While a lot of traders have been successful starting small, they’ve also had to deal with pitfalls involved with trading small accounts.
Trading with oversized and overleveraged positions, for example, presents greater risks of a margin call.
Being more invested in the P/L of each of your trades can also drive you to make more trading psychology mistakes than if you had a larger account you could afford to lose. Don’t get me wrong, you certainly CAN start trading with only a small amount of money. And bad traders can blow a large account as fast as they can a small account.
But trading is not a hobby. It’s a business. And like most businesses, it takes capital to earn a substantial amount of profits. Don’t expect to earn hundreds of dollars per week with your $50 account.
2. You have to be where the action is.
One of the more common trading advice is to maximize opportunities during the time of the day when you’re most available to trade.
This strategy is fine. If you’re a newbie who’s looking to get your feet wet. If you’re serious about developing your trading skills and confidence, you have to trade when the market is giving you the most opportunity.
3. You’re going to be wrong. A lot.
And because no single system can stay profitable through ALL trading conditions, even your tried-and-tested mechanical systems will be wrong a lot.
So, how do you stay profitable even when you’re wrong?
Remember that a trader doesn’t have to have a high win rate to be profitable. Some traders can be profitable with low win rates if their average win is high enough.
Instead of focusing on winning, focus on learning the art of “feeling” the market.
A trader who can quickly identify changing market conditions and who can manage his/her risk exposure while doing so is a trader who can stay consistently profitable.
4. There’s no holy grail in trading.
In case you missed the 57,219 memos we’ve shared, let me repeat it for you:
There’s no “holy grail,” or one indicator, method, strategy, or system that would yield you trading profits 100% of the time.
Now write it down or write it on a T-shirt!
Just because there’s no holy grail doesn’t mean you can’t be profitable. Many traders are already trading full-time and even more are content to be consistently profitable.The key is to control your risk. Since you can’t eliminate it, the least you can do is to control it with proper risk management.
5. Trading is NOT for everyone.
There are many reasons why 95% of new traders eventually fail.
For one thing, it takes TIME, EFFORT, and a lot of PATIENCE to become consistently profitable. Those who can’t or aren’t willing to provide all three will likely find themselves among the 95% before the year is out.
It’s also possible that a person is just not cut out for trading. This doesn’t count against the person or the industry. You wouldn’t force someone into the military or play the piano if they’re not interested or cut out for them, would you?
That said, you won’t know if trading is for you until you’ve tried long enough and made enough effort to try to become consistently profitable.
The best traders follow consistent strategies. Many use the same signals repeatedly to show them when to enter and exit a trade. In other words, they place orders on a trading system that they have developed through trial-and-error.
In my experience, this is true for all traders. Many old school traders are not even aware that they are trading systematically, but they are. This leads me to the first of three simple things traders should do to improve their trading.
1. Develop A Simple System – And Work It
Trading is complicated, so keep it simple. You want your efforts to be highly focused like a sniper rifle, not a shotgun.
You want to develop a strategy that gives a good entry signal thatfollows through to give you a profit. This is very different from what many traders do: they see a stock moving so they buy it (that is not a strategy).
All you need to be profitable is one simple system that works on two or three tradable stocks. Many highly successful traders are minimalists – they only have one or two strategies. Some trade only four or five stocks. But they know their strategy and how it works on specific stocks so well that it gives them an enormous edge.
To start, find a technical signal and study it like crazy on just one stock. Look back at the charts and see how it performs. Volume breakouts and gap trading are a great place to start. Backtest these patterns as much as you can and see if there’s an edge.
2. Take Small Risks To Earn Big Rewards
Whether you’re a short-term trader or a long-term investor, buying a stock has the risk of loss. Sometimes the trade just does not go the way you think it will.
Keeping this in mind, good traders “risk a little to make a lot.” That means when you’re wrong, you lose a small amount that won’t wipe out your account. You expect to lose sometimes, so you move on to the next trade.
But when you’re right, you make at least three times the amount you risked, if not more. That means if you make profitable trades 50% of the time, you will be a consistently profitable trader.
To improve your trading you must look at the chart and determine two locations: where you think the stock will go (your profit target), and where the stock shows you that your prediction was wrong (your stop loss). To do this, you must be familiar with the statistics of your trading system.
There’s no reason to place a trade for 2-times reward vs. risk when there are so many trades that can yield better than 3-times reward compared to the amount of risk.
When you structure the trade correctly, trades can yield 5-times, and sometimes better than a 10-times profit. These trades are in the market every day! You just need to know how to spot them, then wait for the right time to enter. This type of trading requires patience, but the result is worth the wait.
3. Avoid Large Losses
Small losses are inevitable in trading. Large losses are completely unnecessary and easily avoided. In fact, there are only two ways a trader can have a large loss: Either by holding a loser much too long or trading too large (too many shares).
With regard to holding a loser too long, there is a saying among traders: If you can’t learn to take a small loss, then you will eventually take a large loss.
This happens when a losing trade hits the stop loss, but you don’t exit the position. Instead, you rationalize. You want to give the trade “just a little bit longer” to work. This is a recipe for disaster. The situation rarely improves much.
Take action. Take your lumps, exit the trade, and look for the next trade. The sooner you act, the better. Doing this will help you take the steps to ensure your survival as a trader. That is what matters, not any one trade.
