A Process for Generating Ideas

Dave and Michael discuss their systems for coming up with strategy ideas.  Successful traders aren't born with the ability to come up with good ideas.  They create a process that they follow day in and day out to notice unusual patterns in the markets that can eventually be turned into profitable strategies.

Creators & Guests

Host

Dave Mabe

Host

Michael Nauss

What is Line Your Own Pockets?

A weekly show for systematic traders who want to make more money from their trading strategies.

Michael: 00:01

Okay, everyone. Welcome back to Line Your Own Pockets. Today, we are gonna take a look at how we generate ideas. Right? For me, this is gonna be one of the hardest parts for for what it is that I do.

Michael: 00:12

So I'm really excited to hear Dave's point of view on this. I know he's got, like, everything. He's got some systematized ways to generate ideas for our systematic strategies. This, again, I think is gonna end up being a multi stage episode, a multi part episode, because, you know, we're talking about how do we generate ideas, how to record them, which ideas are gonna be worthwhile, which aren't. And I think it speaks a little bit more broadly to, you could say, the state of the world where there is information and ideas everywhere.

Michael: 00:44

When it comes to trading, you go on Twitter, you type in trading, you'll fall into thousands of people out there spinning your ideas. So, how do you generate? How do you know which ones are worthwhile? All that kind of stuff, we'll get we'll get talking talking about. So how's your week been so far, Dave, before we get into the nitty gritty?

Dave: 01:03

Yeah. It's been good. Yeah. Had a good week so far. Excited to I've always looked forward to talking about, trading with you, so happy to be on here.

Michael: 01:15

Awesome. So I wanna get started with, a couple ideas that you have on how to generate ideas. Right? This is something that I do a lot by brute force, and I'll explain, kinda, my rationale behind it, that I think you probably have some more, I don't know, elegant ways to take a look at it. So why don't you just start with one great idea generation source for the people out there?

Dave: 01:40

Yeah. So a lot of traders come to me for my, trading success road map offering. And so it's, you know, a customer road map for, traders. Typically, they've had a little bit of success, but they know they can do better. So I I look at their process and help them improve.

Dave: 02:00

One of the things I always include with that is a process for coming up with new ideas. Now when I was starting out, I had some collaborations with some other traders years ago, and I was always struck at some of the ideas they would come up with. I was like, man, I would never be able to come up with idea that that idea. How did you do it? And what I realized over time, they just have a better process.

Dave: 02:30

They have a process for coming up with new ideas. And so I I eventually came up with my own, and this is what I recommend for traders who are, you know, trying to come up with the ideas in the first place. So at the end of the trading day, this is something that you can put in place and do every single day. And I think it's important that you that that it becomes a daily process. Even weekly or less frequent is gonna be not as good.

Dave: 03:04

Like, doing something daily is gonna build over time, and it's gonna be better for you. You're not gonna have great ideas every day, but you need to put yourself in a position to notice the unusual things that can turn into a strategy. So what I tell people is, at the end of the trading day, have a scan where you can go and look at the stocks that went up the most that day, the stocks that went down the most that day, and then the stocks that have the biggest range that day compared to what they normally do.

Michael: 03:45

Yeah.

Dave: 03:47

Those trades or those stocks are gonna be the ones that you're gonna want to participate in and capture some of those moves somehow. So look at you know, do a chart review for those from those scans every day and just go through a simple exercise where pretend that your life depended on capturing that move somehow. How would you have done it? How you know, go back and look at the chart before the move happened. How would you have captured that?

Dave: 04:20

And like I said, this process, you're not gonna come up with a great idea every day.

Michael: 04:30

No. Yeah. Sure. No.

Dave: 04:32

It becomes cumulative, and you'll notice that you wanna put yourself in a position where you're noticing routinely. And the more you do that, the more you're gonna be able to identify unusual things as a pattern that you can create a strategy from. So that that is a process that I do and that I recommend to people that they do.

Michael: 04:57

Do you

Dave: 04:57

have a similar sort of process that you go through?

Michael: 05:01

Mine's gonna be a little different, but, this is actually the the first thing I thought about, which is funny. And for people joining the podcast a little bit later, again, Dave's exclusively, a day trader. I have some systems I'm working on from a day trading point of view, but I'd I'm more of the longer term swing trade investment time frame. And, William O'Neil, How to Make Money in Stocks. Did have you ever read that one?

Michael: 05:25

That's a classic trading book.

Dave: 05:27

Yeah. He did Many years ago. Yeah.

