So You Want to Be a Trader
So you are brand new to trading and you want to be a successful trader? You'll turn a small amount of money to a large amount in a very short time? Yet you have heard that 80% to 90% of those who trade fail to become financially profitable. You may even have heard from US statistics that 10% to 12% of new traders become bankrupt within the first two years.
But you don't believe these facts or at least you don't believe they apply to you.
Well, I'll let you in on a secret - the stats do apply to you. And, that really is a shame since the road to success is clearly laid out; all you need to is to follow it.
The first step on the road to success is to understand that long term trading accomplishment is not:
Dependent on being to forecast "to the day or minute" turning points.
Being "right" 80% of the time.
Being able to turn "$10,000.00 to $100,000.00 in six months".
Making $12,000.00 trading one contract trading only once a day in two weeks.
Finding a method that generates signals in markets that are 100% accurate.
Etc, etc, etc. You see these types of ads in every issue of Technical Analysis of Stocks and Commodities.
Why does believing the ads set up most beginners to lose? Trading is a probability game. No one can predict the future - by predict I mean nominate a time and/or price that the market will turn, without a shadow of doubt, each and everytime a prediction is made. Once we say that certainty is impossible, we are dealing with the realm of probability.
This means a number of things:
each trade is unique and independent of previous trades
profits and losses are randomly distributed
profits are not dependent on knowing the outcome of an individual trade.
"Indeed, the extent to which you think you know, assume you know, or in any way have to know what is going to happen next, is the same degree to which you will fail as a trader."
Mark Douglas, "Trading in the Zone"
As a novice you have to fully appreciate these points.
One of the most important ramifications is that a number of consecutively successful trades does not mean you have found the Holy Grail of trading. Similarly the fact that you have had a number of consecutively unsuccessful trades does not mean you are a trading failure.
Another important ramification is that a belief you "know" what the market will do will often lead to ignoring market information that the forecast (prediction) is wrong. This in turns leads to the danger that you will hang on losing position turning a small loss into a disastrous loss i.e. a loss that takes you out of the game.
OK so we have some idea of what long term trading success is NOT, now let's have a look at what it is.
You have come to the trading world knowing less than nothing, armed only with dreams of making it big. Generally you will follow one of several routes:
- you will subscribe to newsletters or some sort "trading signal" service: Only problem is you even though you religiously follow all the signals, you end up losing your capital; or because your capital is limited, you take only some signals which usually prove to be the losers.
or you will attend one seminar after another looking for "wisdom" but all you become is more confused - Gann, Elliott, P&L Dot, Market Profile,
or you turn to the "masters" and they give conflicting advice:
Jim Rodgers (co-founder of the Quantum fund with George Soros): I haven't met a rich technician.
Marty Schwartz (one of the most successful S&P traders): I always laugh at people who say, 'I have never met a rich technician'…….I used fundamentals for nine years and then got rich a technician.
Peter Lynch (famed Equities fund manager and author): Don't bottom fish.
Paul Tudor Jones (well known futures trader): Everyone says you get killed trying to pick tops and bottoms and you make all the money by catching the trends in the middle. Well, for twelve years I have often been missing the meat in the middle, but I have caught a lot of bottoms and tops.
But through all the apparent conflicting advice, one pattern emerges.
The trading method you chose must suit your personality and must have an edge (i.e. give a positive expectation for return).
Issues you need to look determine before you compose your plan include such matters as:
Are you more suited to a mechanical or subjective approach?
A mechanical approach means once you have developed the plan, you must take all signals generated by the system. As a general rule, a mechanical method will have simple, unambiguous rules. It's trading history will usually reveal drawdowns of 30% or greater.
The subjective approach will have rules but there will be a discretionary element in its execution. In addition in coming to a decision, there will be a discretion in choosing the information that it applicable to the moment.
A mechanical approach is best suited to those that prefer clear, unambiguous and one-dimensional rules. The subjective approach is preferred by those who can make decisions from a wide variety of information sources and identifying those items which are relevant to the situation.
Are you more suited to buying new highs in uptrends and new lows in downtrends (breakout trader) or buying the end of corrections (dips) in uptrends and rallies in downtrends (responsive trader)?
Most traders have a predisposition towards breakout trading or responsive trading. Being to be able to execute as breakout trader as well as responsive trader is a skill that needs to be learnt.
Do you operate best if you when you have the luxury of time on your hands and are suffer little or no anxiety when you hold positions overnight or do you prefer to make decisions under time pressure and are highly stressed in holding positions overnight?
Do you prefer using fundamentals in your decision making process or are you more disposed towards the technical approach?
Once you have identified the important psychological issues, you can look to the development of your trading plan.
As a technical trader, I can advise only the those who have a preference for the technical approach on the elements required for a plan that has an edge.