Regarding trading too many shares, this is how many traders have blown out their accounts in just one trade. No one gets it right all the time – no one. So, traders must always take reasonable risks. When the losing trades come, we need to be able to weather the storm. There is much more involved with profitable trading, but if you want to improve your trading three steps will go a long way to making any
Intraday trading is generally high-risk trading. Many traders believe that intraday trading is only about the right ideas and trades.
However, it is much more about how the traders can manage their risks and stick to their trading discipline.
Some common mistakes that are committed by the intraday traders are averaging your positions, not doing research, overtrading, following too much on recommendations.
These mistakes have caused many day traders to take losses. Around 90% of intraday traders lose money in intraday trading.
So in this blog, we will discuss 7 common reasons why intraday traders lose money in intraday trading.
7 Common Reasons Why Traders lose Money in Intraday Trading:
1. Not Setting Stop-Loss:
Stop-Loss helps in saving the traders from incurring a huge loss.
As this order gets immediately executed, intraday traders can reduce the loss if the price movements go against their expectations.
But some novice traders do not set stop losses in their trades which results in huge losses.
As a trader, one should look for maximizing their profits but they should also look to protect their losses.
2. Not Conducting Technical Analysis:
Some traders just follow the recommendations of others and do not conduct technical analyses of their own.
Traders should review the prices, analyze the volume, check the prior trends and analyze other technical indicators before placing their intraday orders.
Rushing just to place buy or sell orders is one of the biggest mistakes intraday traders make.
One should conduct proper technical analysis and then start trading.
3. Going against the Trends:
The phrase- “Trend is your best friend” always works in the stock market. Not following the trend is another biggest mistake that day traders make.
Unless a trader has many years of experience and understanding of the stock market, traders should try to avoid going against the trend.
If the market is in a strong uptrend, then one should try to trade in the up direction only unless there is any strong resistance or chart pattern breakout.
If the trader wants to trade against the trend, then they should set a stop loss to avoid the losses.
4. Following the Herd:
Some traders follow rumors and recommendations which are spread by the media houses and brokers.
This is another big mistake that intraday traders make. One should not blindly follow the intraday trading tips and rumours without their own analysis.
Going by these recommendations without conducting your own analysis can cause huge losses.
5. Being Impatient:
Many day traders rush to book their profits or make trading decisions in a hurry which is one of the reasons why they make losses in intraday trading.
Many traders book profits before deciding their price targets or stop loss.
Traders should execute their trades in a planned way like deciding their stop loss and profit target level and then only execute their trades.
Also being impatient and changing trading strategies frequently is one of the biggest mistakes that intraday traders make.
6. Not doing Homework or Research:
Day Traders should do proper research before placing a buy or sell order.
They should do the research and decide which stock to buy or sell before the next trading session.
If they conduct research during the trading session, they can miss profitable opportunities.
7. Averaging on Losing Position:
Averaging for a long position when the prices go against the unexpected direction is good for long-term investors but not for Day Traders.
Traders should take the losses from their bad trade and they should not average their long positions as they have to square off on the same day.
Thus, averaging on long positions is one of the reasons why intraday traders end up making losses.
Advantages of Intraday Trading:
When doing intraday trading, traders do not require large capital. They can also sleep peacefully at night without being worried about how the markets will open the next day.
Due to the dynamic nature of the stock market, they can book huge profits and make money in the short term if they follow the basic principles of day trading.
Bottomline:
As we have discussed above traders should conduct proper research before following any recommendations or intraday tips. As we all know that the intraday trading is a mixed bag of losses and gains. Not every trade goes right or is profitable. Thus traders should put a stop loss of their trades when doing intraday trading to protect their capital from losses.
There is an old expression in business that, if you fail to plan, you plan to fail. It may sound glib, but people that are serious about being successful, including traders, should follow those words as if they are written in stone. Ask any trader who makes money on a consistent basis and they will probably tell you that you have two choices: 1) methodically follow a written plan or 2) fail.
If you already have a written trading or investment plan, congratulations, you are in the minority. It takes time, effort, and research to develop an approach or methodology that works in financial markets. While there are never any guarantees of success, you have eliminated one major roadblock by creating a detailed trading plan.
KEY TAKEAWAYS
Having a plan is essential for achieving trading success.
A trading plan should be written in stone, but is subject to reevaluation and can be adjusted along with changing market conditions.
A solid trading plan considers the trader’s personal style and goals.
Knowing when to exit a trade is just as important as knowing when to enter the position.
Stop-loss prices and profit targets should be added to the trading plan to identify specific exit points for each trade.
If your plan uses flawed techniques or lacks preparation, your success won’t come immediately, but at least you are in a position to chart and modify your course. By documenting the process, you learn what works and how to avoid the costly mistakes that newbie traders sometimes face. Whether or not you have a plan now, here are some ideas to help with the process.
Disaster Avoidance 101
Trading is a business, so you have to treat it as such if you want to succeed. Reading a few books, buying a charting program, opening a brokerage account, and starting to trade with real money is not a business plan—it is more like a recipe for disaster.
A plan should be written—with clear signals that are not subject to change—while you are trading, but subject to reevaluation when the markets are closed. The plan can change with market conditions and might see adjustments as the trader’s skill level improves. Each trader should write their own plan, taking into account personal trading styles and goals. Using someone else’s plan does not reflect your trading characteristics.
