Surviving the Trading Game
So you see in the trading game, after a trader has a robust system it is still the best risk managers that win in the long term.How many losing trades in a row can your capital survive at your current risk level? That may be the most important element for would be traders to fully understand
10 Lessons for Traders
1. Trading affects psychology as much as psychology affects trading – This was really the motivating factor behind my writing the new book. Many traders experience stress and frustration because they are trading poorly and lack a true edge in the marketplace. Working on your emotions will be of limited help if you are putting your money at risk and don’t truly have an edge.
2. Emotional disruption is present even among the most successful traders – A trading method that produces 60% winners will experience four consecutive losses 2-3% of the time and as much time in flat performance as in an uptrending P/L curve. Strings of events (including losers) occur more often by chance than traders are prepared for.
3. Winning disrupts the trader’s emotions as much as losing – We are disrupted when we experience events outside our expectation. The method that is 60% accurate will experience four consecutive winners about 13% of the time. Traders are just as susceptible to overconfidence during profitable runs as underconfidence during strings of losers.
4. Size kills – The surest path toward emotional damage is to trade size that is too large for one’s portfolio. We experience P/L in relation to our portfolio value. When we trade too large, we create exaggerated swings of winning and losing, which in turn create exaggerated emotional swings.
5. Training is the path to expertise – Think of every performance field out there—sports, music, chess, acting—and you will find that practice builds skills. Trading, in some ways, is harder than other performance fields because there are no college teams or minor leagues for development. From day one, we’re up against the pros. Without training and practice, we will lack the skills to survive such competition.
6. Successful traders possess rich mental maps – All successful trading boils down to pattern recognition and the development of mental maps that help us translate our perceptions of patterns into concrete trading behaviors. Without such mental maps, traders become lost in complexity.
7. Markets change – Patterns of volatility and trending are always shifting, and they change across multiple time frames. Because of this, no single trading method will be successful across the board for a given market. The successful trader not only masters markets, but masters the changes in those markets.
8. Even the best traders have periods of drawdown – As markets change, the best traders go through a process of relearning. The ones who succeed are the ones who save their money during the good times so that they can financially survive the lean periods.
9. The market you’re in counts as much toward performance as your trading method – Some markets are more volatile and trendy than others; some have more distinct patterns than others. Finding the right fit between trader, trading method, and market is key.
10. Execution and trade management count – A surprising degree of long-term trading success comes from getting good prices on entry and exit. The single best predictor of trading failure is when the average P/L of losing trades exceeds the average P/L of winners.
10 Questions for Traders
Here ae the top 10 Questions Traders must ask to protect them from themselves.
1. Where does the price of my trading vehicle have to go to prove I was wrong about my entry?
2. How much is the maximum I will lose on the trade if I am wrong?
3. What are my rules for entries?
4. How will I exit my winner to bank profits?
5. What is the current trend of the time frame I trade in?Where is my best entry point to trade in this direction?
6. What is my watch list for things I will be trading today?
7. What is the maximum amount of risk I will put on at any one time?
8. What has to happen in the markets for me to just go to cash?
9. What exactly is my edge that will make me successful in the long term?
10. What is my objective as a trader? Capital appreciation? Trading for a living? Financial independence? 20% annual returns?
To be a successful trader you must first ask the right questions. I believe the above questions are a great place to start.
TRADING IS SIMPLE. IT’S JUST NOT EASY
I think we need to look differences between the context of each phrase.
When I describe the idea of trading being simple, what I really mean is that itshould be effortless. The word effortless is defined by Merriam-Webster Dictionary as:
showing or requiring little or no effort
I believe that good traders are able to trade the markets effortlessly – it’s simple to them. But getting to the point of doing anything effortlessly is noteasy. In fact, it’s really hard. A good analogy would be describing an athletes ability to perform his or her skill. If we took two people – one being a person who runs two miles everyday versus a person who hasn’t ran for the past two months, who will have the easier time running one mile? The answer is simple of course. The person who runs everyday will be able to run one mile easily – it will be effortless to them. However, the person who hasn’t ran in two months will find it extremely hard to and likely have to take breaks in-between so that he or she can finish.