Michael: 05:28

He did the same. That was his exercise. Right? When he talks about in the beginning, he's like, you know, William O'Neil, for those who don't know, Investors Business Daily, invented the Cup and Handle, the CanSlim method, a legendary investor and trader of our time. And he that's how he got started.

Michael: 05:44

He did the same thing. He would go back and look at what the best movers, the 10 baggers, the stocks that went up 10 x over a period of months or years. He would look at what they looked at, like, when they just got started, look at the fundamentals when they just got started, look at all this when they just got started. And that's how he was able to build his whole canceled method because he would look at, you know, Home Depot, I think, was a a prime example of his. Like, what did Home Depot look at before it had its meteor meteorotic rise?

Michael: 06:12

And he noticed, things in the fundamentals, and he noticed things in the technicals. And then it was just an exercise of now that I've discovered what this thing all of these great winners had in common, I just need to go find more of those. So it's just kind of funny, but it's just cool to see that it's it's the same type of methodology even though it's, you know, he obviously wasn't a systems trader. He developed a system, I guess, that he utilized, but he wasn't kind of fully quantitative, and then obviously not a day trader. But I just I love when I see things apply across styles and time frames.

Dave: 06:49

Yeah. And if you didn't know that about him, you would think that he was just born with the ability to come up with strategy. Right?

Michael: 06:58

Yes. Like, some kind of genius or something. Yeah. Yeah. But nobody

Dave: 07:01

not nobody's like that. That that's not that's a myth. Like, there's nobody that just is comes out of the womb with the ability to create strategies.

Michael: 07:10

Yeah. So I just I the second you said, right, find the stuff that did the best and figure out how you'd get in them, I just thought immediately to to that book and that style. And and that is part of it. You know, I I like to go back. I like to look back at, you know, different setups and and trades and apply different indicator sets to them and and do that as well.

Michael: 07:32

I'm one that I really like to dive into content. I make a lot of content, but I also consume a lot of content. So one of the things that I feel really lucky to have done is to met meet a lot of traders in person. So I know very easily I can pull out the the good from the bad. And, my relationship with the CMT, I think, also gives me that as well.

Michael: 07:55

So one thing I do, one process now I have, for example, is the CMT has what they call the DAO awards, where every year, everyone applies papers on, you know, something that they've noticed in the market, some sort of correlational aspect or volatility based position sizing and blah blah. And a lot of people look at this and say it's boring, but one of the quests that I'm on currently so I've downloaded all of them since the creation of the DAO Awards. And free time, I sit and I I read those. And, it like you mentioned, most of them, I won't really apply. I'm not really interested in.

Michael: 08:29

But every now and then, you read something, you go, okay. That's interesting. That's something that I can either apply to an existing strategy or look to apply to a a new strategy. So I'm more of the as opposed to a market consumer, I'm more of a content consumer, or I'll find people on YouTube or Twitter or something that, you know, I I have some faith that what they're saying is legitimate, and I will consume that content as well. And then the beauty of it, which again, we'll talk about in future episodes, is you can then test.

Michael: 09:00

Right? If someone comes up and says, I found the magic wing bang system that's gonna make you so much money. Okay. Well, now let's go verify. So that's mostly how I do it.

Michael: 09:10

I just like to consume. I just find them a consumer of content, so then I end up kinda gravitating to that style.

Dave: 09:17

Yeah. I think, collaborations with other traders are good. I mean, I'm sure we'll do a top do a podcast episode on that, one day in the future. But, yeah, you're right. You get good ideas from lots of different places, and it's good to have a process for doing that and do it religiously.

Dave: 09:42

You know, I I think of an analogy. It's sort of like, you know, imagine a dirty tap, like a spigot that hasn't been running a while, like a long time.

Michael: 09:51

Mhmm.

Dave: 09:51

You turn that spigot on, the first water that's gonna come out is gonna be brown and nasty.

Michael: 09:58

Yeah.

Dave: 09:58

But over time, it's gonna come we're gonna become clearer and clearer and clearer, and soon you got really clean water coming out of there. That's how I think about this process for people. It's it's not gonna be great at the beginning, but over time, you're gonna get better and better at doing it, and it's that water's gonna and the ideas are gonna become cleaner and cleaner.

Michael: 10:20

Yeah. And that's you know, it's funny. I have 2 young kids. I've got a 4 month old and a 2 year old. And sometimes I just find myself thinking.

