The Art Of War & Trading: Part 3

军形篇 – The Chapter of Tactical Dispositions

Original Text: 善战者，先为不可胜，以待敌之可胜。
Translation: Good commanders first evaluate the possibility of being defeated and then wait for an opportunity to defeat the enemy.

Don’t you think this sounds very similar to using a trading stop-loss?

The concept of setting up a stop-loss is to estimate and prepare for the worst case scenario. As a commander, Master Zhu would suggest you treat the money in your account as your soldiers and take care of their lives.

Let’s say you’re on the battlefield and you strategize that a plan of attack might sacrifice 50% of your army, that’s 50% of your soldiers’ lives (i.e., 50% of your account balance), surely no respected commander would approve that kind of attack.

However, in forex trading, some people will quickly lose 50% of their money in a short period. In Sun Zhu’s eyes, this would make for a very unqualified commander.

Therefore, placing a stop-loss that could cause you to lose 50% in a single trade is a poor decision. Most experienced traders might suggest a 2%~5% stop is a wiser move. Even a 10% stop may be considered quite extreme. Would you risk the lives of 10% of your infantry? Some might argue that it depends on the circumstances, either way, the same level of consideration must be given in trading to have any chance of success.

Also, most traders lose 50% of their account or more because they fail to place any stop-loss measures at all. Under the context of the Art Of War, this means you never bothered to estimate the worst scenario before you attacked. In Master Sun’s eyes, that is extremely unacceptable.

Original Text: 不可胜在己，可胜在敌。
Translation: The ability to secure ourselves against defeat lies in our own hands. The opportunity to defeat the enemy is provided by themselves.

A very remarkable concept.

Many investors believe they can actively beat the market, which is wrong. The market is far stronger and smarter beast than the average person.
Instead of trying to “beat” the market, more time and effort should go into improving yourself. For example, try focussing on how to better to defend, such as setting up suitable stop-losses as the previous saying suggests.

Once you’ve developed the ability to protect your soldiers, then all you need is to do is wait for an opportune time to attack (you can observe it from chart patterns), then and only then, will you be trading like an intelligent commander, prepared to lose a battle and win the war.

Original Text: 故善战者，能为不可胜，不能使敌之必可胜。
Translation: Thus, a good commander can secure himself against defeat but cannot make sure of defeating the enemy.

Master Sun corrects us here on another common misunderstanding.

Nowadays many fund managers will brag about their “target profit” to attract your attention. As an individual investor, you might be vulnerable to being misled and start to think “maybe it’s good to set a target profit for my investing too?.” Well, Sun Tzu would argue that this is wrong.

If you set a target return for yourself and you are unable to achieve it, you will most likely become hurried and vulnerable. Imagine your basketball team is losing and it’s the last few minutes of the game. How many times have we seen teams abandon their defensive tactics, throwing caution to the wind and put everything they have into the final attack?.

Perhaps having Michael Jordan on the court may help, but ultimately, this scenario doesn’t end well for those losing teams. With little to no defense in place, the opposing team will typically score more points and much more easily than before making matters worse. The same logic applies to the financial markets. There is a general tendency to increase your position and attack more at the worst possible time, and the market will more often punish those who fail to defend their position adequately.

Original Text: 故曰：胜可知，而不可为。
Translation: Hence the saying: You may know how to win, but sometimes you are not able to do it.

Original Text: 见胜不过众人之所知，非善之善者也；
Translation: To see victory only when it is within the ken of the common herd is not the acme of excellence.

Original Text: 战胜而天下曰善，非善之善者也。
Translation: Neither is it the acme of excellence if you win and the whole world says, “Well done!” to you.

In this paragraph, Sun illustrates another common misunderstanding by the general public.

You probably heard of the 20-80 rule, which states that roughly 20% of the population controls 80% of the global wealth. You may have also heard that 20% of the population will win at trading while the other 80% will lose.

When it comes to trading, this theory suggests the most popular idea about price direction will cause you to lose money in the long run. Thus, if your opinion falls within the common herd, then perhaps you need further training as a trader.

Many beginner traders will follow those famous pundits on the major television stations. You know the ones I’m talking about, those who claim they can predict the market direction with 80% accuracy and never fail. If we consider the 20-80 rule above, then this claim starts to sound quite absurd or should at least raise some internal alarm bells.

Most of these analysts have a claim to fame because they successfully predicted one or two big financial events, say the start of the 2008 crisis. Does this mean they can accurately predict every other upcoming event with such accuracy? Of course not, nobody can. Hence, Sun Zhu said those who won the applause of the whole world might not be as good as you think.

Original Text: 故举秋毫不为多力，见日月不为明目，闻雷霆不为聪耳。

Translation: To lift a hair is no sign of immense strength; to see the sun and moon is no sign of sharp sight; to hear the noise of thunder is no sign of a quick ear.

Original Text: 古之所谓善战者，胜于易胜者也。

Translation: Thus the ancients said an excellent winner is one who not only wins but excels in winning with ease.

Original Text: 故善战者之胜也，无智名，无勇功，

Translation: Hence his victories bring him neither reputation of wisdom nor credit for courage.

Original Text: 故其战胜不忒。不忒者，其所措胜，胜已败者也。

Translation: He wins his battles by making no mistakes. Making no mistakes is what establishes the certainty of victory, for it means conquering an enemy that is already defeated.

Here Sun describes for us what kind of person can be known as an “excellence winner.”

This person has trading success based on defense. They make minimal mistakes (i.e., choosing the right time, trend and setting up sensible stop-losses) they also understand that some losses are inevitable while protecting their account for future battles. This kind of success is often very low-key. It’s unlikely to receive any applause or stardom because he or she is not looking to parade their wins in public as it’s all part of a more important strategy.

Original Text: 故善战者，立于不败之地，而不失敌之败也。

Translation: Hence a skillful commander puts himself into a position which makes it impossible for being defeated and does not miss the moment of defeating the enemy.

Original Text: 是故胜兵先胜而后求战，败兵先战而后求胜。

Translation: Thus a victorious strategist only seeks battle after the defense is guaranteed, whereas a losing strategist first encounters a fight and then looks for victory.

These two sentences summarized what we had covered today.

1. First, make sure it is impossible to be defeated (by managing your positions and stop-losses well). In essence, this means even though losses are possible, blowing up an account on a single trade is not.
2. Seek the most opportune time for a battle (Open a position). Don’t just go with the crowd. Do your analysis and study wisely.
3. Once opened, closely monitor the five elements of the markets ( we covered this in part 1 of this series), then you are heading towards victory.

By Lanson Chen – Analyst

Lanson Chen
@LansonChen

This article is written by a GO Markets Analyst and is based on their independent analysis. They remain fully responsible for the views expressed as well as any remaining error or omissions. Trading Forex and Derivatives carries a high level of risk.