SYSTEM BASICS – A DEEP DIVE

The mathematical algorithm that is the driving force behind Tactical Trading is technically referred to as a ‘tempered Martingale.’ The term Martingale originated from a type of casino wagering where the bet is doubled after a loss or halved after a win. It is commonly known as a mathematical solution to a two-occurrence random walk.

For instance, in the game of roulette, you can place bets on either black or red, which are the two random occurrences. If you bet on black and lose, you would double your bet. If you continue to bet on black and face consecutive losses, you will double your bet each time until you eventually win. This approach allows you to recoup any previous losses and make a profit equivalent to your initial bet.

In the stock market, the Martingale system is similar to dollar-cost averaging. While it can be effective in some instances, there are times when the continuous doubling of stock shares purchased becomes impractical. Additionally, there is the issue of unrealized capital losses should the stock price decline.

The Tactical Trading system rules are built upon a modified version of the Martingale betting system, specifically the “Labouchère Cancellation System.” Originally designed for the game of roulette, this adaptation has been refined to suit the timing of stock transactions, forming the foundation of our trading approach.

From Wikipedia: “The user of such a strategy decides before playing how much money they want to win and writes down a list of positive numbers that sum to the predetermined amount. With each bet, the player stakes an amount equal to the sum of the first and last numbers on the list. If only one number is left, that number is the amount of the stake. If the bet is successful, the two end numbers are removed from the list. If the bet is unsuccessful, the amount lost is appended to the end of the list. This process continues until either the list is completely crossed out, at which point the desired amount of money has been won, or until the player runs out of money to wager.”

Here is an example…

A straightforward way to grasp the fundamentals of the system is by using a coin flip, where heads represents a win and tails represents a loss. When trading a stock a win is when the stock moves up in price, and a loss is when the stock moves down in price.

The starting point of this system is known as the cycle series, which consists of a series of positive numbers used to determine the amount of stock shares to buy or sell. To begin your tutorial, we will use a simple coin flip.

Let’s assume we start with a numerical series of 1 2 3 4. If we win, we remove the two end numbers (the first and last numbers), resulting in a new series of 2 3. On the other hand, if we lose, we sum the end numbers of the current series and append that figure to the end, making it 1 2 3 4 5.

For the purpose of illustration, let’s imagine that the coin flip alternates between heads (win) and tails (loss).

Starting with the cycle series of 1 2 3 4, our first coin toss yields heads, indicating a win. We remove the two end numbers, and the series becomes 2 3.

The subsequent toss results in tails, representing a loss. Therefore, we add the two end numbers (2 + 3 = 5) to the series, which becomes 2 3 5.

The next flip is heads, signifying another win. Our current series is 2 3 5. With a win, we remove the two end numbers, and the new series becomes a single number, 5.

Continuing the pattern, the following flip shows tails, indicating a loss. Again, we add the two end numbers together. Since our series contains only one number (5), that number becomes the end number. Consequently, we add 5 to the current series, resulting in 5 5.

Upon flipping the coin again, we obtain heads, denoting a win. As per the rules, we remove the two end numbers (5 and 5). This action clears all the numbers in the series, signifying the completion of the cycle.

You can easily practice with your own number series to achieve a more random outcome. All you need is a coin, pencil, and paper. For convenience, start with a short series of consecutive numbers, such as 1 2 3 4.

As you continue with your random coin flips, remember that a win requires you to remove the two end numbers from the series, while a loss necessitates summing the two end numbers and adding the result to the end of your cycle series.

You will notice that sometimes the cycle completes quickly, while other times it may continue for a while, resulting in a lengthy series. Regardless, as you keep flipping the coin, eventually all the numbers in the series will cancel out, completing the cycle.

I encourage you to practice with various combinations of number series. The numbers should be positive and consecutive. For instance, 1 2 3 4 is a suitable choice, while 1 3 2 5 can work but is not recommended.

Shorter cycle series tend to work better than very long ones.

The Tactical Trading algorithm is considered a perfect solution for a two-occurrence random walk. For instance, in roulette, you can bet on red or black, or in a coin flip, it’s either heads or tails. In our case, the random walk or the two occurrences refer to the regular upward and downward movement of a stock. In Tactical Trading, the solution is derived from manipulating a numerical series by adding to or subtracting from the series as the stock moves up and down within its natural cycle.

Now, I will introduce how we progress beyond the coin flip and expand the algorithm to effectively work with stocks instead of a coin.

The success of the Tactical Trading engine relies on three key factors: the number series, the share multiplier, and the price change in the stock that triggers an activity, referred to as the trade range.

The “number series” can be composed of any combination of numbers and can be as short or as long as desired. It can be as simple as 1, 2 or as complex as 1, 2, 4, 8, 16, 32. For this example, we will use the series 1, 2, 3, 4, 5, 6, and when this series is activated, we refer to it as a “cycle”.

The “share multiplier”, known as the shares per series, is a number that guides us in determining the initial number of shares to buy and subsequently informs us about the precise number of shares to own at any given point during the cycle’s lifespan.