In order for trading to become simple, there are some crucial and necessary steps that need to be taken. There needs to be consistency in the traders approach to the markets. It’s unfortunate, but we are in a day and age where traders are obsessed with just “trading for the fun of it”, and they aren’t realizing that that’s what’s preventing them from being consistent and successful. Again, if we go back to our analogy, does a great athlete deter from their routine? No. In fact, they have routines that boil down to eating, and sleeping habits in order to keep themselves moving in the right direction. It’s really not a mystery, but for whatever reason most traders seem to fail that this approach is what’s needed if you want to be good.
There really is a direct correlation between traders who are good and traders who are not. There is a direct correlation between traders who are consistent and traders who ride the roller coaster. That difference is preparation. Preparation and repetition is what makes anyone great at what they do. But preparing is not easy. It takes focus, will, and a lot of discipline. In trading that translates to having a very specific trading plan, with specific rules and the discipline to do it every single day. And as you prepare yourself everyday in your approach to the markets, you’ll find that trading becomes simple. It becomes effortless.
So if you want to be a good trader, scratch that – if you want to become a great trader, step back and think about what it really takes, and prepare yourself. It won’t be easy, but sooner or later you’ll realize how simple it really is.
Words of Wisdom from Colm O’Shea
You need to implement a trade in a way that limits your losses when you are wrong, and you also need to be able to recognize when a trade is wrong.
… what strikes me about really good managers (is that) they don’t get attached to their ideas.
You need a method that suits your personality.
People who like trading because they like gambling are always going to be terrible at it. For these people, the trading books could be greatly shortened to the message: “Don’t trade. You are really bad at this. So just don’t do it.”
Traders who are successful over the long run adapt. If they do use rules, and you meet them 10 years later, they will have broken those rules. Why? Because the world has changed.
Jack: How do you go long a bubble and protect yourself?
Colm: When it starts to go down, you sell it.
Jack: Are there traits that determine who will be a successful trader?
Colm: Perseverance and the emotional resilience to keep coming back are critical because as a trader you get beaten up horribly. Frankly, if you don’t love it, there are much better things to do with your life. You can’t trade because you think it is a way to make a lot of money.
Expectancy
Expectancy = (probability of win x average win) + (probability of loss x average loss)
The average win and average loss can be either percent gain or loss or it can be dollar values. For example, following are the performance statistics for one of my trading strategies:
Probability of win = 71.7%
Average win = 2.72%
Probability of loss = 28.3%
Average loss = -3.59%
I can calculate the expectancy in percentage terms as follows:
Expectancy = (0.717 x 0.0272) + (0.283 x -0.0359) = 0.93%
The above calculation appears to be by far the most common used by traders. However, after reading Kevin Davey’s article on the Futures Magazine site, I engaged Kevin in an offline conversation about the expectancy calculation. In his article, Kevin presents a means of normalizing the expectancy by dividing the result in the formula above by the average loss.
Normalized Expectancy = [(probability of win x average win) + (probability of loss x average loss)]/absolute value of average loss
For my trading system discussed above, the normalized expectancy is 0.93% / 3.59 = 0.26%. At this point, one has to wonder what is the benefit, if any, of normalizing the expectancy.
I suspect most traders would choose the system with the higher expectancy with all other things being equal. If, for means of calculating compound annual growth rate, gain per day and Calmar Ratio, we assume that the trades for these two systems occur at the beginning of consecutive months we will find that the system with the higher expectancy in our example also has the higher Calmar Ratio and higher average percent gain per day. For me, the system denoted by the blue equity curve is the preferred system to trade. In this example, the normalized expectancy indicates that both systems are equal but I don’t agree with that. Therefore, the normalized expectancy was of no value to me in comparing the two systems. Does that mean normalized expectancy never points a trader towards a superior system? Stay tuned.
4 Trading Quotes From Mark Douglas
If you really believe in an uncertain outcome, then you also have to expect that virtually anything can happen. Otherwise, the moment you let your mind hold onto the notion that you know, you stop taking all of the unknown variables into consideration. Your mind won’t let you have it both ways. If you believe you know something, the moment is no longer unique.
To whatever degree you haven’t accepted the risk, is the same degree to which you will avoid the risk. Trying to avoid something that is unavoidable will have disastrous effects on your ability to trade successfully.
The less I cared about whether or not I was wrong, the clearer things became, making it much easier to move in and out of positions, cutting my losses short to make myself mentally available to take the next opportunity.