Blog / Don't Go Broke
Don't Go Broke
In this article I will try to raise awareness, that to be a long-term winning market player you constantly need to strive for better and better performance as a world-class athlete or any top level sportplayer try to do.
You constantly need to improve:
- Your trading system (Reliability, performance, data sources…
- Your market knowledge. (General analysis, Real time market status diagnosis, strategy recognition, opportunity recognition, risk / reward recognition…)
- Yourself. (Both ,mentally and physically) A winning trader’s mind is quite different than the rest of the market player’s mind, or as we say, the other 95 [%].
If someone ask me what is the most interesting characteristics of the market in general, I would say, that its ability to mislead the most amount of market players the most of the time.
It very often gives “false” signals, temporarily breaking trends just to continue soon in the original direction, it often gives false breakouts or false breakdowns, it often moves suddenly to take either long or short stops from traders and turn back quickly after that.
I consider this to be a very important characteristics of the market.
We humans learn throughout our lives a lot of different things.
1. We learn the rules of Nature. How things work.
Most of the time the rules apply, so those things work the same way independently of time and location.
For example If you switch on a TV it works as expected. If you switch on a car, it works as expected….
2. In social science the rules are different and a bit more complicated, but those, who have enough intelligence can learn and apply the proper rules to make things work.
For example you learn how to create friendships and maintain those friendships over time. Since you know the rules, you know what you need to do to make it work (Most of the time.)
3. When someone who spent all his / her life learning the rules, that belong to category #1 or category #2 come to the stock market and start playing it, will quickly realize, that rules NOT work the same way, or even the rules, that the person try to apply, very often questionable. The market has an unlimited number of rules, that one person will never be able to discover completely. (Does not even need that for consistent profitability.)
Many of the market rules never revealed by public documents.
And even those, that revealed, very hard to apply in practice, due to the nature of probability. Unlike most of the rules, that we learned in our life, the rule of probability might be hard to digest and accept for those, not well versed in that topic.
I heard from some professors on the IT field, that Today’s students are excellent to learn the rules, that they teach to them, but they are basically not capable to discover new rules, or only a very small number of those future scientists, maybe one out of hundreds or even less than that. It was not like that 30 – 50 years ago.
To be a real innovator you need to ask questions (Or more importantly the Right questions) from yourself or from others, and you need to find the answers, which is usually the hard part and take much more time.
The best learning occurs, when you find the answers to those questions yourself. That is the best feedback, which will be engrained deeply in your brain.
If someone, who consistently loosing money on the market asks me what to do to be consistently profitable I can give a cynical answer:
Do exactly the opposite of what you did, when you consistently lost money in the market.
If someone ask me what is more important for me that I focus on during a specific trade:
1. Get the expected profit out of the trade or
2. Execute my market participation the best possible way
according to my current knowledge of the market or
3. Not to lose more than a predefined minimum, or possible not to
loose at all in the trade or
4. Focus to get in and out of the market at ideal market turning
points on my time-frame to reap maximum possible profits.
Than my answer would clearly be #2 from the above four.
Books will not make you great trader alone.
If you read hundreds of trading books, and than go into the market, than do you think your perceived knowledge will give you a relief? No.
But when you learn one little aspects of the market in which you find an edge and in that little area get truly professional and consistently profitable to trade it than this will give you a relief.
From that you can start building upward.
You Must find a True Edge in the market. That is the first requirement. Without edge, you have zero chance to survive long-term. If someone else give you the edge, that you able to take advantage of, that is OK.
Than you need to learn risk management, position management not to get broke.
We can read from literature to strive to trade only situations, when the Risk / Reward ratio is greater than 2.5 or even three.
That sounds nice, but worth little in reality unless someone really do the homework in this area.
Suppose you are a swing trader trading S&P500 related ETF and in a specific Long situation you estimate the risk to be 1.2 [%] and the potential profit to be 3 [%]. Ok you go in and after the trade entry you enter a stop trade 1.2 [%] below the purchase price. All is done. Do you really control the risk this way? No.
Take a look at the biggest 50 Gaps during the past 20 years in the market in the following table:
So as you can see, the potential Gap against your position overnight is much bigger, than your stop in the worst case.
Since ETF-s are not traded overnight, the true risk might be way bigger than you wanted to be.
With this ETF trading you can control the risk by entering stop levels only by trading during opening hours, basically if you are a Day-trader.
On the other side, trading the S&P500 futures, your chance that the entered Stop will function and save you from a real headache is mush better, as those futures are traded overnight.
To be able to perform well and consistently well, you must decrease position size during slumps and must increase position size during good times. To do this you need to be able to recognize quickly the good times and the bed times using objective methods.
As it is written in the order if risk / reward, for the real professionals the first question during a specific market situation is Not the Reward, but: “What is the risk a this point?”
I guess must market players learn the hard way how to protect their trading capital.
To give you a few selected thoughts about why traders “fail”, and how can they improve in general I collected useful ideas from my friend Brett Steenbarger (who is a Day-trader, and trader coach) and present those for you below:
●The majority of traders are looking for expertise in all the wrong places. They look for *the* right trading charts, indicators, setups, or systems. They are like beginning golfers who think they'll succeed if they only get the right set of clubs. Because they hope to get "the answer", they expect success in a year or two. The research is unequivocal: expertise develops over a period of many years. If those years are not structured properly, traders will repeat a single year's experience ten times; they won't acquire ten years of experience.
●The vast majority of offerings in trader education are not structured for expertise development. Seminars, books, Web articles and blogs, weekend courses--all can be useful in imparting information. But expertise development is not simply about the accumulation of information; it is about skill development under realistic, challenging conditions. No doctor, athlete, or musician could acquire expertise by attending seminars or reading books alone. The same is true for traders.
