Framework Terms
The Trader
Fallacy of Knowledge The framework’s starting point: no one can know what price will do next, and acting as though one can is the source of most trading error. The fallacy of knowledge names the error; the fallacy of knowledge framework names the model built on recognizing it.
Trading Identity The internal sense of who you are in relation to the markets: your values, your beliefs about how markets work, your emotional tendencies, and the routines that structure your day. It shapes every decision before any decision is made.
Expectations Beliefs about what is likely or supposed to happen. Formed from identity, beliefs and prior outcomes, they present themselves with the feel of knowledge.
The Known Not knowledge of the market but the body of expectations the trader brings to it. Expectations wearing certainty.
Unknown What lies beyond a trader’s expectations. Not an obstacle in this framework but the source of performance. Always someone’s unknown—see your own unknown.
Your Own Unknown Everything your expectations fail to capture. The boundary is drawn by the trader, not the market: it begins where your expectations end, and it moves when they do. Not a gap to be closed by knowing more, but the domain the strategy exists to navigate.
Observation What the price sequence and the calendar show at this moment: structure, levels, conditions, scheduled events. Present-tense and checkable; it carries no claim about what comes next.
Fear of Loss (FOL) An automatic defense triggered by anticipated pain from future losses. It presents itself as prudence and operates as avoidance.
Fear of Regret (FOR) The fear of the pain of a missed profit: a trade not taken, taken too small, or closed too early. Reflexive, drawn from stored past regret—distinct from FOMO, which is reactive and driven by social comparison rather than fear.
Mental State The psychological accumulator: the running charge left by every past decision and its outcome. Losses charge it more heavily than gains credit it.
Emotion-Induced Blindness The loss of the capacity to recognize that judgment is distorted, caused by the emotional load itself. The condition in which mindful override fails, because awareness is the thing compromised.
Mindful Override (MO) The deliberate interruption of an automatic System 1 response by consciously engaging System 2. Not the suppression of emotion but the space to evaluate it, activated in five stages before a trade.
Doing the Right Thing Acting in alignment with the plan regardless of pressure and independently of the outcome. The attitude that is the leverage trader’s only edge.
Right Attitude / No-Right Attitude Right attitude is expectations grounded in probability, objective thinking, and disciplined behavior under stress. No-right attitude is its absence: reactive, undisciplined, emotion-driven.
Mental Accounting The subjective labeling of funds by source or purpose, so that identical money is treated differently. The reason a dollar is not always a dollar.
Epistemic Discipline The stance of treating internal feelings as noise and the unfolding price sequence as the only source of usable information.
Cost of Staying in the Game The losses the stop-loss imposes on trades that would have recovered. The price of surviving under leverage.
Value of Realization What taking profit delivers: capital at risk reduced, time-related risk mitigated, capital freed, compounding begun, mental state strengthened.
Thinking Patterns The recurring mental frameworks used to process information and judge situations. Once automatic, they act before conscious awareness can intervene.
Emotional Mistagging The assignment of an inappropriate salience tag—urgency, threat, opportunity, significance—to a trade, timeframe or signal that does not merit it.
Deliberate Ignorance The conscious choice not to form strong predictions, in order to avoid the rigidity that certainty produces.
On-Tilt A heightened emotional state in which agitation and frustration push the trader toward irrational, high-risk behavior in an attempt to recover losses.
Mental Reset Clearing mental state accumulated emotional charge by disengaging from trading for a sustained period.
The Trade
Price Sequence The unfolding flow of price over time; the observable layer in which plays are found.
Play A recurring pattern, the conditions under which it holds, and the rule that places its levels. Stated in relations.
Conditions The market structure and market environment in which a play has been observed to work.
Edge The expectancy a play carries across its instances. A property of the play, not of the trade.
Trigger The predefined signal that confirms the pattern has formed. Defined by the play as one of its conditions, and used at execution.
Traded Timeframe The chart interval to which a setup is anchored. Fixed before entry and unchanged during the trade.
Trade Setup An instance of the play expressed at actual prices within a traded timeframe. The setup is the trade, fully specified before the position exists.
Trade Structure The complete specification of the trader’s response to the price path: an entry, an invalidation, and a series of realizations, all committed before the position exists.
Invalidation Point The price at which the pattern supporting the setup is proven wrong. It defines the stop-loss, and with it the cost of the trade.
Realization Point A price at which part of the position’s unrealized value is converted into realized value, enforced by a take-profit.
Realization The conversion of a position’s unrealized value into realized value, when the take-profit fills. It settles what the trade has paid and makes no claim about where price goes next.
