The Art Of War & Trading: Part 4

Original Text: 孙子曰：凡治众如治寡，分数是也；
Translation: The control of a large force is the same principle as the control of a few men; it is merely a question of dividing up their numbers.

Often beginner traders with relatively small accounts tend to treat them with less significance as they believe losing an amount of this proportion wouldn’t matter in the long run. These new traders may even say things such as “Had I had a more substantial account such as $10,000, I would not have lost as I’d take more care. In the spirit of Sun Zhu, this type of thinking would be incorrect.

Sun Tzu illustrated that you should not randomly increase or decrease the number of your positions just based on the money in your account.
Alternatively, you should separate your money into several parts (for example, ten parts), like a commander lining up their troops into several square formations.

Upon observing a battle opportunity (a potential trade), you would allocate a fixed percentage of troops (money) to attack, for example, 20% of your money, and if it gains 5% of profit, you then retreat.

The detailed principles varied depends on your risk appetite, but please remember the key is——Do not change your rules discretionarily, especially when you have a few successful trades in a row, or you may be become blindly over-confident and increase the number of your troops in next battle unnecessarily.

Original Text: 凡战者，以正合，以奇胜
Translation: Any victory in warfare should be acquired by universal principles and supplemented with surprise strategy.

This idea is an abstract one.

Qi (奇) means to surprise and tricks while Zheng (正) means direct and normal.

We can refer Zheng (正) to the fundamental aspects to illustrate the market, like Fundamental and Technical analysis, covered in episode 1 of this series, which Qi (奇) means keep misleading enemy’s expectation to one direction but attack in another direction.

The market knows how to use Qi (奇) more than you or I can imagine.
I did a simple summary regarding the direction of the price after a piece of news was released.

Are you surprised by the results below? No matter the news is good or bad, the probability of the price increases & decreases is 50/50 chance.

This simple summary tells us that relying solely on Zheng (正)—— the traditional fundamental & technical analysis is not enough. Standard analysis can only help you to reveal the broad trend of the price but often fails to predict the short-term price fluctuations.The market assumes most of the participants will place buy orders after good news, and sell after bad news. It is human nature after all. Thus the market may take advantage of this by using the principle of Qi (奇) —— predicting your psychology and then look to move the price in the opposite direction if possible.

Original Text: 故善出奇者，无穷如天地，不竭如江海。终而复始，日月是也。
Translation: Thus, people who good at using Qi (奇), are inexhaustible as the sun rises and sets.

Original Text: Qi (奇) Zheng (正)相生，如循环之无端，孰能穷之哉?
Translation: The direct and the indirect lead on to each other in turn. It is like moving in a circle–it never comes to an end. Who can exhaust the possibilities of their combination?

Following on from what we discussed above, price movements are affected by both common factors, and psychological factors (Qi 奇) as well.

Common factors generally affect the overall trend while psychological factors usually affect short-term price fluctuations.

Take the following US Dollar chart as an example. You can see that it is a significant trend, and the US Dollar is dropping. Let’s say, for example, the latest Non-farm Payroll data was just released, and it is terrible news. The media will typically tell you whether this month’s number is better or worse than expected. In the usual way, you might assume “Well, the trend is dropping, and the news is bad, so I should sell.” You might even break your own rule of separating your troops and use all your money into selling the USD. This thought pattern would be a prime example of what Sun Zhi suggests not to do.

The market is smarter than you and already think one step ahead of you like a chess opponent.

The market may use the idea of Qi (奇) by pushing the price into a short-term rising trend (as the shadowed area in the chart), trigger your stop-loss line (like he captures your chess piece), and then the price trend reverts to normal.

Since we’ve already established that trying to conquer the market is not advisable, my suggestion would be to follow the significant trends and avoid battling with the market during a short-term abnormal trend. This suggestion is also another application of Sun Tzu’s shining ideology.