Building the Perfect Master Plan
No two trading plans are the same because no two traders are exactly alike. Each approach will reflect important factors like trading style as well as risk tolerance. What are the other essential components of a solid trading plan? Here are 10 that every plan should include:
1. Skill Assessment
Are you ready to trade? Have you tested your system by paper trading it, and do you have confidence that it will work in a live trading environment? Can you follow your signals without hesitation? Trading the markets is a battle of give and take. The real pros are prepared and take profits from the rest of the crowd who, lacking a plan, generally give money away after costly mistakes.
2. Mental Preparation
How do you feel? Did you get enough sleep? Do you feel up to the challenge ahead? If you are not emotionally and psychologically ready to do battle in the market, take the day off—otherwise, you risk losing your shirt. This is almost guaranteed to happen if you are angry, preoccupied, or otherwise distracted from the task at hand.
Many traders have a market mantra they repeat before the day begins to get them ready. Create one that puts you in the trading zone. Additionally, your trading area should be free of distractions. Remember, this is a business and distractions can be costly.
3. Set Risk Level
How much of your portfolio should you risk on one trade? This will depend on your trading style and tolerance for risk. The amount of risk can vary, but should probably range from around 1% to 5% of your portfolio on a given trading day. That means if you lose that amount at any point in the day, you get out of the market and stay out. It’s better to take a break, and then fight another day, if things aren’t going your way.
4. Set Goals
Before you enter a trade, set realistic profit targets and risk/reward ratios. What is the minimum risk/reward you will accept? Many traders will not take a trade unless the potential profit is at least three times greater than the risk. For example, if your stop loss is $1 per share, your goal should be a $3 per share in profit. Set weekly, monthly, and annual profit goals in dollars or as a percentage of your portfolio, and reassess them regularly.
5. Set Exit Rules
Most traders make the mistake of concentrating most of their efforts on looking for buy signals, but pay very little attention to when and where to exit. Many traders cannot sell if they are down because they don’t want to take a loss. Get over it, learn to accept losses, or you will not make it as a trader. If your stop gets hit, it means you were wrong. Don’t take it personally. Professional traders lose more trades than they win, but by managing money and limiting losses, they still make profits.
Before you enter a trade, you should know your exits. There are at least two possible exits for every trade. First, what is your stop loss if the trade goes against you? It must be written down. Mental stops don’t count. Second, each trade should have a profit target. Once you get there, sell a portion of your position and you can move your stop loss on the rest of your position to the breakeven point if you wish.
6. Set Entry Rules
This comes after the tips for exit rules for a reason: Exits are far more important than entries. A typical entry rule could be worded like this: “If signal A fires and there is a minimum target at least three times as great as my stop loss and we are at support, then buy X contracts or shares here.”
Your system should be complicated enough to be effective, but simple enough to facilitate snap decisions. If you have 20 conditions that must be met and many are subjective, you will find it difficult (if not impossible) to actually make trades. In fact, computers often make better traders than people, which may explain why most of the trades that now occur on major stock exchanges are generated by computer programs.
Computers don’t have to think or feel good to make a trade. If conditions are met, they enter. When the trade goes the wrong way or hits a profit target, they exit. They don’t get angry at the market or feel invincible after making a few good trades. Each decision is based on probabilities, not emotion.
7. Keep Excellent Records
Many experienced and successful traders are also excellent at keeping records. If they win a trade, they want to know exactly why and how. More importantly, they want to know the same when they lose, so they don’t repeat unnecessary mistakes. Write down details such as targets, the entry and exit of each trade, the time, support and resistance levels, daily opening range, market open and close for the day, and record comments about why you made the trade as well as the lessons learned.
You should also save your trading records so that you can go back and analyze the profit or loss for a particular system, drawdowns (which are amounts lost per trade using a trading system), average time per trade (which is necessary to calculate trade efficiency), and other important factors. Also, compare these factors to a buy-and-hold strategy. Remember, this is a business and you are the accountant. You want your business to be as successful and profitable as possible.
8. Analyze Performance
After each trading day, adding up the profit or loss is secondary to knowing the why and how. Write down your conclusions in your trading journal so you can reference them later. Remember, there will always be losing trades. What you want is a trading plan that wins over the longer term.
The Bottom Line
Successful practice trading does not guarantee that you will find success when you begin trading real money. That’s when emotions come into play. But successful practice trading does give the trader confidence in the system they are using, if the system is generating positive results in a practice environment. Deciding on a system is less important than gaining enough skill to make trades without second-guessing or doubting the decision. Confidence is key.
There is no way to guarantee a trade will make money. The trader’s chances are based on their skill and system of winning and losing. There is no such thing as winning without losing. Professional traders know before they enter a trade that the odds are in their favor or they wouldn’t be there. By letting their profits ride and cutting losses short, a trader may lose some battles, but they will win the war. Most traders and investors do the opposite, which is why they don’t consistently make money.
Traders who win consistently treat trading as a business. While there is no guarantee that you will make money, having a plan is crucial if you want to be consistently successful and survive in the trading game.
Your trading system goals impact everything you do in trading system development and your ultimate profitability.
Most traders fail because they try to use someone else’s system, take tips, read trading newsletters or rely on broker recommendations. These methods are all flawed because they do not take into account YOUR trading goals.
