If ever there was a topic that will send experienced traders to arguing it is how to measure and account for randomness and setting stop loss/profit target levels. I also couldn't talk about randomness without recommending reading Dr. Burton Malkiel's "A Random Walk Down Wall Street." Dr. Malkeil emphatically argues that past movement cannot be used to predict future price movement. Needless to say, you will not find this tome in most technical traders libraries. As an individual who has spent most of his lifetime trading institutionally and most recently retail, I believe that Dr. Makiel is dead wrong but the book is well-worth reading to get a handle on randomness and it's implications in your personal trading. Dr. Malkiel's ideas are broadly classified as Random Walk Theory.
I can personally attest that any trader who does not factor this component into his/her written trading plan will doom themselves to failure. If you have traded for any period of time you will have noticed that between market moves the price action tends to wander in unusual and contradictory patterns. These patterns are frustrating to trade and may cause you to want to set your hair on fire.
What is randomness is short-term e-mini trading?
Randomness is the din of accepting and filling orders that are not correlated to a specific trading plan. For example, Joe the plumber stops by your home and tells you that he heard from his Uncle Pete that General Electric has a new wiz-bang technology that will soon be released and will revolutionize the way power grids distribute electricity. Without doing your own research, you figure Uncle Pete is a reputable source of information and you buy 84 shares of General Electric. You have not checked the price of GE, nor reviewed charts of the company but buy based on third or fourth party recommendation. This is certainly a random buy. You don't know Uncle Pete and Joe the Plumber is, at best, a casual acquaintance. This sort of buying is far more common that you might think.
What is the relationship between Average True Range, tight stop, and randomness?
Any trader who fails to account for random movement in the market is doomed to failure. I measure this variable by using the Average True Range (ATR) and multiply the reading by 2x or 3x (depending upon anticipated market volatility) and set my stops and profit targets accordingly. It is quite common to read trading websites that claim they use tight stops. In researching this article I found several e-mini scalping sites that claim they set their stops at 5 ticks. Let's also assume the ATR 2x equals a 24 point range. I can tell you that setting your stops at 5 when the correct stop loss is 24 is going to result in consistent 5 tick losses. To win a trade setup of this nature the price action has to move in your direction from the git-go. I have not had many trades in my career that rocketed straight up without wandering about for a bit. Generally speaking, I put little faith in individuals that claim they trade ultra-tight stops and a large pile of academic literature supports my belief. On the other hand, consistently winning with a 5 tick stop is certainly an appealing prospect. Unfortunately, I have yet to meet the trader who claims to use tight stops successfully demonstrate that the strategy works. It doesn't.
My point here is to make you aware that you must account for randomness in your trading. You cannot set stops in a volatile market based on the size of your account or the aforementioned tight 5 tick stop. If you set your stops correctly you stand a far better chance of winning than if you claim to use 5 tick stops. As always, best of luck in your trading endeavors.
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