Your plan must first have some way of identifying the trend of the timeframe you are trading and changes in trend in that time frame. Identifying the trend or change in trend gives you your strategy. In an uptrend, you are a buyer, in a downtrend a seller and in a congestion market, you have a number of options:
you can stand aside
you can initiate trades in the direction of the previous trend and liquidate positions at the opposite extreme of the sideways market.
The rationale for this is that in the absence of evidence of a change in trend, the market will exit the sideways market in the direction of that in came in. Thus if there was an uptrend before the congestion market, the market will have an upside breakout if there has been no change in trend.
You can initiate buys at the bottom end of congestion and initiate sells at the top end of congestion.
Once you have your strategy, you then have to implement it - choose your tactics. The first tactic is to enter the market - what I call low risk entry.
Low Risk Entry has three components:
1. A Zone:
If you are a breakout trader, this area where the trend has probably resumed on a breakout basis i.e. a new high in an uptrend and new low in a downtrend.
If you are a responsive trader, this is the area that probably marks the end of a correction.
Examples of zones are Fibonacci and Gann retracements, Dynamic Gann Levels, Steidlmayer Zones, statistical zones.
2) A Setup:
If you are a breakout trader, this is a chart pattern area that tells you that the breakout is probably valid.
If you are a responsive trader, this is a chart pattern that tells you a zone is likely to hold.
Setups are found in many described in a number of books. Some of the more recent ones:
Hit and Run Trading by Jeff Cooper
StreetSmarts by Connors and Raschke
Finbonacci Ratios and Pattern recognition by Pessavento
Stock patterns for Day Trading by Barry Rudd
3) An entry technique and initial stop placement.
The entry tells you how to enter the trade and the initial stop placement tells you where the trade is wrong and where to exit.
It is worth meantioning that in setting stops, first identify where the stop should be and then identify if the stop is within your money management. I do not recommnend placing pure money stops. It is the nature of markets to back and fill unless they are thrusting directionally and as a result, pure money stops tend to get executed. This is the main reason for the trader's lament:
"They gunned my stop and the market then moved my way!" (grr!!!!!)
I am not saying our technical stops don't get hit only to find that the market then moves in our direction. But it in my experience pure money stops are inefficient.
Now once we are in a trade, our plan must set out the rules for managing the trade - trade management.
Trade Management is an essential ingredient of the plan and one that most novices neglect. Trade management can be separated into initial management and subsequent management.
Initial management answers the question: "Should I exit a trade even if my stop is not hit"?
Subsequent management sets down the way we will protect our profits.
Too often the novice trader belives he has done all he needs to once he has completed his plan. Nothing could be further from the truth.
There are two other planks for trading success. The first of these is an effective money maangement plan. Effective money management answers a series of questions. The answer to the questions is dependent on our financial ability to take a loss, the trading edge of our plan, the volatility of the markets we will trade and our psychologically ability to take the loss.
So what are the questions?
How much capital do I need to start trading?
Too many traders come to the markets undercapitalized. Trading is a business; it is a well known fact that most small businesses fail from a lack of capital. The same can be said for trading failure.
How much of my capital should I risk in any one trade?
How much capital should I allocate for all my postions at any one time?
How do I increase the number of traded contracts as my capital increases?
The books I have found helpful:
"Winner Take All" by W Gallacher (chapter on Money Management)
"Bankroll Control" by M Pascual (chapter on commodity trading)
"The Trading Game" by Ryan Jones
The final element for successful trading is cultivating a winning psychological attitude. This is far the most difficult. There are many important traits that a trdaer needs to cultivate - the books by Robert Koppel and Howard Abel set these out. But the two most critical traits are:
a) Accept the outcome of the Trade.
At its core, winning psychology has as its base the "acceptance of the outcome of a trade".
By acceptance I mean the ability of being aware of an emotion without "buying into" its content; some may call this 'mindfulness'.
e.g.
Contrast:
Imagine you have just entered a trade and the very next bar is a big range bar against your position:
"My God here I go again! Can't I do anything right! What will my wife say if I take yet another losing trade!
May be I should move my stop? No I can't do that - the last time it cost me my bank! But what about the other day when I got stopped out only to have go my way? This is just too hard!!!!" etc etc.
With:
Imagine you have just entered a trade and the very next bar is a big range bar against your position:
"The market is approaching my stop. I feel uncomfortable with the price action and I can live with the discomfort".
The first trader may think he has accepted the outcome but in fact he has failed to do so at the emotional level; the second trader has accepted the outcome at all levels.
This idea of acceptance applies not only to loses but to profits as well. The trader that "accepts" an outcome realizes that on an individual trade basis a positive outcome on one trade does not translate into a future of unlimited profits.