Your goals are as unique as you are!
More than most disciplines you will need to be 100% clear on your objectives to be successful in this trading. Without clear goals, you will not succeed in trading – PERIOD!
Set Your Trading System Goals First_Your trading system goals are as unique as you are
Your trading system goals are as unique as you are – write your goals down and accelerate your trading today!
Writing my specific trading goals gave me dramatic and unexpected benefits which I will tell you about below…
Setting written goals puts
you at a significant advantage over other traders
What Should Trading System Goals Include?
Trading system goals should consist of a precise written statement about each of the following:
Your ideal lifestyle (that you want your trading to support)
Amount of time you will spend on your trading each day
Annual percentage return
Maximum drawdown
Maximum monthly drawdown
Maximum length of drawdown
Worst case drawdown
If you don’t have these objectives clear, it is impossible to know when your trading system is sufficient. You will also not know if your trading results are meeting your objectives once you actually start trading.
This sounds like a minor point, however, trading through a drawdown of 15-20% will be very difficult if you have not already established your maximum drawdown tolerance and designed your rules to support and deliver on this objective. On the contrary, if your trading system goals are to avoid drawdowns of 40% or more, then a 15-20% drawdown will not be an issue for you.
Knowing how much to risk on each trade is impossible if you have not established your profit objective and your drawdown tolerance. Surprising as it may seem, changing the amount you risk per trade by only 0.25-0.5% can make a dramatic difference to the shape of your equity curve, your rate of return and the size of your maximum drawdown.
Without written trading system goals it is impossible to
determine how much to risk to take on each trade
How My Written Goals Helped Me
My personal experience on this was a real eye opener for me. Before writing my trading system goals I spent countless hours tinkering and ‘optimizing’ and tweaking trading systems.
With no clear outcome to work towards, so there was no way of knowing when to stop, nor what was being optimized for. It was difficult to gain confidence in new systems and progress on diversification became very slow.
Once I documented my goals for my overall trading program and for each new trading system, the trading system development progress accelerated, objective functions became clear and the system parameters fell into place much more easily. I also ended up building much more profitable trading systems with smoother equity curves!
If you haven’t already done it, write down your trading system goals in as much specifics as you can. Do this before continuing on with your system development.
Establish Your Reason To Succeed: Your Ideal Life
Trading system goals are just one aspect of setting objectives and goals for your life. It is important to have your trading goals written and clear, but if you have no idea how these fit into the rest of your life then you will likely struggle to find the motivation and discipline to succeed in your trading business.
Jim Rohn said that if your ‘WHY’ is big enough then the ‘HOW’ doesn’t matter. What this means is that when your reasons for succeeding are big enough, nothing can stand in your way – you will find a way to succeed no matter what.
Developing a profitable trading business is difficult, but if you have a big enough reason to succeed then you will.
Once you succeed in the trading systems
business the rewards are immense!
An exercise that I have been through a couple of times in different forms and have found extremely helpful in establishing a ‘big why’ is to define what your ultimate life will look like in as much detail as possible.
The intent of the exercise is to capture all the things you want to do with your life once time and money are no longer a problem for you – once you are free. Whether you call this your dream board, your dreams list, your dream life or your ultimate lifestyle doesn’t matter, the intent is the same:
Create a detailed picture of your ideal life to move you to take action and succeed on your stock trading journey
This can be done in one of three ways depending on your preference:
Assemble a dream board that has pictures of everything you want in your life
Create a dreams list of ~100 things you want to do with your life
Write a document that describes in rich detail what your future life looks like
Take 30 minutes NOW to describe your ideal life – Identifying the dream is the first step to achieving it!
The trick with this exercise is to not hold back or limit yourself to what is ‘reasonable’ based on your past experience. Remember you are trying to create a compelling future to drive you to the action required for you to become a successful systems trader.
In Van Tharp’s fantastic workshop ‘Blueprint for trading success’ one of the exercises he takes you through covers exactly this – They call it your ‘Dream Life’. The workshop helps you establish compelling reasons to succeed and puts you on a firm footing for trading success regardless of your trading style.
‘Blueprint for trading success’ then goes far beyond this to help you understand yourself as a trader and formulate your own unique approach to trading with a solid understanding of the key principles of success in this business. Van Tharp is a world renown trading coach and is one of the few trading workshops educators that we recommend
Incorporate Your Goals Into Your Trading Plan:
My trading plan discussion explains the rational and value in documenting all elements of your trading business. The beginning of your trading plan should establish your reasons to succeed, to give you the drive to follow the rest of your plan.
Now that you have created a first draft of your ideal life (you have done this right?) I recommend you include this in your trading plan so that you always remind yourself of your reasons when reviewing your trading plan (which should happen often).
If you don’t have a trading plan yet then we recommend you start one as a first priority – your ideal life is the first step in your trading plan!
Warning: Your Objectives May Not Be Conscious
All behaviour is driven by our objectives. The difficulty most people have is that the objectives that drive them are not conscious. If objectives are not conscious then we are not really aware of what we are working towards or why we do the things we do.
If you have no written trading system goals then you are in extreme danger with your trading because you are being driven by subconscious objectives. These are very unlikely to support good, profitable trading. Read a range of trading psychology books and you will see that these subconscious objectives are likely to be something like:
Desire to be right
Desire for excitement
Social acceptance
Avoidance of pain and discomfort
Each of these subconscious objectives can sabotage your trading:
Desire to be right: Causes you to cut winners early and hold onto losses in the hope that they will turn around. This reduces the size of your average winning trade and increases the size of your average losing trade.
