed for every edge.
- Micro uncertain, macro predictable: think in probabilities.
Deep dive
A single whale takes out your support
Price movement is only a function of what individual traders believe. Douglas tells how one large player broke through the supposed bottom in the soybean market with a single order, by 10 cents.
The crypto equivalent: a whale with a large market order breaks through any support, and liquidation cascades amplify the effect. It takes just one participant to make your analysis worthless in seconds. That is why every trade demands a stop.
Why a 53 percent edge is enough
The casino earns day after day with an edge of around 4.5 percent, even though every hand is independent and unpredictable. The reason: probable outcomes deliver consistent results over a large sample.
- Richard Dennis: a 53 percent hit rate produces almost 100 percent chance of profit in the long run.
- Michael Steinhardt makes his living being right 51 percent of the time instead of 50.
- Cherry-picking destroys the base, take every valid edge mechanically.
Five losers in a row mean almost nothing
Kahneman's law of small numbers: small samples throw up extremes more often, purely by chance. Anyone judging after 10 to 20 trades confuses noise with signal. You can only judge seriously well above 100 trades.
After five red candles no reversal is due, the market has no memory. This is the root of knife-catching and martingale. You experience this streak on the free demo exchange, without any single outcome knocking you off course.
Sources: Douglas, Schwager, Taleb, Goodman
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