Stop-Loss The order placed at the invalidation point. A tactical tool for limiting loss, not a judgment on the trade.
Take-Profit The order placed at a realization point or to exit at a profit.
Runner The portion of the position left open with no target once the committed realizations have filled. Governed by conditions.
Actionable Price The current price: the only price at which the trader can act, and therefore the only place value can be secured.
Fading Declining the entry when the trigger validates the play and instead waiting for a retracement toward a better structure before positioning. A deliberate delay that improves the structure and accepts missing the trade.
No-Position The decision not to trade, treated as a position in its own right: zero market risk, full optionality.
Risk within a Trade Structure The estimated probability that price reaches the stop-loss before any realization occurs.
Cost The capital loss the stop-loss imposes.
R The trade’s cost, used as the unit for expressing outcomes so that setups of different sizes remain comparable.
Expected Value The probability-weighted average of a setup’s outcomes. The test a setup must pass before it is taken.
Expectancy The average outcome a play produces across many instances.
Realized Performance The actual average return per trade across a series of closed trades.
Glossary of Trading Terms
Market Type
Accumulation Sideways price action after a downtrend, often preceding an uptrend as demand builds.
Distribution Market structure where price rotates within a range after an uptrend, often a precursor to a downtrend as supply overcomes demand.
Compression A market condition in which price is confined to a narrow range as volatility contracts.
Discovery A market condition in which price moves directionally in search of new value.
Mean Reversion The market repeatedly returns to a central value area after deviating from it.
Volatility Expansion Price movement widens as energy builds, often after a compression phase.
Liquidation Phase Rapid, forced selling across correlated assets due to risk-off sentiment or margin calls.
Panic Phase Emotion-driven selling or buying characterized by extreme moves and high volume.
Directional Moves
Trend A market condition characterized by persistent directional movement, typically defined by a sequence of higher highs and higher lows in an uptrend, or lower highs and lower lows in a downtrend.
Breakout A decisive price move beyond a well-defined support or resistance level, often initiating a new trend phase.
Push–A brief directional thrust, often used to probe liquidity, test a level, or extend a local move.
Drive–An aggressive directional move fueled by initiative participants, frequently emerging from the open or from consolidation.
Run–**A sustained directional move that continues through multiple price swings with limited opposition.
Leg One segment of a broader price movement, often part of an impulse-correction sequence.
Liquidity Events
Liquidity Pressure A sustained surge of directional order flow that overwhelms opposing liquidity, compressing available depth and driving price persistently in one direction.
Liquidity Imbalance Zone of mismatch where one side of the market fails to provide sufficient resting orders, forcing price to jump through levels and leaving behind an inefficient, unfilled void.
Run-on-Liquidity A deliberate directional push into a region where large resting orders are expected, with the goal of finding counterparties.
Hunt A deliberate move toward a known liquidity pocket, designed to provoke forced participation from clustered stop-losses.
Sweep A rapid, aggressive traversal through multiple price levels, consuming resting liquidity and triggering stops in a single decisive burst.
Flush A sharp downward move, shaking out weak long positions before reversing.
Squeeze A forced covering of positions—short or long—causing rapid price acceleration.
Trap A false breakout that lures participants into poor positioning before reversing.
Value & Auction Concepts
Auction The continuous process of buyers and sellers interacting to discover a fair price.
Value Area The price range where most trading occurs, representing perceived fair value.
Rotation Price oscillating between value extremes within a balanced market environment.
Acceptance Sustained trading at a price level, suggesting market agreement on value.
Rejection A swift move away from a price level, indicating a lack of market acceptance.
Reversals
Reversion Price returning toward a mean or prior value area after deviation.
Retest or Feedback Loop Price revisiting a previously broken level to confirm its new role as support or resistance.
Backfill A retracement that revisits prices traversed quickly during a prior directional move.
Trading Types
- Holding Period
Scalping Ultra short-term trading aimed at capturing small price moves within seconds or minutes.
Day Trading Opening and closing all trades within the same day to avoid overnight risk.
Swing Trading Holding positions for several days to weeks, aiming to capture multi-day price swings.
Position Trading Long-term holding; weeks to months.
- Execution Style
Discretionary Trading Trading based on analysis and judgment rather than strict rule-based execution.
Systematic Trading Predefined, rule-based systems, often automated for execution.
Semi-Automated Trading Combining discretionary decision making with algorithmic tools for execution.
- Strategy Objective
Trend Following Trading in the direction of the prevailing trend, holding as long as the trend remains intact.