Desire for excitement: Causes you to over trade (trade too frequently), and take poor trades just to give you some action. The desire for excitement may also cause you to excessively monitor your trades, wasting time, increasing stress and increasing the risk of mistakes.
Social acceptance: Causes you to discuss your positions/holdings or performance openly, leading to attachment to positions, stress about your performance and the giving/taking of tips or advice which can undermine the integrity of your trading system.
Avoidance of pain and discomfort: Causes you to not take actions that may lead to pain such as taking a loss. If you are unwilling to incur a small pain now, the situation could deteriorate and become a much larger pain in future. Causes you to cut winners early and hold onto losses in the hope that they will turn around. This reduces the size of your average winning trade and increases the size of your average losing trade.
Trading system goals need to be written down and revisited regularly to keep you focused on what you are trying to achieve with your trading system as you go through the trading system development process.
80% of the Traders blow their account in the first 2 years of their Trading career.
Why?
Is it because they don’t have enough knowledge of technical analysis?
Or
Is it because they don’t have enough money to trade?
Or
Is it because they did not buy any fancy courses?
The answer is “ NONE OF THE ABOVE ”
Then why are they blowing up their accounts?
The answer is “bad position sizing”
What is Position sizing?
It decides the “HOW MUCH” quantity you will buy or sell in security when you get your entry signal.
It decides how much you will make on a trade.
Now you might have this thought in mind, what the heck this has to do with the profitability of a trader?
Let’s know-how.
Say there are 2 traders, Rahul and Akshay.
Both Follow the same System with a Win rate of 50%, which means out of 1000 trades, 500 trades are likely to be positive and 500 are likely to be losers.
Both have the same amount of capital, i.e 100,000 Rs.
(Win rate is In how many Trades you make Profit out of Total trades.)
Let’s take a sample size of 20 trades, though it’s a small sample size it will work for this example.
First, take a look at the below table, which shows how many losses you can have in a row with different Win rate%.
So a 50% win rate system can have 16 losing trades in a row.
Now, let’s get back to Rahul and Akshay.
First, let’s talk about Akshay.
He is a passionate trader who wants to make a living out of trading, but as of now his capital is low so he has to do his job and Trading side by side.
Though he hates his job and wants to become a full-time trader as soon as possible but with a small amount of 1 lakh, he can’t become a full-time trader.
Because of this, he decides to take higher risks so that he can make money faster.
As his trading system has a 50% win rate and 1:3 Avg Reward to risk ratio.
He calculates that he only has to be right in 3 out of 10 trades to break even/become profitable.
So, he thought about risking 5% of his account on every trade, because he is sure that he will make money in 5 out of 10 trades, because of his 50% win rate.
He is calculating in excel that he needs only 10 profitable trades to double his account, and he is sure that he will 10x his account this year.
He starts to trade and the next 5 trades come to be losers.
This means that his account is down by -25% and now he is only left with 75,000 Rs.
He was shocked that how come he got 5 losers in a row, there must be something wrong, maybe things will take a U-turn and the next few trades will make me profit, he thinks.
The next 4 trades are also losers and his account is now down -45%.
He is Frustrated but he is sure that this is just the worst going on, and the profit is the only thing that is going to come from here on.
His account is now down to 55000 Rs, He thinks of increasing the risk to make the lost money as fast as possible.
So, he increases the risk per trade to 10% of his initial capital.
Bad luck again!
The next 3 trades are also losers, he has lost about 75K of his total account, and now only has 25K left with him.
He is really worried, because he has lost 75% of his capital, and has left with only 25k capital to trade.
Desperately in need of making his lost money back, he again increases the risk to about 15% per trade, he thinks that this must be the end of the losing streak and I will take back everything in just 3-4 trades.
The next 2 trades also come to be losers, Akshay has blown up his trading account.
Now, let’s take a look at how Rahul’s performance looks like-
Because they both were trading the same system, both got the same trades, it’s just that Rahul only took a 1% risk of his initial capital.
Rahul also got the hit because of 16 losers in a row, but because of his low risk he was able to survive the losses, and then because his profitable trades were 2-3 times of his losses, he is only down 6% of his initial capital.
Rahul was not in a hurry to make money, because of his low risk he was able to keep calm during the drawdown phase.
Both Rahul and Akshay were using the same system, Akshay got bankrupt and Rahul was able to continue his trading and will make money in the long run.
But, Akshay came in the grip of Gambler’s Fallacy.
Gambler’s Fallacy
In simple words, if an event occurs too many times in a row then we expect that it will stop occurring in the future.
In the above image you can see that when three heads come in a row, the person thinks that it’s highly unlikely that another head will come up next.
They try to predict the future outcome based upon the last few observations.
What they forget is that each toss has its probability, which is 50%, every time the coin is tossed there will be a 50% chance of the tail to come and a 50% chance for heads to come.
Similar to this, each trade also has a 50% probability of being right and wrong, i.e the result of the last few trades has no impact on the probability of the current trade, it will always be 50%.
In Akshay’s example, we saw that he increased his risk because the last few trades were losers, and he thought that now it’s highly likely that a winner will come, so he kept increasing his betting size, which eventually led to his blowup.
