​In his classic trading text “Trading in the Zone,” author Mark Douglas finishes his book with an exercise that he calls “Learning to Trade an Edge Like a Casino.” 
 
And it’s this skill that separates most amateurs from professionals in this field. We might have a statistical edge, but we give up at the first hint of trouble and run off looking for the Holy Grail. Does a Casino do that? Not if they want to stay in business. They don’t panic when someone wins big, because they know the odds are in their favor. 
 
It’s really worth your time to read through the entire exercise, but I’ll summarize the steps here: 
 

• Pick a Market - choose one actively traded stock, option, or futures market to trade. 
• Choose a set of market variables that define an edge - this can be any trading system that you want, as long as you feel that it has a statistical edge over time. The variables that you use to define your edge have to be absolutely precise; the system has to be defined so that it does not require you to make any subjective decisions or judgements about whether your edge is present. 
• Define Trade Entry - again, precision is key. There must be no ambiguity about whether an entry signal exists or not. 
• Stop Loss Exit - your methodology must tell you EXACTLY how much you need to risk to find out if the trade is going to work. 
• Time Frame - entry and exit signals must be based on the same time frame. 
• Profit exits - creating a system with a decent reward-to-risk opportunity is key so that the profits are worth the risk. 
• Testing - if you do not have access to backtesting software, then running a defined exercise on paper seems to be prudent. 
• Accepting the Risk on a 20-Run Sample Size - Calculate the potential loss on a typical trade based on your precise stop limits, and then multiply this by your run size of 20. The potential risk is that you might lose all 20 trades. It’s important that you “let go” of this capital and assume that it is already gone before the test commences. 
• Run the strategy per your rules - take twenty trades based on your precise set of rules, no exceptions. Your goal is not to win nor lose money, but rather to see if this system does indeed “work” as you drive it. 

 
How is this different from most retail traders running a system? In many ways! First, few precisely define their entry and exit rules, and then they compound this error by giving up too early when they find out that they are not truly comfortable with the aggregate risk. 
 
Consider running the Mark Douglas challenge with your own strategy, and let us know if you need any help doing so!
 

Something that’s hard for traders to understand is the concept that all moments in the Market are independent from each other; each moment in time is unique in the manner that the Market processes it. We humans are different, however; we tend to create Pavlovian responses to specific “trigger” events through learned behavior. 
 
For example, when we’re young we figure out very quickly which things bring us pleasure, and which experiences bring us pain. A bag of Halloween candy will put a smile on our face, but picking up the cat and turning it upside down might get us clawed for our mischief. As we experience life, we catalog and inventory these experiences, which we eventually call “wisdom.” 
 
But then we start to tangle with the Market and we expect the same predictable response from stimuli and patterns. We note certain responses from the market to inputs, and we mentally catalog those responses as well. Pretty soon you’ve got it all figured out!
 
“I know that when I see the price test the lower edge of the Opening Range from below, it will always reject that level!” or “Every time I see the stochastic cross to the upside, it’s a great buy!”
 
We then entangle these beliefs with what’s called “recency bias” where we tend to give more weight to recent experiences over the span of time. Let me give you an example from this week that will help you understand how to pull all of these concepts together: 
 
A little while back on a Monday we had a pretty nice “range” day; the price stayed in a relatively tight range all day. That led to a nice Zero DTE Iron Butterfly trade. On Tuesday, the same pattern showed up for a “range trade” entry, same as Monday…and within ten minutes I had to close the trade for a loss. Something shifted in the sentiment and the “range” day became a “trend” day to the downside. 
 
Most new retail traders would immediately abandon that setup, not because it worked on Monday, but specifically because it DID NOT work on Tuesday. This is Recency Bias in action. They will sit on their hands for the next five good setups just because it failed that one time. 
 
Would you care to guess what will likely happen when they finally gather the courage to enter again on the next setup? More than likely it will fail on them again. This is the classic symptom of “trading NOT to lose” instead of “trading to win.” 
 
Learn to accept the fact that every moment in the Market is unique. By doing so, you can start to wean yourself off of the human need to apply recency bias to what you believe “should” happen. 
 
In your corner….Doc Severson

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Reading history can be enlightening…especially when it’s your own. 
 
When I first started trading, I reacted to pullbacks in an uptrend just like everybody else did: “Here we go! Price will crash from here! Time to sell everything!” At which point the price would pivot and move higher, thumbing its collective nose at me while I struggled to figure out what had just happened. I had to learn from these situations after the fact and understand that the “anchor trend” was still intact, and I had been “shaken out” like all the other chum in the market. 
 
I had to study my actions and learn to “fade” that temporary fear. After a while, I was able to stow my concerns and look to pullbacks as an opportunity to enter long. 
 
And then the crash of 2008 happened. Reading one of my entries from October 2008, it now sounds like a horror novel. Journal entries like “I’m not sure if this market will ever recover” are funny to read now, but it was the real deal at the time and certainly reason for concern. After seeing crash after crash occur that year and into 2009, I had to learn to study my fear and reactions after the fact, and learn to decode them as a signal for opportunity. 
 
Ultimately, what you learn to do over time is to detect your reaction as a human being to a normal situation that would create a fearful response, and try to learn to create a different response to it than the “fight or flight” response that we’re all programmed with. And the only way that you can create this feedback loop is to create some form of journal. I create a strategy journal for every different trading strategy to track the numbers, but I also maintain a written journal to record my perceptions to a certain situation, and it’s my job as a trader to decode that “normal” response and see if opportunity is on the other side. 
 
You must learn to think differently than the rest of the crowd if you want to do this for a living. Journaling your thoughts is the first step towards accomplishing this. 
 
In your corner…Doc Severson
 
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