The “trade range” represents the specific point change in the stock price that must occur to trigger an action. Later, you will learn how the trade range is used to calculate the expected gross profit once a cycle is completed.

In this initial example, rather than using price changes, we will employ a coin flip to determine whether the stock goes up or down. We will alternately assign heads and tails until the cycle is completed. A cycle is considered complete when the number series is reduced to zero, meaning all the shares owned have been sold.

Let’s begin with the number series 1, 2, 3, 4, 5, 6. In this example, we will set the number of shares per series to 100 and the trade range to $1.00. It’s important to note that you can choose any series of numbers of any length and order, but for now, we will stick with the numerical series 1, 2, 3, 4, 5, 6.

For the coin toss, we will assume that if it lands on heads, the stock price has increased by $1. On the other hand, if it lands on tails, we will assume that the stock price has decreased by $1.

The first step is to determine our initial number of shares to buy. To do this we add the two end numbers of the series together and multiply the sum by the share multiplier.

Series 1, 2, 3, 4, 5, 6

Sum the two end numbers: 1 + 6 = 7.

Multiply the sum by the share multiplier: 7 x 100 = 700. The total shares required to be held at any given time will always be the sum of the series’ two end numbers multiplied by the share multiplier.

Our initial purchase will be 700 shares. If the coin toss comes up heads, a win, we will remove the two end numbers from the series.

If the coin flip is tails, a loss, we will append the sum of the two end numbers onto the end of the numerical series.

We will toss the coin until all numbers in the series are canceled out.

Win and the series is reduced from 1, 2, 3, 4, 5, 6 to 2, 3, 4, 5.

Lose and the series grows to 1, 2, 3, 4, 5, 6, 7, the first number “1” plus the previous last number “6” results in the addition of the number 7 to the end of the series.

Now, let us start to flip the coin… Again, we begin with a series of 1, 2, 3, 4, 5, 6. In this example, the coin flips will simply alternate between heads and tails.

The following tables explain the succession of the cycle:

I find that when I introduce the system for the first time, it can be confusing for some people. So, I suggest going back and running through the example once more, if necessary. You may find it helpful to follow along with pen and paper. The next scenario will be closer to what happens when the cycle is live and invested, and it is a bit more complicated.

In our first example, we assumed a scenario where the stock simply alternated up and down, up and down, up and down. However, in reality, such perfect price patterns are very rare. If you do come across a stock that behaves in this manner, Tactical Trading can help you make a fortune.

In the real world, stocks behave randomly. But don’t worry, this doesn’t prevent the system from working. So, let’s try flipping a coin to simulate the random and unknown behavior of stock prices. You can either follow my example or, if you understand the formula well enough by now, you can give it a try yourself.

This time I am going to use a shorter series of 1 2 3 4. This has proven to be a particularly good number series in real-world trading.

Series: 1 2 3 4

Trade range: $1

Share Multiplier: 100

One of the amazing features of Tactical Trading is that we can determine in advance the exact amount of gross profit we will earn when the cycle is completed. This profit is not dependent on the stock’s price and remains mathematically perfect regardless of how long or short the cycle duration may be.

To calculate the gross profit potential, we need to add the Series Numbers together: 1 + 2 + 3 + 4 = 10.

Next, multiply the sum by the Trade Range: 10 x $1 = $10.

Then, multiply this result by the Share Multiplier: $10 x 100 = $1000.

That’s it! Even before purchasing a single share of stock, using this combination of Series, Trade Range, and Share Multiplier, we can confidently anticipate a gross profit of $1000 at the end of the cycle.

We can increase our profit by adjusting any of the three factors. If we double the Share Multiplier from 100 to 200 and apply it to the formula, we can expect a gross profit of $2000. Similarly, by increasing the Trade Range from $1 to $2, we can also achieve a known gross profit of $2000. Changing only the series from 1 2 3 4 to 1 2 3 4 5 would result in a gross profit of $1500.

Conversely, reducing any of the three factors will yield a lower profit.

Now, on to our coin flip… We are going to use money this time so let’s assume the stock we are buying is trading at $10 per share. I will show the dollars used to buy shares as a debit and sells as a credit.

As we anticipated, this cycle has resulted in a gross profit of $1000. If we had purchased a $10 stock, this profit would represent a 20% return on our initial investment. Considering that the cycle took one month to complete, the annualized return would be an impressive 240%! Just imagine the possibilities if we were to compound our profits by engaging in consecutive cycles throughout the year.

To provide a fair assessment, I recommend calculating the return on the maximum investment made during the cycle as well. In the previous example, the maximum investment amounted to $8300, resulting in a gross profit percentage of 12%. This is still a commendable return over such a short period.

If we were to factor in the use of margin to purchase the shares, the potential profits could be even more remarkable. Assuming a 50% margin, the return on our cycle would increase to 40%, corresponding to an annualized return of 480%. We will delve into the use of margin in a later chapter for further exploration.

Did you notice that the cycle series started and ended at the same price? Despite buying our initial shares at $10 and selling our final shares at the same price ($10), we still managed to achieve a gross profit of $1000. This shows the power of our position management system.