At its core "acceptance" realizes that trading is based on probabilities, as such every trade is unique. In other words, the past does not equal the future.
Ultimately to succeed, we, as traders, need to adopt two apparently contradictory beliefs:
"That the market is uncertain and unpredictable and that the market is relatively certain and predictable".
The resolution of this apparent conflict is found in the timeframes that we hold the beliefs.
At the trade by trade level, we hold the first belief. Because the market can and will probably do anything, we seek first to protect our capital in the execution of our trading plan. In other words, we must always have an exit strategy.
At the level of a "large sample size", we hold the second belief. To the extent our trading plan has an edge, will be the extent to which the market will be predictable and certain.
In short we accept that with trading we are dealing with probabilities and not certainties.
It is of imperative importance we hold these beliefs not only at an intellectual level but also at every level of our being - especially the emotional level.
As a trading coach I have seen, time and again, lip service acceptance to the idea of probability; but when it comes to actually trading, the traders behave as if each and every trade must be a winner - they have a need for certainty. How else can we explain the popularity of services advertising 90% hit rates? If the ads were not drawing an adequate response, they would disappear.
Probability thinking leads to a host of other states and beliefs:
1. Because we know that we will succeed in the long run and because we know we will protect ourselves no matter what the market does, we acquire the state of "self trust" and the state of being "carefree". In turn these states allow us to remain....
2. Focused, confident and carefree when we are experiencing the inevitable prolonged drawdown.
3. Because at the trade by trade level we know that the market is random, we will not allow euphoria to set in and lead us to reckless trades. Each trade will only be one in a series of probabilities.
4. We will view market information not as a source of pleasure/pain but merely as data providing us with opportunities. This is not to say trading should not be fun; indeed not only should it be but for most traders it MUST be.
However the fun comes from the flawless execution of the rules appropriate to our stage of evolution and not from trade by trade results.
If we accept the outcome of the trade, we are on our way to overcoming two blocks to winning psychology:
Fear and Euphoria.
The universal fears are:
The fear of being abandoned and
The fear of losing control.
If we reflect for a moment, we'll see how the fear of being abandoned comes about.
As young children, we are totally dependent on our parents. Very quickly we come to realize that if they ever abandon us, we shall be unable to care for ourselves. Most of us fail to confront this fear as we grow into adulthood. As a result we automatically deal with it by attempting to control our environment - the people, conditions and events that surround us.
This tendency to control may or may not be appropriate in other areas of life but as a strategy for trading the markets it is a bust. Most of us are incapable of influencing the market even for the shortest moment, let alone control it.
The effect of fear is to drive out knowledge; it leads to myopia; it immobilizes us and leads to inaction.
The mirror image of fear is euphoria - the feeling that we can do no wrong. As much as fear, euphoria will ultimately lead to trading failure. Since trading is a game of probabilities, we will experience times when we can do no wrong. But these times will come to an end. The trader caught in the euphoric trance will not recognize this and taking one risk too many will eventually get caught in a heavy loss. If he is lucky, the loss will not be a catastrophic loss.
Fear and Euphoria can catch not only newbies but also the most experienced and successful trader. Witness the demise of (Trader) Vic Sperandeo. Vic started trading public funds in 1972 and for over 25 years had a very successful career. His view on trading can best be summarized by the passage below:
"I'm a market professional....and I am very good at what I do.... I never gamble more than I can afford to lose.... I think my unique strength is in my consistency.. I pride myself in my ability to successfully stay in the game..."
(Trader Vic, Methods of a Wall Street Master page ix)
In 1998 Vic was said to have gone bankrupt as a result of one trade.
Euphoria or Fear?
It doesn't matter. Whatever the reason, Vic lost a reputed US$50 million and is now out of the game.
The best book I have seen on this area is Mark Douglas' "Trading in the Zone"
The other critical element is what has been named "the adversity quotient" (AQ). What is the adversity quotient? To quote:
"First, AQ is a new conceptual frmework for understanding and enhancing all facets of success….Second, AQ is a measure of how you will repond to to adversity….Finally, AQ is a set of scientifically-grounded tools for improving how you respond to adversity".
(Adversity Quotient by Paul Stoltz, PhD)
Trading forces us to face our deepest fears and to shine a light in those dark corners we would rather leave dark. AQ gives a set of tools that makes it easier to persist in the face of the greatest of difficulties.
Trading is simple but not easy. It is simple because the roadmap to success is clearly laid out; it is not easy because following the map is diffiult. One thing is clear, there is no short cut - you cannot buy success (i.e. money alone will not be enough); you can acquire information but in the last resort, your success is function of the effort (time, energy and money) you put in.
Ray Barros
ramonbarros@visto.com
Monday, September 20, 1999
tradingsuccess.com |