Michael: 10:29

I'm like, well, you know, if my son came to me now, because, obviously, he doesn't have to at 2 years old and said, well, what is gonna be kind of the most important or one of the most important skills for him to master? I think it's going to be, not the knowledge of things because we as a human race, we kinda got that conquered. It is the the parsing of what's important in in knowledge of things. And I think when it comes to idea generation, that's super important as well is that, you know, you go to YouTube right now and just type in trading systems, and there just be millions of them come up. And some of them pretty common sensically, you can get rid of.

Michael: 11:09

Right? And it says 99% win rate or, right, double your money every month or you can parse those out. But, there are some people and there's some content out there which can, do a pretty good job of fooling you that it's good content or or bad content. So being able to parse through that, I think, is important. Same with, your methodology, Dave, where you're looking at the biggest winners and losers each day.

Michael: 11:39

Part of the issue that can come from that is just being able to say, you know, a, is whatever happened achievable? And, b, am I just making shapes of clouds? Right? I think that's a a common thing that the human brain needs to needs to kind of force out is that the ability to fool yourself, and, oh, I definitely would have saw that thing before it happened. And then one question that I wanna ask based off your method is that okay, so if I notice every day that, you know, the, the biggest winner starts with some sort of opening range break right Because I'm looking at the biggest winners and biggest losers, I guess I'm just by kind of naturally, I'm filtering out all the ones that had an opening range break and didn't work.

Michael: 12:24

So is that something that you flush out later in testing, or is that something that you address during idea generation?

Dave: 12:30

Sure. So this is the at the very first stage of coming up with a strategy. And what you're gonna find, you know, these are not gonna be fully flushed out ideas. These are just gonna be the beginnings, the starting points you use to come up with a strategy, do some back testing, go through the process of getting that to a form where it's tradable. But to get I mean, start getting to that point, you have to have a good starting point.

Dave: 13:00

So, you're you're there's gonna be a lot of trial and error. There's gonna be some bad ideas that you come up with. But even the bad ideas you come up with are valuable in that, you know, they're BS. Right? And you can avoid that in the future.

Dave: 13:20

So, yeah, it's it's, it's an important thing to be able to do.

Michael: 13:27

That was the what the Thomas Edison quote that, you know, I, every time he did something wrong, it wasn't that something happened wrong. He's just eliminated a wrong thing that he can he can then mark off his list, which I think is is very common. It it's very easy to kinda gravitate to, trying to trying to look at something and especially the way in the human brain will look at the thing and say, oh, that occurred 3 times, and I can see it happened 3 times in a row. Therefore, it's a good good idea. But like you mentioned that over time, what we end up learning is that, okay, there this, this thing actually isn't what I want it to be at all, and I wouldn't know that unless I went and did the testing.

Michael: 14:17

But often, sometimes you can find things that maybe when you're testing a strategy, the strategy ended up not working. But there was one interesting fact in the strategy. There was there was an indicator that as you were wiggling that indicator did seem to have some effect on on what was a bad strategy then you can take that one little indicator and you can maybe apply it to some other things you do or some things you do in the future which one thing that I really really like and even if people aren't going to be, auto traders one of the reasons that I suggest this this kind of idea generation and the testing of ideas that you see around is yeah, the I believe it dramatically accelerates learning Right? And, you know, I would me and Dave were talking before I went on here. I had a a question that I was asking of one of my systems last night, and I ran, you know, again, like, 2,000,000 trades through.

Michael: 15:11

And it answered a pretty interesting question that I had just completely taken for granted. And then that opens up another door in my brain that makes me want to explore down with different other trading strategies that maybe I've made the same assumption on. So, I think being open to that kind of stuff is best. And I see this a lot in traders, and I'm gonna be interested to see your, your feedback on this, Dave, that traders seem to get kinda stuck in their ways quite often. It's like, it's so hard to achieve any form of profitability that once they get there, they just seem to stop.

Michael: 15:47

They won't change their platform. They won't change anything about it. So, you know, if someone's listening and they're like that, and they're like, you know, listen, I'm making a few bucks and everything's fine. How do you encourage someone like that to to continue to get new new ideas coming in?

Dave: 16:02

Yeah. That's I'm glad you brought that up because that that is really and the most important part of of being successful for the long term is being able to come up with new ideas. And because I've experienced this myself, the first strategy I traded worked great for 3 or 4 years, actually, probably more than that. And all of a sudden, I was in a drawdown, and I knew that, gosh, I wish I had some other other ideas to fall back on. So this is the process that I wanted to have in place at that point.

Dave: 16:38

And if you have something successful now, it's so easy to sort of rest on your laurels and just go with it. But you you constantly have to be coming up with new ideas because you don't you you you don't know when you're gonna need to have those new ideas. And if your strategy stops working, you're gonna be at a dead end, and it's gonna suck.

