People enjoy seeing their “worlds” on TV or in the movies. Viewers love to debate how accurately (or not) being a lawyer; EMT, doctor or nurse; or a cop is depicted.
Less common but equally true is Wall Street and trading. Billions is the TV gold standard. In movies, two titles, both now over 35 years old are the most beloved: Wall Street (“Greed is good, greed clarifies…”) and Trading Places (everyone’s introduction to frozen concentrated orange juice-FCOJ). And honorable mention for the more recent Margin Call which is very good, but not iconic and lacks characters remembered or loved today.
Trading Places is awesome. It’s ginormously good and fun. But besides that, if you paid attention it was a mini trading education and a primer on supply and demand.
<Spoiler alert!!! – although should one really be concerned about that for a movie that came out in 1983?>
The Duke brothers’ explanation of how brokers function and supply & demand to Eddie Murphy (Billy Ray Valentine) in the back of the limo is great. Their example of pork futures and “bacon, like bacon in a bacon, lettuce and tomato sandwich,” justifies the movie right there. It’s that funny but also accurate. But the climactic trading floor scene rewarding our heroes, Valentine and Dan Ackroyd (Louis Winthorp…the third) and wipes out the Duke brothers is supply and demand in action and nicely depicted.
The Dukes are commodities market makers and brokers. As part of this, they are also proprietary traders, i.e., they trade their own accounts. But in their case, greed isn’t good. They pay for an illegal advance copy of an orange crop report to gain inside information. Valentine and Winthorp learn of the plan, and behind the scenes maneuver the substitution of a phony report stating the forthcoming orange crop would be low. This forecasts a low supply of oranges to make FCOJ, so FCOJ will become much more expensive. Meanwhile, the real report will say the crop will be normal, so prices will actually remain relatively stable in the short- to mid-term.
After getting the phony draft report, the Dukes act on it the next day, when it’s scheduled to become public a few minutes into the trading session. They start aggressively buying FCOJ at the open, accumulating FCOJ futures contracts. They expect FCOJ prices will soar once the (phony) crop report about a low orange harvest comes out (lower supply and higher demand = higher prices), resulting in a huge profit.
The Dukes start aggressively accumulating and other brokers and traders pile in since everyone knows the Dukes and figures “they know something.” The buying fuse lit by the Dukes illustrates another well-known trading concept, “FOMO,” the fear of missing out. So, while the Dukes and other traders are paying higher and higher FCOJ prices, they believe they’ll be rewarded when the official report is released and prices spike.
But it’s not to be. The real report’s issued, and everyone realizes there’s no coming price surge. In fact, FCOJ prices were already driven far too high by the buying frenzy. Then the fun really starts…
The traders stand silently for a few seconds after the report is broadcast, realizing their predicament and they’re about to get smoked. Then, one of our heroes yells out at the top of his lungs an order to SELL SHORT a slew of FCOJ contracts, knowing that will set off a selling cascade. The panic bubbling beneath the surface is ignited and a selling frenzy starts as everyone who just bought FCOJ futures (at inflated prices) looks to dump them and limit the damage, and prices come crashing down.
As the wild selling ensues, our heroes gauge the panic on the floor, the order surge and how prices are descending. They wait, they wait, they wait and when they sense the time is right, they now yell out orders to BUY THE SHARPLY DISCOUNTED FCOJ FUTURES, which serves two purposes:
Q: What do these have in common? Unicorns; The tooth fairy; Santa Claus; Politicians prioritizing the public good against their own self-interest 🡪 A: All are, of course, mythological figures.
Here’s another: Trading services and discretionary traders claiming “real” success with win rates of 99%, 93%, 87%. Good luck with that.
No discretionary trader achieves success shooting for rates like that. The only beneficiaries of these claims are those making them to people hungry to believe them.
Before continuing, note the word “discretionary.” This refers to individual retail traders, like us, like you. We evaluate charts, determine entry & exit criteria, manage trades, and manually execute them. We don’t have black boxes doing algo, high frequency trading. We’re not quants. Discretionary vs non-discretionary trading are entirely different worlds.
Here’s an obvious truth: trading is about making money, not about “being right.” In baseball, offense really isn’t about a .300+ batting average. It's about either knocking in runs or scoring them. Of course, you need baserunners to score runs and in trading you need to be right a “certain amount of time” to be successful. But like almost everything in life, it’s not binary – it’s how much, to what extent, and how frequently.
Many traders, if we really went to the effort, could have lofty win rates – maybe not 90%, but certainly 75-80%, because that amount of time, our trades go green at some point. So if we closed those trades with stupidly low profits, they’d be “winners.” But….to what end?
In business, net results come from the sum of outcomes. You aggregate money brought in and subtract what goes out. In trading that’s Winning Trades minus Losing Trades. Winners pay for losers, and only then are there profits. But if you have $300 losses and a bunch of $50 winners, is that really the foundation of a robust trading method? Is that sustainable? In the real world, can you really be right 93% of the time, pay for your losers and run a business where losing trades are, by design, part of the recipe? It’s really insulting to one’s intelligence to put that out there.
There are three ways successful discretionary traders operate, with the latter two the most frequent.
A small number of people scalp intraday, often profiting on small moves magnified by throwing large volume at them. Either way, it’s not a life and certainly no way for most of us who love trading want to do it, especially when it’s our livelihoods. There’s nothing wrong at all doing that, but it’s impractical for most people.
Middle-ground positive trade frequency and reasonable reward-to-risk ratios
A well-planned system where the average win rate is a “realistic” percentage, and the average win-size is a “reasonable” multiple of the average loss. For example, being right 40-50% of the time & the average win-size is 2-3 times the average loss. So, for every 10 trades, here are sample scenarios:
Depending on your trading style and trading frequency, maybe you do this every month. Maybe every two week. Maybe far less often, but you trade a larger account so have more money in each trade. The numbers can be extrapolated to your personal situation.
Sometimes, especially with certain credit spreads in options trading, you may have some high probability trades with low or even inverted reward to risk. This is okay because these trades are rooted in math and facts. Not fiction and intelligence insulting marketing claims.
In baseball terms, this approach is like a singles and doubles strategy. You aim for consistency and moderate drawdowns when things don’t go right (which they inevitably sometimes will). You avoid being unduly stressed, especially when starting out with real money and then shooting at a financial target. Done right, you can make a very, very nice living doing this, or have an awesome supplementary source of wealth generation.
“And Now for Something Completely Different”
This is geared at catching fewer, but (much) bigger moves. But it is NOT necessarily high-risk, high-reward. Rather, when done right, it involves cutting off ill-performing trades very quickly and taking a large number of (very) small losses. This is often characteristic of a trend-following strategy.
These systems feature lower “trading batting averages” (win-rates), but (much) higher average wins per trade. There are often multiple “stabs” at a trade, aiming to catch the start of a big move, and trying multiple times if the setup fails but remains valid. After entry, there are sometimes add-ons to grow the position. Returning to baseball, this is like swinging for home runs. Such systems often see win rates of 15 or 20%, but average win/loss ratios of 7-8:1 and higher, sometimes much higher.
The upside is obviously mega-results when things work. The downside can be larger drawdowns, as well as being battered psychologically since as human beings we want to be right.
In future pieces we’ll talk about the elements of a good trading system and realistic win rates and reward-to-risk ratios.
But for now, we’ll leave you with this. Do you notice in both the “Realistic” and the “Completely Different” scenarios, there’s no mention of 87%, 93% or 99% win-rates?
Q: Do you know why? A: Because unicorns and the Tooth Fairy don’t trade.
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