How To Beat Randomness In The Financial Markets?

Here is another great piece on Randomness In The Financial Markets.

David Paul, the veteran trader, explains it in a very casual way with some good examples, read on and enjoy…

“It’s always been my understanding that it’s quite difficult to make money, long-term, if you’re trading currencies, or Indices, but you make that work in a very short time frames. Is that correct?

Well, I look at the Forex market on Daily charts for the Trend and then, I look at 4-hour charts for entries. Yesterday, I looked at a 30-minute chart, because I had the time to focus on the 30-minute chart. I haven’t got that today…you’re trading technically alone in the Forex Market.

There’s a lot of news around, it drives prices one way, or the other way and your hit-rate suffers. I think using VectorVest on the stock market, good quality stocks, you can get your hit-rate up to 75 percent. On the Forex market that comes down, I don’t care who you are, it comes down significantly. If you speak to any Institutional trader, they’ll tell you that if your hit-rate comes down, then what happens is, you get into these ghastly clusters of good and bad luck.


To illustrate that:

– Do you ever go to the casino?”

– I do…

– Okay…If you play a Roulette?

– Yeah…

– Okay, all right. Well, roulette is red and black…so, If you look at the scoreboard down at the bottom of the roulette wheel – the electronic score book…if you look, you’re going to see long runs of Red and long runs of Black. It should be: red and black, red and black, red and black, but Life is not like that. You get clusters of good luck and clusters of bad luck.

image of a roulette wheel that explains the Randomness In The Financial Markets

Your mother may told you that bad things happen in threes…that’s because Life is mostly random.  In eight observations, you get a cluster of three. In other words – 1/2 times, 1/2 times, 1/2 …Okay. And your mother could only remember eight observations, so she says that things happen in threes. So, in a 50% system you should be right one out of two and, one out of two – you should be wrong…

– What’s the probability of two bad ones in a row?

Is, half times a half…Okay, – two bad ones in a row. That means in a 50% system, in every four trades you have two bad ones in a row and two good ones in a row. Now, that means, if your hit-rate comes down towards 50% and many Trend-following traders would “sell their granny” for a 50% system; most Trend-following systems are less than 50 percent. Meaning, in 4 trades you’re gonna have 2 bad ones in a row.

Now, most people will give up after 2 bad ones in a row, but it gets worse…

– What’s the probability of three bad ones?

A half, times a half, times a half…Okay, which means that you get a cluster of 3 bad ones in a row every 8 trades…You get a cluster of 4 bad ones in a row every 16 trades! And you’ve got a cluster of 5 bad ones in a row every 32 trades!

Five bad ones in a row…how good will you be in executing your system, with precision, after five losses in a row?!

three dices on a chess board representing the Randomness In The Financial Markets


That’s the challenge in the short-term market, as the hit-rate comes down, then these ghastly clusters of bad luck start, and of course, a cluster of good luck. You can have a cluster of good luck, as well.


Actually, cluster of good luck is even more detrimental to your health than a cluster of bad luck, because in a cluster of good luck you get a little thing between your ears, called a pituitary gland, and it pumps all sorts of muti-muti-zulu. It is Zulu medicine; it pumps all sorts of Muti into your bloodstream. When you leave the gym after a good workout, you feel good, yeah?! All right…When I leave the gym after a good workout, I feel, I’m 18 again, and similarly, when you have one good trade in a row, two good trades in a row; the old pituitary gland gets to work. And it pumps stuff into your bloodstream; you feel good, you become euphoric and when you become euphoric – the definition of euphoria is, Invincible.

a happy woman that thinks of a Randomness In The Financial Markets

You start to forget about all those position sizing. You say: “Let’s have a big bet.” When you have a run of good luck that euphoria takes over and most people, in fact, go bankrupt after a run of good luck, not after a run of bad luck. Because, they think they’re God, and they forget about all those position sizing stuff…it’s happened to me on a few occasions.

If you’re a risk manager; the risk managers in the City are, in fact, coached into assessing the susceptibility of their traders to Euphoria. That is a big problem, and anybody who’s traded for more than 10 minutes will tell you this – the big problem is, getting your mind around the clusters of good luck and the clusters of bad luck, as the hit-rate variably falls.