●The reason most traders fail is that they never enter a path of expertise development. It is rare to find training programs of any quality and substance at proprietary trading firms; one finds mentorship at investment banks and some hedge funds, but this is very hit or miss depending upon the commitment of the mentor and his/her skill in imparting skills and structuring a learning process. The independent trader has even fewer resources to generate and sustain an accelerated learning curve. There is much more to acquiring expertise than keeping a journal and trying to follow a simple plan.
So what does a trader need to progress from being a novice toward becoming competent toward exhibiting expertise? A curriculum: a structured process, like physicians undergo, that begins with information and understanding and then progresses steadily through skill development.
Would the distribution of elite talent look any different for musicians, basketball players, research scientists, or chess players? A high and sustained level of success in any of these domains is rare, but it *is* attained and attainable. It is achieved as the result of a developmental process, not as the uncovering of any magic setup or indicator. The single greatest challenge for traders and trading psychologists alike is to harness this developmental process. Are you on a learning curve that can lead to the acquisition of expertise? I can think of no more important question for self-evaluation.
●Especially interesting is the discussion of how the brain undergoes changes (myelinization) as the result of proper training.
So there you have it: why so many traders fail. They begin trading without technique. They try to develop their trading accounts before they've done the work to develop their brains.
●It's a common observation that traders fail because they don't stick to their plans. My experience is different. Traders develop plans and trade patterns that simply don't work; they're based on randomness. When the patterns don't work, traders become frustrated and abandon their plans. So it looks like lack of discipline causes trading failure. But planning doesn't create success; sound planning does. Sticking to plans based on randomness is no virtue.
●Among the predictors of trading success, a "passion for trading" is grossly overrated. The successful traders have a passion for markets, which is very different from a passion for trading. Indeed, a passion for trading in the absence of passion for markets is a fair definition of addiction.
●Some traders habitually look for tops in a rising market and bottoms in a falling one. There's much to be said for countertrend methods, but not when the need to be right exceeds the need to make money.
●An underrated element in trading success is mental flexibility: the ability to shift views and perceptions as new data enter the marketplace. It takes a certain lack of ego to form a strong view and then modify it in the face of new evidence.
●A trader I spoke with recently told me he was going to trade more aggressively by putting on more trades. Trading more frequently is not necessarily trading more aggressively, and it certainly isn't necessarily trading prudently. Trading more aggressively means allocating more risk capital to particular (sound) trade ideas. A considerable portion of traders would benefit from trading less frequently *and* more aggressively.
●Many traders fail because they're focused on what the market *should* be doing, rather than on what it *is* doing. The stock market leads, not follows, economic fundamentals. Some of the best investment opportunities occur when markets are looking past news, positive or negative.
●Success in trading requires the capacity for personal investment. Too many traders close out their efforts, along with their positions, at the end of the day.
●When you are functioning as your own trading coach, you are also acting as your own trainer. You are creating a directed program to train yourself to perform more effectively under given sets of emotional and market conditions. This is why so many traders fail to change their behaviors, despite the best of intentions. They operate as if a coaching session--with self-talk or journal entries--can correct their problems, when what they really need is an ongoing process of training
●Many traders fail because they cannot limit their risk. Many others fall short because they
lack the courage of their convictions. Somewhere between confidence and overconfidence lies the sweet spot for successful traders.
●Many traders fail to reach a high level of development because they change what they're doing--run from one approach to another--long before they could ever build and internalize core trading skills. Many others fall short of their potential because their development is relatively unstructured, with vague goals and few concerted efforts to learn from experience.
Think of how an Olympic athlete develops from childhood to the point of elite competition and think of how they train for an Olympic event: that will provide a useful template for how traders can reach similar elite levels of performance. Psychology is necessary for elite performance; it is not sufficient.
●I've written quite a few posts to attempt to guide beginning traders. But what if you're a trader who has reached the stage of competence? Now you can consistently cover costs and sustain modest profits. How do you get to the next stage of expertise, where you can make a solid living from your trading?
What many competent traders do is try to magnify their modest profits by trading more instead of by trading larger. Because they have modest account sizes, they cannot size their trades significantly, so they try to put on more trades. Such overtrading takes them out of their niches of competence and leads them to lose money.
Those traders don't recognize that they may already have the skills to become excellent traders. After all, a trader who can make $200/day trading 5 lots in the ES futures could be making $2000 a day trading 50 lots, not a bad six figure income. Given the liquidity of the market, the trades that work with 5 lots by and large will work with 50 lots. It's just a matter of growing into that size. The actual trading doesn't have to change significantly.
The second thing that competent traders need is access to expert traders. A beginning trader, like a Little League ball player, can benefit from coaching from a more experienced person. It doesn't take an expert to coach a rookie. But once athletes becomes college stars, they require hands-on mentoring from coaches and mentors with expertise. It is not too unusual to see self-made competent golf players, traders, or singers. It's rare to see expertise develop in relative isolation.
That is because expert coaches and mentors help to mold and accelerate learning curves, to make the most of a person's talent. If you've reached a stage of competence, it is vital to use online resources, personal networking, and/or access to trading firms to learn from pros. Look at the history of great achievers in business, the arts, sciences, and sports: even the self-made greats stood on the shoulders of giants.
- Your trading system (Reliability, performance, data sources…)
- Your trading system (Reliability, performance, data sources…
- Your market knowledge. (General analysis, Real time market
status diagnosis, strategy recognition, opportunity recognition,
risk / reward recognition…
- Yourself. (Both ,mentally and physically) A winning trader’s mind
is quite different than the rest of the market player’s mind, or as
we say, the other 95 [%].