The most famous example of Gambler’s fallacy occurred in Las Vegas at Monte Carlo casino in 1913.
The roulette wheel’s ball had fallen on black many times in a row, so the players think that now it’s highly unlikely for the ball to fall on a black, so they bet heavily on the Red.
The ball fell on the Red square after 27 turns, Gamblers lost millions of dollars during this event.
The Law of Small Numbers
Extreme examples are more likely to be found in small rather than large samples.
In Akshay’s example, you saw that the winning probability of his system was 50%, which means that out of 1000 trades 500 will be losers and 500 will be winners.
So, one may say that every 5 out of 10 trades will be profitable, Right?
Wrong! When you take a random and very small sample size there is a chance that extreme events can happen like we saw that their system got 16 losers in a row, which was highly unlikely, yet it occurred,
His system has a 50% winning probability, but only over large sample size.
So, now we can say that a trader is more likely to be profitable in the long run if he keeps trading, over a large sample size, with small risk.
The need to make the money fast can be fatal for our accounts.
Now we know how position sizing can affect our performance. Let’s know how to calculate position sizing.
Position Sizing Methods
There are several position sizing methods, here are a few of the most important methods.
Percent Risk Position Sizing Method
As the name suggests in this position sizing method we are risking a fixed percentage of our account on every trade, irrespective of the account size.
If the account size says 1 lakh and we are risking 1% on every trade, our risk per trade will be 1000, so now if we make some profit and our Capital grows to 1,10,000 then we will risk 1% of it, which will be 1100, and say if we make some losses and our capital reaches to 90k, then we will risk 1% of that, which will be 900.
The main things you need to use this method are a stop loss level and the percentage you want to risk on every trade.
Let’s take an example to understand this method more.
Say you want to buy Reliance at 2000, and according to your method, the Stop-loss level for this trade should be 1950.
And you decide to take 1% risk on every trade that you take and your capital is 1 lakh Rs.
The position size in this example comes to be 20, which means that you have to buy 20 qty of this stock.
Let’s take an example of short selling also –
Say you want to short a stock at 1000 Rs and your SL for this trade is 1020.
Your risk% per trade is 1% and your account size is 1 lakh.
The only change in the case of short selling is that to calculate Risk points, you have to subtract entry price from stop-loss price, otherwise, the risk points will come in negative.
In this trade, you have to short 50 qty of a stock.
Now let’s move on to the next position sizing method.
Equal Units Position sizing method
In this method, we allocate an equal amount of money to each trade, irrespective of our stop loss level.
We divide the total equity into parts, say 5, and then we allocate the same amount to the 5 stocks that we buy in our portfolio.
For example, if we have 1,00,000 in our account, and the max position we want to hold at a time is 5, then we can divide the total capital into 5 parts, which will be 20K each.
So, we will allocate 20k of our account on each trade that we get, irrespective of anything else.
Say we got a signal to buy Icici bank at 600 Rs, your account value is 1,00,000 and you decided to put 25k in each stock that you Trade.
So, this is how you will decide your position sizing using this method.
This method is mostly used in investing or portfolio building, where we buy a bunch of stocks, with similar 5-10% below SL levels.
The equal unit approach allows you to give equal weightage to each investment in your portfolio.
Now, let’s move on to the next method.
Percent Volatility method
This Position sizing method is based upon the Volatility of a stock, By volatility what we mean to say is the daily movement of an instrument.
To calculate the daily movement of a stock we have to subtract the Low of the day from the high of the day.
Say, Reliance stock Opened at 2000 and it made a high of 2150 and a low of 1980 and closed at 2020.
Then its daily movement is High – low = 2150 – 1980 = 70
So we can calculate the last few day’s volatilities by calculating the average daily movement of the last few days, but we are ignoring the gaps if we use this method.
To counter this we use the ‘Average true range’ to measure the stock’s volatility.
This method is used in combination with the percent Risk method that we discussed earlier.
Let’s see how, with the help of an example
Say, Our Trading account value is 1,00,000 and we don’t want to risk more than 2% on any trade.
Say we get a buying signal at 145 because the stock had found buying in this zone many times in the past.
Then we check the ATR indicator value, which is around 7 Rs at the time of entry, so we subtract 7 rs from 145, which is 138, which will be our stop-loss price for this trade.
Calculating the Position sizing
So you would have to buy 285 Qty of this stock according to this method.
The main merit of using this method is that it takes into account the volatility of the stock, as different stocks have different volatility, and even the same priced stocks can have different volatilities.
So, this method gives us an objective way of setting our stop loss according to the volatility of a stock, without any guessing work.
Many times when a stock gaps down, most people lose heavily because they use stop losses based upon guesswork or intuitive levels, but when you use the ATR, you are at least ready for 1 ATR gap down which is the normal volatility of the stock.
Many of my friends who work at Corporate culture are fed up with their work life, one question they keep asking me is how much money do I need to retire and live comfortably? Gone are the days when our parents used to work 30 or 40 years in same organization, after years of hard work they end up getting PF, VPF, all sorts of retirement funds using which they either plan for the daughter’s wedding or son’s higher education. They hardly spend for themselves, but in our generation we do not want to toil and work too hard only to retire rich at an old age. We wanted to live the life to the fullest, wanted to travel around the world, spend more time with the loved ones, go on road trip with friends often. But to do that we should have a rich dad or work harder, create multiple source of income and set a target of retirement corpus, once we achieve that we can retire.