Michael: 17:05

And I'll go I'll go one step, further in that. I personally believe and the more I'm getting into this world, right, the more I'm I'm getting into kind of the systematic side of things and the more I'm trading different styles and different assets. Right? So we mentioned Dave's more on the day trading side of things, and I'm exploring to get back into that world. But I'm doing some, you know, swing trading, revision to the mean pullbacks, a lot of different strategies.

Michael: 17:32

And I'm trading forex at the same time when trading stocks. And, you know, even if you're doing one thing that's working well, what I've noticed is that the more I'm able to bring into my world when it comes to different strategies, different instruments, different time frames, different styles, is there always seems to be something that's working. So, you know, even if you're someone who's gonna focus exclusively on day trading, I think bringing in more and more ideas and more and more styles will just smooth out returns. Right? So even if you're someone who's doing very well trading, you know, a certain gap strategy and it works and everything is fantastic, we know that there'll be periods of time even if it doesn't degrade permanently, like like Dave was talking about, even if it just degrades when you're outside of a a high volatility season in in the market.

Michael: 18:22

The market changes its characteristic in some way and becomes incredibly boring, and that makes less money. Well, if you had taken that time when things were good to develop a a strategy that worked well when the market was boring, you've just kinda smoothed out your returns. And that's the way I look at it, is that the more strategies that you can kinda combine and the more ideas you can get, it may not amplify returns, but it smooths drawdown and it smooths out returns. For me, this is one of the hardest parts, and I I wanted your feedback on this. Am I right to say that this is probably the most time consuming endeavor of, of strategy development?

Michael: 19:01

Because once you have a strategy and that strategy is testing okay and you're and you're trading and it's working okay, that doesn't create a lot of work. And and the the problem I think a lot of people have, is the whole too good to be true aspect of systems trading. They're like, well, I just, you know, if I just for me, once a week, I just set it all my swing orders and I walk away. You know, does that mean I go to the golf course and, you know, I don't have to do anything else? And I think the gotcha there that most people don't explore is that the one of the largest parts for me anyway, if I were to do, like, a pie chart of my time, one of the largest parts of my time is that trying to figure out that idea generation side of things.

Michael: 19:45

When would you notice that that's a a big part for you, or the way you systemize it, does it make it less?

Dave: 19:51

I think as a as a beginning trader, you're gonna need to spend more time in that area coming up with new ideas. And then once you get something that's work that's working, that's where you're gonna be focusing, and we could probably do a whole another episode on this. Like, what I'm thinking about now in this process is coming up with new ideas that you're not trading. The more lucrative thing actually is gonna be once you get something that is working, improving that and focusing on that. Like, there's a whole there's a whole bunch of different ways to improve something that is working.

Dave: 20:34

And I think of that as different from what we're talking about here is just coming up with new ideas. You get that the new new idea generation stuff, you could get that process going, kinda put that in on cruise control and have that running behind the scenes sorta all the time.

Michael: 20:57

Mhmm.

Dave: 20:57

And, but I think once you get something that works, you're gonna spend most of your time with that thing and improving the strategy and idea that you've come up with that does have legs.

Michael: 21:11

And that, for sure, I think, is gonna be an exciting, probably, series of episodes on, the tweaking of things. Right? Because it's one of those it's a very it's very fine lines, a very interesting tight rope on, you know, tweaking things too much or or doing things in a way that, end up hurting returns over time and and all of that. But, I would still kind of classify a lot of that in idea generation because, like, we mentioned the the the question that I asked this one system last night that, the my notepad, I was scribbling all through last night and saying, okay. Well, this is a new idea that is then opened up.

Michael: 21:50

Now I need to look at all my other strategies and say, am I, am I making an assumption with this one indicator set that I did in this this strategy, which the testing told me I was wrong? I was looking shorter term. I should have been looking longer term. So now I have it on on my screen, actually, right there, just a a sticky note that says, hey. I want you to take every strategy that you've made that assumption on and go back and retool it with what this new strategy has taught you, and then and then kinda go from there.

Michael: 22:19

So, I think you're right in basically saying that when you get to a point where you've been doing this long enough, one pathway will open up another pathway, which will open up, another pathway. It just seems to be a series of doors that okay. Now that I've opened up this door, that answered a question, which was good. It improved the system I was looking to improve. But now it also created another couple nights of work, you know, re retooling other systems down the way.

Dave: 22:47

For sure. Yeah. And and, you know, when you when you think about this whole process that you have to put in place, pretty daunting. Right? It's a lot of work.