Also, read: How To Use Round Numbers In Forex Trading To Your Advantage

Now, if you’ve got a system with trend-following and the darn thing goes in to a range – the system doesn’t work. Many people will say: “Well, don’t trade a trend-following system when it goes into a range!” But, you don’t know the darn things is in a range until it’s been there for a while! You can put all the ADX’s (Average Directional Index) of this world on, – it makes no darn difference.

The market has to go sideways for a while, before you know it’s in a range. Similarly, if you’re buying support and selling resistance, and the market starts to trend – well, you’re wrong again! And then, there’s the noise in the market that causes you to get stopped out and stopped out, unless your stop-losses are really good, the market-makers will pick them off, all day and every day, and the algos will have what’s left after the market makers.

So, your hit-rate comes down and if you can be right, in the Forex market, 55–60% percent of the time, you’re right up there, – with some really good traders. You can make a heap of money with a 50% system. If you make three times more when you’re right, than when you lose. When you’re wrong – five times three is, fifteen and five times one is, five. That means, that in ten trades you risk a pound to make a pound, so you’ve got a positive expectancy system. And that’s great!

hundred dollar bills inside the aluminum case that represent Randomness In The Financial Markets

But, handling a winning system that is right 65% of the time, or 60% of the time, – that makes a fortune on paper, most people will lose with that system. Unfortunately, because, of these darn clusters of good luck and bad luck. And if you’re over 20’s you must have had periods in your life where everything goes well, and the periods in your life where nothing goes well and that’s a cluster.

They happen in every facet of life, Okay. And certainly, if you get to over 50’s and over 60’s, I have to say it to believe it…If you get over 60, you’ve got really good years and bad years, that’s for sure.

– “What’s the best week of trading that you’ve ever had…in terms of profit?”

– “Ahh…the best one, without the doubt, is a Copper trade that I did a lifetime ago. I took the trader on, while I was in South Africa. And I was here, in London…I remember, vividly…I was checking broker; I didn’t think, I had any positions, because I was sure that I’ve been stopped out of this Copper trade before I left South Africa. And, I was going along to whatch Celine Dion at the Royal Albert Hall. It was that “Titanic Era.” I don’t know, when was that – 1999…1997? A long time…20 years ago, in fact. What had happened was: I’d missed the stop, by a tick, or two, and the Copper price had ran up the page and it just ignored all those Fib (Fibonacci) levels and just kept on going. When I opened up my brokerage account; and I looked like an old spread-better here…when I opened up the brokerage account, there was thousands in it – completely unexpected. I think, that stands out as a wonderful trade, yeah! I just let it run, run up the page, for weeks on end, because I didn’t think I had a position…

– “You are one of the traders that gets currencies right. Where do you think other people go wrong?”

– “Well, I get currencies right, 60-65% of the time. Thirty to thirty five percent of the time, I’m wrong. And the reason that I’m still around in all of these markets is that, when I’m wrong, – I lose a little bit. And, when I’m right; I’d like to be three times bigger, when I’m right, that when I’m wrong. I’m not consistent with markets, because of my ability to read markets better than anybody else, and in fact, I am, probably, consistent in markets, because I manage risk well.

calculator, pen and a sheet of paper, all Randomness In The Financial Markets

And, I am conservative…many of my friends said to me: “David how the hell can you be a commodities trader, you’re most conservative guy in the world?”

When I go to the Airport, – I hire a car. I always take the Windscreen; they always ask you, if you want that and the tire waiver. I always take, and I take the Super Cover, as well…and, so they say to me: “How can you be a trader and take risk?” And the reason that I’m still around after all these years, and people have come and gone, is that, – I manage risk exceptionally well. The objective of doing business; whether you’re in the media business, whether you’re in the stock market, or the Forex market…the objectives of doing business is, to do business at the least risk.” – David Paul, Managing Director of Vector Vest UK

The bottom line is this, there is no way of beating the Randomness in the Financial Markets. You just have to be a good risk manager.

Consider loosing, as a part of the Game; operational expenses, if you will. Then, the only thing left to do is, – making sure that your winners are bigger than the losses.

Until next post,


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