Systems Trading (part 3) By Jake Bernstein www.trade-futures.com

A Black Box Theory of Market Behavior: The Money Exchange

My understanding of the futures market is different from that of many traders.  I suggest divorcing oneself from traditional understandings.  We should view the marketplace as an organized vehicle for the exchange of money from weak hands to strong hands, from losers to winners, from the public to professionals.  I propose understanding the market in terms of inputs and outputs.  In other words, thousands of unsuccessful speculators contribute relatively small sums of money to the market, never to see most of it again, and a few successful traders remove large sums of money from the market.

Between these two groups we have a host of other cost factors that remove money from both groups.  Among these are brokerage commissions, market quotations costs, advisory services, commodity fund management fees, chart services, computer hardware and software costs, etc.  Hence, the sum of the outputs will not equal the sum of the inputs unless we consider these cost factors as outputs.

The situation is clear and simple.  Prices go up and down, traders take their positions, a majority of traders lose and a minority of traders win.  Your time as a trader is best spent not on understanding the precise nature of these inputs or the intricacies of their functioning, but rather on understanding the tools that allow you to progress from the losing group to the winning group by knowing how to manipulate the inputs.  I propose that we accept this as the way most traders should view the markets.

Purpose of the Futures Market

Contemporary approaches to futures trading theory and education attempt to convince us that the futures markets serve an economic purpose.  By standard definition, the futures market provides a vehicle that allows producers and consumers to buy and sell their products in an organized exchange using the public outcry system.  We are told that speculators are valuable to the futures market in as much as they provide a buffer between producers and commercial consumers.  We are told that the futures markets are the ultimate expression of a capitalist system and that they are essential to the effective functioning of our economy.

The collapse of Communism in the 1990’s underscores the validity of capitalist vehicles such as our free market system, monetary system and futures trading, no matter how riddled with corruption and inefficiency they may be.  Ad this solidifies traditional ideas about capitalism and the free market system.

Students of economics are indoctrinated with a variety of theories regarding the functioning of our economic system.  They are educated in the laws of supply and demand; they are taught systems of macroeconomics, econometrics and economic forecasting.  However, their tools are often useless in the market jungle where these rules do not apply.  Where were those theories when the killing wave of bankruptcies burned through the U.S. banking system in the 1980’s and early 90s?  What happened to those Wharton and Harvard MBAs who helped lead their brokerage firms and insurance companies to ruin on a wave of junk bond investments?  If our knowledge of markets and economics is so advanced, why do world economies experience continued volatility as well as periods of extreme boom and bust?

The Inadequacy of Old Knowledge

A college education is no longer necessary in the markets and in life.  I’d say the rules of the game have changed.  Here are the new rules and understanding that will facilitate success:

•    The purpose of futures markets is to provide a seemingly organized medium by which money can flow from weak hands to strong hands
•    Most traders will lose their speculative capital no just once or twice but repeatedly.
•    Understanding market fundamentals is not necessary for success and actually may prove a hindrance in the quest for profits.
•    Most of a trader’s money will be made on a small number of trades while the higher percentage of trades will be losers or break-even trades.  It is said that 90% of your money will be made on 10% of your trades.

•    Some of a trader’s worst losses will be a function of the self as opposed to the failure of a trading system.
•    Trading systems and their operators must be dynamic.  Whizard Trade is dynamic.
•    Traditional ideas regarding market entry and exit tools may be more myth than reality.  These ideas must be abandoned in favor of techniques that can be thoroughly tested and evaluated in all types of markets.
•    The traditional method of placing stop losses may not be the most efficacious.  Stop losses should be placed according to the dictates of a trading system.  Wizard Trader does this as well.
•    To stop losing and start winning, it is necessary to completely change one’s modus operandi both operationally in the markets as well as personally in one’s thoughts and actions.
•    In addition to radically changing one’s behavior and attitudes as well as one’s goals in the markets, it will be necessary to become more mercenary, focusing complete attention on the goal of futures trading, which is, first and foremost, to make money.
•    The idea that futures trading is  primarily a form of entertainment, adventure, excitement, a gamble or a challenge must be abandoned.  Futures trading is a serious business.
•    The market must be viewed as a treasure chest-a trader’s job is to remove valuables from the chest skillfully, carefully and consistently.  To do so the trader must know when the chest is most likely to open, how long it might remain open and when it is likely to slam shut.
•    Each market has through the years acquired a ‘personality’ of its own, which is most likely a reflection of the major traders involved in that market.  An understanding of these unique and often revealing traits can assist you in your goals.  WT uses parameters specific to each market’s personality.
•    The most successful trading methods are likely to be the most simple.  Spend more time applying your methods as opposed to optimizing or complicating them.
It has been amply demonstrated that perception is a key, if not the key stimulus to many behaviors.  There are specific things you can do to alter your self-perception as well as your perception of the outer world.  I suggest a thorough reading of Tony Robbins’s Unlimited Power as an excellent source of information and training in this area.  By altering your perception as well as your behavior, you will avoid the pitfalls of old and counterproductive habits, adapting new and profitable behaviors and perceptions.  It is my sincere hope that WT can help you achieve these goals by adding consistency and direction to your trading.

Part One, Part Two, Part Four, Part Five, Part Six, Part Seven, Part Eight, Part Nine