Momentum–Trading strong directional price movement in anticipation of continued acceleration and order-flow imbalance.
Mean Reversion Betting on price returning to an average after over extension.
Breakout Trading Entering trades when price breaks key levels, aiming to catch momentum.
Event-Driven Trading Strategies that seek to exploit pricing inefficiencies that may occur before or after an event, around scheduled or unscheduled events.
Cognitive Biases Observed in Trading
Perceptual Distortions
These operate at the input stage. They shape what the trader notices and how it is weighted before any reasoning begins.
Anchoring Bias: Over-weighting a reference point such as the current price, the entry price, or the last high or low.
Availability Heuristic Overestimating likelihood based on vivid or memorable examples.
Framing Effect The same choice feels different depending on whether it is framed as a gain or a loss.
Recency Bias Letting recent market moves dominate expectations.
Selective Attention Focusing on certain cues while filtering out others.
Heuristic and Probability Errors
These are shortcuts that simplify complexity at the cost of systematic misjudgments about risk, randomness and future outcomes.
Disposition Effect Selling winners too soon and holding losers too long.
Gambler’s Fallacy Expecting a reversal because one is due.
Hot-Hand Fallacy Expecting a streak to continue.
Prospect Theory and Reference Points Evaluating outcomes relative to the entry price rather than on their merits.
Sunk Cost Fallacy Staying in a losing trade because closing it would mean accepting the loss.
Emotional and Motivational Biases
These arise from fear, attachment and ego. They drive the emotional volatility behind poor discipline and inconsistent execution.
Affective Forecasting Misjudging the emotional impact of future outcomes.
Emotional Attachment Ego, hope or revenge overriding evidence.
House Money Effect Taking bigger risks after gains because the profits feel expendable.
Loss Aversion Losses feel roughly twice as painful as equivalent gains.
Motivated Reasoning Reasoning toward a preferred conclusion that protects existing beliefs, expectations or identity.
Myopic Loss Aversion Short-term losses feel disproportionately threatening.
Recovery and Revenge Trades Impulsive attempts to get back to even.
Regret Theory Decisions shaped by fear of future regret.
Temporal Discounting Prioritizing immediate relief or gratification over the long-term outcome.
Interpretive and Narrative Biases
These distort how traders explain and justify market events after the fact, reinforcing overconfidence or rigidity.
Confirmation Bias Seeking or trusting information that supports existing beliefs.
Hindsight Bias Believing I knew it all along after the fact.
Narrative Fallacy Creating coherent stories to explain randomness.
Overconfidence Overestimating the accuracy of one’s judgments, skills or predictions.
Self-Attribution Bias Crediting skill for wins and blaming luck for losses.
Three Measures of Outcome
Three Different Objects
Each measures outcome in units of risk, but each applies to a different object.
Expectancy The play, across many instances. Prospective. Aggregate.
Expected value (See Chapter 4)—One setup, at its prices. Prospective. Per instance .
Realized performance Trades actually closed. Retrospective. Per trade or aggregate; the basis for estimating expectancy.
Expectancy Is Not a Forecast
Expectancy is the average outcome a play is expected to produce across its instances, measured in units of initial risk. When positive, it is the play’s edge, expressed as a number:
Expectancy = the sum of each outcome multiplied by its estimated probability
(outcomes in R; losses counted as negative)
Expectancy Versus Expected Value
Expectancy and expected value use the same arithmetic but answer different questions. Expected value is what one setup is worth at its actual levels, based on the trader’s estimate for that instance. Expectancy is what the play is expected to return on average across many instances, based on its record.
The record gives an exact average of past results, not the expectancy itself. It is only an estimate: the sample is finite, markets change, and in an open-ended play the outcomes that matter most are the rarest.
A play with positive expectancy can still produce setups whose expected value falls below the strategy’s threshold. Refusing them keeps the play’s expectancy intact.
Expectancy belongs to the play; expected value belongs to the setup. Reading expectancy as a statement about the next trade confuses the two.
Realized Performance
Realized performance is the average outcome per trade across a series of closed trades: the sum of realized outcomes divided by the number of trades. It is the empirical counterpart to expectancy, and the basis for estimating it.
It can be expressed through the record’s win and loss frequencies:
Realized Performance =
(Hit Ratio × Average Gain) + ((1 − Hit Ratio) × Average Loss)
Where:
Hit Ratio = proportion of winning trades
1 − Hit Ratio = proportion of losing trades
Average Gain = average outcome per winning trade, in R
Average Loss = average outcome per losing trade, in R (negative value)