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Much of our applied trading knowledge comes from the mistakes we make and the subsequent corrective iterations, rather than from books or courses. Therefore, it is crucial to establish a feedback loop in which we continuously receive input on our actions and how we can improve them.
How to implement an effective feedback loop :
Most traders are able to grasp the general basics of trading (such as probabilities, risk-reward etc) within the first few months through books and courses, which are now available in abundance. While they may not yet have the skills to consistently achieve superior performance by utilizing its underlying first principles, this basic knowledge still offers significant protection against major drawdowns and the risk of ruin. However, maximizing upside requires a deeper specific knowledge of your behavioural tendencies and aligning them with the structural principles of the market. Therefore, it is important to develop a feedback loop that quantifies your actions and the processes that result in those actions.
A feedback loop is a process in which the outputs of a system, such as the results of your last 30 trades, are fed back and used as inputs for managing your next 30 trades. Every successful scaled business relies on this process: using customer or employee feedback (the outputs of a service, or product) to improve the product or workplace. This leads to efficiency of each subsequent output being generated with lower incremental input.
Feedback loops are implemented and optimized using the following framework:
Build
Build with Frequency
The first step to building a feedback loop is to take as many trades as possible, using the basic market principles and rules that you have learned. At this stage, it is important to prioritize the quantity of trades rather than being overly focused on perfectionism regarding quality (with the obvious caveat of avoiding recklessness and ruin). This approach will guide you towards a more effective path of using practical application to validate theory, rather than the other way around.
This may go against the common belief of waiting and entering perfect setups under ideal market conditions. While it is an "aspirational" approach to trading, it is highly inefficient at the start and often keeps you on the sidelines. Sitting on the sidelines is a prudent approach, only if you have developed the awareness of when to sit out and are agile enough to jump back in without missing out on too many opportunities, which we don't have at this stage.
Build with Speed
The longer it takes for feedback to arrive, the less it will influence future decisions. Thus, starting out with velocity trades (VCP, breakouts, pullbacks, reversals) are easier for building than magnitude trades (IPOs, EPs). It is also viable to take velocity trades on alternative lower time frames or other instruments (such as currency or commodities) to build feedback loops faster.
The shorter the feedback loops, the easier it is to replan in the small - precise points of buy, sell and size on lower time frames; and in the large - the context and effectiveness of the setup within the different market conditions.
WHY
Every trader, in their process of development, is likely to make a broadly similar set of mistakes and, if they persist, will also likely arrive at a broadly similar set of outcomes. Trading is not really rocket science; it's more about finding repeatable processes that are unique to you and developing FAITH in them. The concept of building with speed and frequency aims to achieve the same outcomes in the shortest possible time and with the least amount of financial risk, enabling you to focus on better problems like scaling up.
Measure
Measuring the tangibles
One of the simplest and most effective tools to use for measurement is a trade journal. Please note that I have used the word "tool" for a trade journal as it is only the starting point for measuring actions and is meant to be an input to your feedback loop. Only maintaining a static spreadsheet to log trades and compute ratios and averages, is a wasted effort.
I had shared a trade journal format (https://bit.ly/TradeJournal_Anuragg) that includes everything you need for most aspects of your trading journey. It provides all the necessary journal ratios, monthly and setup-wise summaries, distribution curve, equity curve and size calculator. There are also many online trading journals available (I personally like @TradeZella by @UmarAshraf a lot) that allow you to integrate bar-by-bar replays with your journal, although the pricing may not be suitable for most retail traders in India.
Measuring the intangibles
The main purpose of trade journal is to provide insights into how the tangibles (such as journal ratios and averages) are influenced by unrecorded variables of your processes and market conditions. These insights are mainly derived from the questions you ask yourself during the post-review of the tangibles.
Here are some example questions to consider on the unrecorded variables which can be integrated by bar-by-bar replays and evaluating your every action or inaction in as much depth as possible. This is only an indicative list, and I urge you to develop additional and more tailored questions for yourself. The key to improvement lies in the quality of questions you ask yourself with integrity and continuously experimenting on the answers.
Learn
By consistently measuring the tangible aspects within the context of the intangible aspects, you can gain insights that may be general in nature, but will be unique to you in its specifics. These insights are where you will discover the maximum opportunities for super performance and find solutions to improve in future trades. A few insights from my earlier days from the questions asked in the journal reviews are as below-
Q - Could I have reduced by stop loss ?
I noticed that in over 85% of cases, when the price dropped below 3% of my buy price, it would trigger my deeper stop losses. Even if I had set my stop loss at 3%, my win rate would not have changed much, R multiples would have been faster and trailing position size would have doubled. The same trades would have yielded my 71% more returns than the actual returns.
Q - Could I have entered earlier ?
Although I was trading range breakouts (VCP), 55% of my winners did not immediately become risk-free (cross 2R+) as expected according to the books. I observed that most breakouts I entered had a tight (NR) or even a negative day before actually breaking out. Instead of waiting for confirmation from a swing high or a trendline break, I started buying closer to the start of the momentum. I initially began buying based on the previous day's high, but I have since improved my strategy to buying opening range highs. This approach enabled me to raise my stop losses more quickly and helps me identify squats faster, especially in choppy markets. Most importantly, it maintains my FAITH in a higher win rate system because it aligns better with my behaviour.
Q - What is the cause of the move ?
70% of my biggest winners started their momentum with gap-ups from surprise earnings, leading to FOMO and intensity in upmoves. This led me to focus more of my capital on EP setups, which also suited me as a working professional and merged well with my daily life.
Takeaway
It isn’t 10,000 hours that creates outliers, it’s 10,000 iterations
- @naval