How much that corpus should be? That’s what this article is all bout, how much money do I need to retire comfortably.
The 4% Rule:
Willian Bengen in 1994 published a research paper that revolutionized the financial planning industry. As per his research, if you can withdraw an amount worth 4% of your portfolio every year, then for 30 years you can continue to withdraw without running out of money. But you need to figure out how much fund size is optimal?
You need to figure out what’s your annual spending. Say my monthly expenditure is around 1 lac a month, then my annual spending is 12 lacs. As per William, if I need to retire tomorrow, then I need to have a corpus of 25 times of my annual spending, so I should have 25 x 12 lacs, which is 3 Crores. Even if the withdrawal amount keeps increasing 3% every year considering inflation, still it would not run out of money.
Retirement Corpus = 25 x Annual Expense
If we are investing in an Index fund, Since its inception in November 1996, the NIFTY Next 50 index has delivered an annualized return of 17.2% as compared to 12.2% of NIFTY 50. So if we invest in both the index funds, average returns would be 14% which is much higher than our withdrawal percentage of 4%.
If we invest the corpus in 50% Index + 50% bond or fixed instruments, then again overall returns will be much higher than our withdrawal limit.
As long as our investment grows higher than our withdrawal limit, we can continue to spend and live comfortably. We don’t need to worry too much about investment analysis, you don’t need to pick stocks, simply investing in a balanced fund that invests in bond and equity will do good. Because equity returns can be volatile, when markets get into bearish phase, the value can quickly erode, so it’s not wise to keep everything in an equity market. Diversifying help here.
The Cross-over point rule:
There is another way to determine when you can retire. Vicki Robin and Joe Dominguez in their book Your Money or Your Life discussed a concept called the Crossover Point.
This is the point When your monthly income cross your monthly expenses, which grants the financial freedom.
For example, if your monthly expense is 1 lac, once your investment can pay you more than 1 lac a month, then you have reached your crossover point.
How do we find the amount of money required to reach this crossover point. Let’s call this amount as Crossover assets.
Let’s consider our investment portfolio generates 4% annual returns, so if we divide that then monthly returns will be 4%/12 = 0.33%. Our monthly expense is 1 lacs, so to get crossover assets, 1 lac divided by 0.33% which is 3 crores.
But if we can make just 12% per year, which is 1% per month, then the retirement corpus required is just 1 Crore which is 3 times lesser than what we say in 4% rule. This is mainly because the rate of our investment return we considered is 12%.
It’s not about Money:
I really loved this quote from Jim Carry. Retirement is not just about having shitloads of money, sitting in Hawai beach and having a sip of beer.
Kevin O’Leary from Shark Tank once said about his retirement after selling his first company at the age of 36.
“I retired for three years. I was bored out of my mind. Working is not just about money. People don’t understand this very often until they stop working. Walk defines who you are. It provides a place where you are social with people. It gives you interaction with people all day long in an interesting way. It even if you live longer and is very, very good for brain health
The moment you stop working, it takes away your identify. You will be in a lonely world. For a year or two, you many enjoy your early retirement life, but then your mind wanders. The moment a founder sells his startup, there is a higher probability that he might end up a serial entrepreneur. Once an entrepreneur you are always an entrepreneur, people always want to get occupied with something that makes them happy and exciting.
So you should not need to figure out how much you need to retire early, you need to figure out what are you going to do after you retire. Or else you might be utterly disappointed once you reach the other end of the spectrum.
You do know the mathematical formula of compounding. But do you also understand the non-linearity of compounding?
If we want to create wealth over the long term, we need to fulfill three important criteria –
Living a very long life.
Uninterrupted compounding for decades.
Frguality.
Take the example of Ronald Read. He was a resident of Brattleboro who died at the age of 92. He worked at a gas station for most of his life but still managed to die with a net-worth of $8 million. What worked for him? Remarkable frugality, decades of compounding, and living till the age of 92.
Frugality has to be a constant irrespective of our income levels. Instant gratification in our generation is at it’s peak. We spend anywhere between four to six hours everyday on our phones. Social media and online retailing has made it easy to spend money after a few clicks. Shopping was never easier. Saving money is last of our priorities.
Forget wealth creation, our generation is reeling under retail debt. We do not like waiting. We bury ourselves with debt at the first instant possibility. A retirement case study in India by HSBC found that while 76 percent of working age people in India expected a comfortable retirement, only 33% of those were actually putting aside money to retire. 68% respondents in the study said that they would rely on their children to provide for their retirement.
Depending on your children is the last thing you want to do in your retirement. While I believe it is not morally correct to depend on your children, thinking that your children will support you is having unrealistic expectations from them which may not come true. There are thousands of old age homes filled for a reason.
It is our responsibility to provide a good upbringing to our children. It is also our responsibility to provide for our own financial independence.
“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things” Charlie Munger
At the beginning of the article, I said that compounding is non-linear, what did I mean by that?
Let’s take a simple example. If you started investing at the age of 20 with INR 10,000 every month and invested the same amount every month for forty years till the standard retirement age of sixty. In the second instance, let’s take the example of your friend who starts investing INR 20,000 every month from the age of 30 and invests till the age of 60. Both of you compound your money at 10% per annum.
