The Art

and Science
of Trading
Course Workbook

Adam Grimes

Hunter Hudson Press, New York, New York

Published by Hunter Hudson Press, New York, NY.

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 3

Module 8–Pattern Failures

In some sense, this module is a “bringing it all together” perspective on the patterns we have studied through-
out the course. We focus special attention on how these patterns fail. Some traders will choose to specialize in
entries around pattern failures, and other traders will use this information to more effectively manage risk. All
traders can gain good insights into pattern development and evolution through this study of pattern failures.
The course material and readings also include some thoughts on position sizing. This is an important ques-
tion: how much to trade? Trade too much, and even a good system can blow up and take all your money. Trade
too little and everything you do is meaningless—it’s important to understand the tradeoffs and consequences
for your particular approach to trading, and this section includes an exercise you can return to as your trading
develops.
Last, this section concludes with a few thoughts on risk and how to effectively manage the risks of trading
and investing. It’s no exaggeration to say that trade is mostly about risk management, but we must define our
terms for that statement to be meaningful and useful.
It is also worth noting that this module continues to move you in the direction of personal responsibility.
The actual number of pages in this module’s supplementary materials is less, but this is because more of the work
is your own work. You are ultimately responsible for your own success or failure in the markets. The tools here
can help you grow and develop, but the hard work is yours… and so are the rewards.
4

Section 1: Trading Plan: Revising and Refining

Your trading plan is a living document. Over the years, you will revise it as your trading style grows and pro-
gresses.
In this module, take some time to revisit your plan. If you did not do the work in the last module, stop and
do it. This section is here to re-emphasize the supreme importance of having a solid trading plan—without it,
you’re just guessing!
What, exactly, you need to do in this module will vary for each trader. At a bare minimum, make sure you
have the documents discussed in the previous module, and have them completed in a format you would feel
comfortable sharing or presenting to investors. You will likely reconsider or want to change many aspects of these
documents as you grow and progress in your trading.
You should also begin to work toward a backtest-able and backtested trading plan: now that you have all the
pieces and can formulate your trading thoughts in a good format, create the plan that explains exactly how you
wish to trade. Subject this plan to some backtesting, some papertrading, and only then are you ready to move
into live trading.
Though creating a plan is a terribly unexciting topic, it truly is one of the most important steps in a trader’s
development.
 5

Section 2: Your Own Research Project

You should, by this point, have some ideas about things you might want to research and examine in the
market. Ideas do not have to be complicated, nor do they have to be unique. You may be interested in revisiting
one of the pattern research projects you have done earlier in the course, and changing the way you structure that
pattern as your trading plan has developed.
You should be very interested in examining your trading plan from a backtesting/research perspective. You
will certainly find ideas in conversations with other traders you wish to test. You may get ideas from books, and
all of this will probably filter down to your research journal, which will become a burgeoning source of ideas for
further exploration.
Begin the work of doing this research. The bar-by-bar testing you have worked with certainly has its place,
and I suggest it even for the more quantitative-able traders I work with. You may also wish to begin exploring
some ideas using other backtesting frameworks, building simple Excel spreadsheets, or coding in language such
as R or Python.
So, use this as a departure point, and begin doing your own work. You now have a good sense of what to do,
what skills you may need to develop, and what you need to learn. If you continue to trade and to work on becom-
ing a trader, much of that work will be in testing and examining trading ideas.
Begin your own research and keep good records of the results.
6

Section 3: Position Sizing Project

Intellectual understanding of the math behind position sizing, drawdown, and the volatility of an equity
curve is one thing, but deeper investigation will bring further insights. One way to dig deeper is to create a simple,
model trading system and to run many iterations of the system with different position sizing rules. Doing this
effectively will require use of some programming structure or a spreadsheet.
Here is one possible procedure:
Define the “trading system” with three conditions (each of which can be a variable): the probability of a win
or loss, the size of a win, and the size of a loss. For instance, you might have a 50% chance of a win. If the trade is
a win, assume you make 1.1. If it is a loss, assume you lose 1.0.
Create a series of 100 trades drawn from this distribution. If you are using a spreadsheet, each one of these
trades will be a row.
Assume a starting capital of $100,000. Decide the amount risked on each trade. (To begin, assume you will
risk $1,000 per trade, but this should be a variable you can change in subsequent tests.) If the trade is a win, mul-
tiply your size of a win variable times the amount risked and add the resulting amount to the previous account
balance. (If the trade is a loss, make sure the amount is subtracted.)
Repeat for each trade so you will have a running account balance beginning at $100,00 and changing for each
of 100 trades in the series. Calculate basic stats for the equity curve and graph it.
Add one more refinement: if the equity curve goes to or below zero, terminate trading for the run and leave
the account balance at that value. In your analysis, you will want to flag this as a run that went bankrupt.
Your random number generator should create a different equity curve each time the system is run. Generate
multiple curves and consider how variable the results are.
Repeat this work with different amounts risked for each trade. Build a system that will allow you to risk a
percentage of the previous account balance rather than a simple, fixed dollar mount. Last, repeat this work with
different values for your base system. How does a stronger or weaker edge affect the variability of your results?
With a system that has a positive edge, you will generally see that there’s truth to the “risk more/make more”
approach, but also consider the variability and risk of ruin, both of which increase as trading size increases.
 7

Section 4: Belief Inventory

Our beliefs define much of who we are, and drive our behavior, sometimes in ways we do not fully under-
stand. The market environment is extremely challenging; most of the obstacles that stand in a trader’s way are, to
some extent, self-imposed. Much of the work on trading is work on ourselves.
This project asks you to spend some time considering your beliefs. This exercise appears to come out of no-
where: we have not spent much time focusing on the psychological and mental issues of trading. Rather, we’ve
focused on the intellectual aspects of learning patterns, the math behind successful trading, and exploring how
to put a trading approach together. This exercise is a bridge to carry you forward to the work on yourself.
The exercise is simple: spend a few minutes a day, for several days, in quiet reflection and write down some
insights into what you think your core beliefs are. Of course, these can be explored and broken down on many
levels, but it’s enough to get the high-level perspective. Do not pay attention to whether beliefs or “good” or “bad”
(empowering or limiting might be better labels), and do not think too much about where the beliefs came from.
Suggested topics to think about might be:
• Yourself
• Health
• Career
• Universe
• Family
• Relationships
• Money
• Success
Belief language typically begins with phrases such as “I am...”, “People are...”, “Life is...”, etc. Many of these
belifs are things that probably have not considered carefully; you simply accept and believe them to be true. You
might be surprised what you find when you starting digging into these, and this exercise will reveal some import-
ant things about you and how you understand the world in which you live.
You may be inspired to think about other topics, but if you can end this exercise with a handful of most
important beliefs about these, or similar, topics, consider the exercise a success. We will go deeper in the next
module.
8

Section 5: Readings

From The Art and Science of Technical Analysis: Market Structure, Price Action, and Trading Strategies by
Adam Grimes, Wiley, 2012:

263-290 (risk)

You may also find the following blog posts interesting and useful:

https://adamhgrimes.com/problem-reversals/
https://adamhgrimes.com/dont-be-this-guy/

https://adamhgrimes.com/are-you-losing-position-size-matters/
https://adamhgrimes.com/six-keys-to-effective-risk-management/
https://adamhgrimes.com/where-are-your-risks/

https://adamhgrimes.com/the-slings-and-arrow-of-outrageous-fortune/
https://adamhgrimes.com/discretionary-consistent/
https://adamhgrimes.com/managing-luck/
https://adamhgrimes.com/whats-luck-got/