Dave: 22:56

You're doing something every day. And you're not gonna get a payoff from it every day. The the payoff is gonna be in bunches over time. It's not gonna be, you know, a linear curve of improvement. So that's hard for people.

Dave: 23:12

The improvements are gonna be, you know, you're gonna flatline for a while, and then all of a sudden you're gonna have sort of a breakthrough. You don't know when that's coming. Could be next week, could be next year, could be 5 years from now. But it will come if you have a good solid process and you think about it and you are improving that process routinely.

Michael: 23:38

I think, a good analogy again, my brain just exclusively thinks in analogies, but I think a good analogy for that is is any sort of, gym going or or exercise type endeavor. Right? If you're working on your, you're working on your bench press and you're plateaued at a certain place and you and you wanna up your bench press a little bit, you're right. You're gonna keep kind of banging your head against the wall eventually if you end up doing the right things and you're working on your form and then everything outside of it that ends up being a daily grind, then eventually, right, you'll you'll break through that plateau, but it won't be every day. Every time you go to the gym, you won't be able to add £5 to your bet.

Michael: 24:16

You may have to go back some days. You may need to work on, you know, some areas that you're you're struggling with, and this would be the same if you're, you know, jujitsu or swimming or running or or whatever it is that yeah. It's not always linear, but just like an equity curve. Right? You you hope it's it's pointing in the right direction even though it it kinda won't be going that way that way every day.

Dave: 24:38

Yeah. You you have to take a long term approach with this. It reminds me of you mentioned, running. Of course, you you know I'm a runner.

Michael: 24:45

Yeah.

Dave: 24:46

When I first started running, I had this loop that I would run for my house. I was probably I was in middle school, not running competitively at all. But I would go to this loop, and I would do it every day, and I would time myself. And I would get a little faster every day. And I said, man, this is great.

Dave: 25:05

This is fun. And then, of course, one day, I was way off my fastest time. I said, man, this sucks.

Michael: 25:13

Mhmm.

Dave: 25:14

But, of course, you realize you have to take a long term approach. It's unreasonable to expect improvement every single time you go out. That's just not reasonable, and that's not how the world works. But to have a process for improvement that you know in 1 year, 5 years from now, you're gonna be better, that's the process you wanna put in place.

Michael: 25:38

Well and and sticking on that example, I think the, diminishing returns can is something that people need to need to understand too. Right? So just to use the running example, say you were getting 5 seconds faster every day for a period of time. Well, if you extrapolate that out in the long run, then you're essentially not taking any time to run the race. Right?

Michael: 26:00

So the the increment in which you need to measure yourself has to change. Right? So maybe your initial goal was to get 1 minute faster around that loop. Well, you know, once you're that fast, well, now your goal should be to get 10 seconds faster around that loop and then 5 seconds. And then, when I used to swim competitively, I remember, you know, the difference between the winner and the loser was sometimes a tenth of a second.

Michael: 26:23

Right? So it was it was always you know, you're you're always pushing to a goal, but you need to know that your goal is always decreasing. Right? So if I have a strategy right now that yields 30% a year, well, you know, I would love to if if it ever got to 300% a year, that'd be fantastic. But the the goals then change to say, okay, well, can I generate a little bit more return and can I do a little bit less drawdown and can I do it's no longer going from 0 to 30 and then, you know, 30 to 60 and then all the way to 3,000,000 percent return?

Michael: 26:54

I'm, you know, posing outside of my Lambo, on my YouTube video that I rented. It's it's the the increment in which you have to measure yourself also has to change. Right? So as you're kinda going down that road, you need to say, okay. Well, you know, I'm generating new ideas, but it might not be to double my return again.

Michael: 27:14

It might be to lower my drawdown or increase consistency or do that or the other thing. So as you're as you get better and as you get more consistent, that that goal will kinda shift as well. Right?

Dave: 27:26

Yeah. For sure.

Michael: 27:28

Alright. Well, again, I love how we always start with, like, a small topic, and and in my head, I'm like, are we gonna be able to cover time in it? But it ends up always being super fun and and super cool, so I always look forward to these. And we're not done with the idea generation topic. We got a whole, other slew of things that we're gonna go down this road of.

Michael: 27:48

So, you know, make sure you're staying tuned wherever you stay tuned at. And, do you have anything to leave the kids with there, Dave?

Dave: 27:56

Yeah. I think, I think that's a good place to drop off. We'll, see you next week.

Michael: 28:01

Alright. See you next week.