So you are a discretionary trader and a friend sends you a link to an awesome blog post where a world-famous trading teacher shares how to trade a Support Play. Excited you watch as the charismatic guru walks you through his system for trading this set up. He is an excellent communicator, has a solid trading track record and you are the best of listeners. Soon you start spotting support plays, trade them live for the next few months, following religiously what you thought you learned, yet something funny happens. You are not making money.
I have blogged relentlessly about the necessity for purposeful practice to develop trading skills. Heck I have even written a magazine article about this and jammed it into One Good Trade. And Outliers and Talent Is Overrated and The Talent Code have taught us that no one becomes great at anything without deep practice. But why is this? And more importantly how does this affect us as traders?
Let me introduce combinatorial explosion. Simply for a trader it means when we introduce a new affecting element to a trade it materially changes the outcome. For example, if I say buy every time RIMM trades down to 48 because this is an important support level, then that is one trade. If I say buy RIMM when it finds support at 48 AND the intraday market is strong (a new affecting element), well now this is an entirely different trade.
Let’s consider some affecting elements of a support trade for RIMM at 48 support:
- Time of the day
- Strength of the overall market on a longer term time frame
- Strength of technology stocks
- How quickly RIMM dropped to 48
- Is there buying on the tape near 48?
- Strength of the market intraday
- Fresh news in RIMM
- Volume in RIMM intraday
- Volume of the market intraday
- Volatility of RIMM recently
OK let me stop here. As you can see we could create a very long list of affecting elements for just this one trade. And when we introduce each new element this will materially affect the buy at 48 for RIMM. When you develop trading skill you can better navigate the subtleties of each trade. Instantly you can calculate how to attack this support trade with its specific affecting elements. Each trade is its own trade. Each support play is unique because the affecting elements can never be the same.
From Bounce:
The best way to get a sense of the strange power of combinatorial explosion is to imagine folding a piece of paper in two, making the paper twice as thick. Now repeat the process a hundred times. How thick is the paper now? Most people tend to guess in the range of a few inches to a few yards. In fact the thickness would stretch eight hundred thousand billion times the distance from Earth to the sun.
So when that guru teaches you a new set up please understand the power of combinatorial explosion on your success rate. And start developing a purposeful practice routine to find the support plays that make sense to you. This will build your trading skill so when a similar but materially different support trade appears you have the skill to make an excellent risk/reward decision.
Mike Bellafiore
Author, One Good Trade
6 Comments on “Combinatorial Explosion- A Trader’s Hurdle”
Excellent post. So true.
Excellent article. I just finished reading Bounce this last week and noted the same passage to my wife.
I’m transitioning from a 20 year career as a software development project manager to trader, and one aspect of my former life that translates is the knowledge of complex (and chaotic) system theory. In any system that has multiple inter-related variables (where a change in one variable can impact other variables), the addition of a new variable can add an exponential increase in complexity. Because of this, systems such as these are not usually managed by predictive mechanisms, but by close monitoring and minor path corrections, otherwise the system devolves into wild fluctuations and chaos. Which I think all of know describes the stock market.
But what successful project managers also understand is that software development itself is also a complex system, so they should apply the same methods of close monitoring, small changes (iterations), and continual re-evaluation of their assumptions to their management of the project as well as the management of themselves. And, as you said, it’s quite similar for traders.
Sorry for the tangent, but your article struck a passionate place in me.
Love your analogy. Thxs so much for sharing. Bounce is another great book in the elite performance field!
Love your analogy. Thxs so much for sharing. Bounce is another great book in the elite performance field!
Thxs for reading!
Thxs for reading!