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History repeats,but not consistently

Updated: Sep 30, 2019

Everyone has heard saying that goes around in trading "history repeats", or "history repeats sooner than later", or any other derivation of that. Its true, plenty of things move cyclically in markets and repeat over and over again, but one thing to keep in mind is that they do not necessarily repeat with full consistency. Some patterns are more consistent than others, some have larger gaps in their behaviour.


Think of pattern behaviour and its consistency like this:



Once the pattern starts to repeat itself as it is seen on left example with strong consistency of "winning" behaviour and trader can actually check and validate that (on chart, on macro analysis or whichever else the case...) what it creates is it puts short term bias on trader, where trader will expect this high consistency of behaviour to keep repeating without any failures in between. This is especially common to traders who have not yet traded / executed the pattern with enough trades.

While if trader trades pattern with performance on right side he will not have high expectations of future performance because the pattern performs too randomly (50% reaches expectation and the rest it does not). Again this applies mostly to traders who have not executed specific pattern with enough trades, as with experience this short term bias is pushed down with better realistic expectation at each specific trade.


This creates something called in trading "short term cognitive bias" where if trader has had performance on pattern as seen on left example he might start to expect too much of this consistency to keep performing at the rates it was already. While in reality sooner or later chances are there will be slump period where pattern will all of sudden print series of failures to meet expectations, that is what often happens.

The reason i am pointing this out is because in my cases i have had few times significant losses on trades when such strong and obvious consistency presented itself (over past several trades / patterns) and i have seen many other traders falling for same sword, especially in first 2 years of trading. It is almost like reality check where market wants you to cool off so you can get ready for potential slump period of bad luck, but cognitive bias in brain is working completely against that.


Bellow is good such example on ticker FFHL, where the daily charts has strong pattern of gap-spike and rejection moves. Pattern is very consistent and yet on the 23rd August, the pattern completely changed its behaviour / performance. This is the kind of consistent pattern that usually burns a lot of traders because they get too comfortable expecting the same behaviour on asset that has repeated before 30 times. It is important to be flexible always in trading and to understand the above concept of patterns behaviour distribution over 5 or 100 samples.




In my opinion no trader should form any expectations whatsoever of pattern or trading performance behaviour, just based on last 5 traded patterns. It is common to see in trading, where beginner traders will start doubting strategy they trade just base on 5 trades they took since they started to use it and wondering why is it not working. For any credible questioning of if pattern can be traded with edge, there should be minimum 30 samples of data, but better would at least 100. In trading you are not trading hits, you are trading the process. And the process by default requires minimum amount of data to be called process in first place.


Another macro example could be Swiss franc in 2015. Consistency of previous bounces on EURCHF and the backing of central bank by soft pegging the currency provides trader with consistent behaviour on retests of peg level. But once the currency peg was removed, the move was crushing, usually the assets that have very consistent behaviour of bounces around same price levels tend to have the biggest moves once that behaviour changes.




MRCY


Example bellow is my worst loss of 2018 on ticker MRCY where we had two very similar price accumulation structures, with similar behaviour on tape at least initially and i was way too biased for the second play , expecting it to also play out exactly the same as initial first play was, simply because they were so close together and developing so similarly. Text book short term cognitive bias. My size was large on trade due to that, and funny enough by the last 25 minutes while in trade, i started to observe on tape that huge buyer was trying to lift price up and he was always offloaded and stuffed big time against some seller / sellers. And that was where i started to think if this trade does not work out and this large buyer flushes out, the price might tank fast. But i did not do anything, i did not size down position or cut it, again simply due to the short term cognitive bias i was ready for pattern to play out with gains on long, even that my rational thinking processes were telling me to size down. I have seen this mistake hundreds of times on other traders and yet i was also un-able to react in correct response as well. I took the loss around 38,50 with delayed response (entry 39,00ish). It was textbook trade of being caught with the pants down.




The point being, it is a powerful concept this short term cognitive bias and trying to always be humble and open minded on setup without having too much expectations on play is always a huge help to fight this monster. Understanding how patterns behaviour is distributed over time and executions helps a lot, along with always being open minded on each new trade.




Distribution of successful patterns or trades




To put it in simple case scenario. Imagine trading setup that has 80% success rate, meaning 8 out of 10 times the setup performs the way trader expects it, 2 times it fails to do so (over 100 samples). This would count in trading world as very high edged play. And yet even such high edged play can have one row of consistent performance where it fails 10 times in a row. Is it possible? Absolutely. Why? Because patterns are never distributed with perfect mathematical symmetrical ratios like 1, 0, 1, 0 ,1 ,0. Instead they go: 1,0,1,1,1,0,1....

Thus its always a need to be open minded, just because you are watching same pattern that performed exactly as you expected last time and is high performing play, it could still fail completely on the current case that one is trading. This is one of the hardest concepts for any trader to get used to, because we all are seeking for robustness in the business or work we do, and this concept challenges every trader, every day.


Bellow is example of pattern distribution over 100 samples, or over 5 consequent randomly collected samples of that specific pattern. This is something every trader needs to keep in mind, even great edged pattern can over random 5 consequent taken trades perform terrible with 5 losses in row.





The more consistently the history repeats, the more traders will notice it. One of the most difficult things in trading is distribution of successful patterns and managing the expectations on each individual play. If all traded patterns would be distributed in perfect mathematical ratios (winer,loser,winer,loser...) then trading would be much easier.


Or to keep it with a bit more depressing but blunt and real note: At each specific play in the market ,trader has 0 control or certainty over whether the play will work, out or not.


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