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By Cory Mitchell Updated Jun 25, Random Reinforcement: Using arbitrary events to qualify or disqualify a hypothesis or idea; attributing skill or lack of skill to an outcome that examples of unsuccessful trading unsystematic in nature; finding support for positive or negative behaviors from outcomes that are inconsistent in nature—like the financial markets. One of the most interesting topics in trading, and really throughout many areas of life, is random reinforcement.
Random reinforcement, as it relates to harmful trading practices, occurs when a trader attributes a random outcome to skill or lack of skill. The market occasionally rewards bad habits and punishes good habits because the market is so dynamic.
To IPO or Not to IPO?
It is especially negative if a new trader who wins a few trades, with absolutely no plan whatsoever, attributes this success to "intuition. Random reinforcement can create long-term bad habits that are extremely hard to break. How Random Reinforcement Affects Us The concept of random reinforcement is hard to grasp for some traders, but understanding it can be the difference between actually improving as a trader or simply believing we are improving optonbt binary options we are not.
The best way to understand this to go through a few examples.
Failure of Patterns
He has a business background, watches the news and follows the stock market, but he has not traded personally. He feels he has a good handle on what it takes to be a good trader, but so far, he has not written any of these methods down. John has opened a trading account and believes his background knowledge will make him a profitable trader.
Opening his charts for the first time, John see a default stock in the trading platform, and it is rising quickly. He quickly buys shares without even thinking. The stock continues to trend line channel line while he makes lunch. John makes another trade and ends up with a similar result.
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In analyzing the situation, experienced traders will notice a few things that could lead to short-lived trading career for this trader. The main problem is that several successful trades are not a valid sampling for if a trader will be profitable over the long run.
John, the trader in this case, needs to make sure that he does not fall into the trap of believing that his current methods, which are still very much untested, will bring him long-term success.
The danger lies in refusing proper market guidance or methods, whether self created or provided by someone else, because this initial untested method is believed to be superior based on these preliminary trades. The trader can begin to think very strongly that, if it worked once, it can work most, or all, of the time.
In the next example, we will look at random reinforcement again, but from a different angle.
Defining the Success of an IPO
This example pertains more to experienced traders, or traders who are coming to the market with a written down strategy or method that is back tested or proven to be profitable in live trading. It should be noted that not all methods that were successful in the past will continue to be, as we just found out in the previous example on a small scale.
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But methods that have shown success in the past examples of unsuccessful trading more likely to provide a chance of profitability in the future than a method that is completely untested or has never been profitable over the long run.
Example 2: Abandoning Strategy John has now been trading in the markets for some time. He has overcome the problems evident in the first example and now has a solid trading plan for approaching the markets.
This method has worked well over the past two years, and he has made money. John is now facing another problem. Despite past success with this plan, his method has now led him to nine consecutive losing trades, and he is starting to worry that his plan is no longer working.
John therefore changes his plan for trading, as he feels his method is no longer valid. In doing so, John ends up trading a new untested method, possibly similar to when he started trading.
Your success depends on avoiding these pitfalls
This could put John right back to the beginning, even after trading successfully in the markets for a number of years. Why did this happen? John failed to realize that, while randomness can create winning streaks using a flawed trading method, randomness can also create a string of losses with an excellent trading plan. Therefore, it is very important to make sure a trading plan is not actually going to work anymore was the original success random?
All traders experience losses, and there is no definitive number of losing trades in a row that will tell a trader if his or her plan is no longer working. Each strategy is different, but we can learn to deal with randomness.
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While each trading plan is different, each trader must have a written trading plan that outlines how he or she will trade. This plan should be well researched and lay out entries, exits and money management rules.
In this way, the trader will know over the long run if the plan is flawed or successful. It is also extremely important to risk a very small percentage of capital on each trade; examples of unsuccessful trading levels of each trade should be covered in the trading plan under the money management section.
This gives leeway to the trader, as he or she will be able to withstand a string of losses and be less likely to make a premature change in the trading plan when it is not needed.
The Bottom Line The markets are extremely dynamic and in constant flux. This brings in an element of randomness that can create profits for unskilled traders and losses for skilled traders, and it happens all the time.
The only way to do this while you are learning is to approach the markets with a trading plan and risk a small percentage of capital on each trade.