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I take the view that long-term persistent profitability in discretionary trading strategies is impossible because the trader must repeatedly get all three of the following factors correct: Direction, Magnitude, and Speed. This post was written primarily with stocks in mind as the particular asset class, but these ideas can apply to other asset classes such as futures, bonds, currencies, etc. or “buying” options, where profit and loss result from a buy or sell decision tied to the future direction of the security. The counterexamples will involve the “selling” of options.
One way I conceptualize the market is in terms of states of the universe, and attempting to explicitly pick a particular smaller set of states in that entire universe is much harder than being agnostic and implicitly picking a larger number of states. Let’s consider Direction, Magnitude, and Speed in turn.
Direction
It’s hard or even impossible to pick the direction of price movement, which is effectively random. (Paradoxically, it’s this random and unpredictable nature that permitted the entire mathematical structure modeling price movement via such ideas as Brownian motion.) Let’s assume there are three states of price action:
- up
- down