Your friend Vs. You
Aren’t the results mind-blowing? Not only your principle outgo is lesser, you also end up with more money at retirement. The more time you give to compounding, the better your results could be. You do not have to start withdrawing at the age of 60. You can continue to work as long as you enjoy working and quit only when you want to.
“Compounding matters and does so far more than people expect. The human brain thinks in a linear way which means that if we were asked to estimate what 10.22% compounded over 100 years would be then our answer is likely to be closer to 1,022% than 1,679,600%, something economists call exponential growth bias. This means that compounding is often underestimated and should be at the heart of long-term investing” Marathon Asset Management
What Are Some Strategies That Could Be Used To Start Early?
From the day you start making money, start putting aside some money in index funds. Starting with a small contribution of 5% to 10% of your overall earnings will take you a long way.
Invest before you spend, not the other way round.
Don’t fall in the “get rich quick” trap. Blindly avoid all strategies that promise you quick returns. Everything is a scam.
Practice frugality. Live a balanced life.
Play the long game. Make volatility your friend.
Compounding takes time. The returns are back ended. You need to be the tortoise on the road to financial freedom. It’s a long and lonely journey. But the probability of you ending up wealthy in this journey is extremely high.
Does backtesting work? Backtesting is a tool that not only small retail traders use but also big institutions. The world’s most successful hedge fund, Jim Simons’ Medallion Fund, uses backtesting continuously to develop new strategies. Why? Because backtesting works!
Why does backtesting work? We have done daily backtesting for over 20 years and this article summarizes what we consider the main reasons why backtesting works. Backtesting works because you can falsify or confirm a trading idea, you can automate all your trading based on the backtests, exploit the law of large numbers, limit behavioral mistakes, and lastly you can save a lot of time in executions. Backtesting is definitely not a waste of time.
We start by explaining briefly what a backtest is:
What is a backtest?
A backtest has strict rules for when to buy and when to exit. In other words, you can code the strategy and find out with 100% certainty how the strategy has performed in the past. Thus, this is a backtest on historical data.
Of course, this doesn’t give any certainties about the future, but you know if the strategy has performed well or poorly in the past. If something has performed poorly in the past it’s unlikely that it will perform well in the future.
Opposite, if a backtest proves that your idea has worked well in the past, it most likely will perform better than any idea that has performed poorly. But of course, a positive backtest is no guarantee that it will work in the future. But we believe it’s the best indication you can get.
A backtest follows this procedure:
Find an idea you want to test.
Define clear and concise entry and exit parameters – they need to be quantifiable.
Specify the market you want to test on.
Specify the time frame you want to test.
Code the strategy.
Run the strategy on the in-sample period.
Test the out of sample backtest.
This is all there is to it.
If the backtest returns a positive and promising result, we recommend that you paper trade the strategy for several months before you commit real money. This can save you a lot of money!
Backtesting works because you can confirm or falsify a trading idea
Backtesting works because you can easily check if something has worked in the past or not.
Just define the rules and start the backtest. You’ll find out in five minutes.
Do you believe you see an interesting pattern in the chart? Then quantify it with strict buy and sell rules and test it.
Did the strategy work in the past? If something has not worked in the past, you can easily falsify your hypothesis and go on to test another idea.
Because most ideas don’t work, you should not spend much time testing a hypothesis. Many traders waste months, even years, in both programming software and tweaking their strategies only to find out it was a waste of time. You don’t need “perfect” strategies to make money in the markets. You need many strategies that complement each other.
Backtesting works because it lets you automate
If you have successfully backtested a strategy, you can easily go “live” with the strategy.
Obviously, this saves you a lot of time. There is no need to check quotes, prices, or follow the markets. The computer does all the work!
Backtesting works – you can exploit the law of large numbers
Your computer can easily trade and supervise hundreds of strategies. This lets you exploit the law of large numbers and you can diversify into time frames, asset classes, directions, and types of strategies.
The main reason for the success of the Medallion Fund is twofold: they use enormous amounts of data to generate hundreds of uncorrelated strategies. Because of the low internal correlation among the strategies they can use leverage to boost returns.
However, leverage is dangerous and certainly not something we recommend. Only use leverage if you have many years of experience.
Backtesting works because it removes emotions
Investors tend to sell into a panic and buy after a big rise. Most of the time you need to do the complete opposite. A backtest can’t capture such mistakes and that’s why you need to stick to the trading plan.
In order to stick to the trading plan, you need to trade smaller than you’d like or prefer. This is the best way to keep detachment to money.
The closer you follow the markets, the more likely you are to overrule your systems when your “intuition” tells you to sell or buy. But most of the time the intuition is plain wrong, unfortunately.
Overruling your systems and strategies is unlikely to work. You have not backtested overruling, so how do you know if it works?
Backtesting works because it saves time
If you have tested 15 backtests and found one of those ideas seems promising, the rest probably just a waste of time. You can generate and test hundreds of strategies in just a single day. Even better, you can falsify or confirm the ideas quickly.
Trading is mainly about trial and error. And luckily, backtesting is a great tool for that and at the same time, it saves you a lot of time.
90% of your losses come from less than 10% of the trades.
If you don’t believe me check your P&L report and You will see that you are at loss due to very few but big losses.
In this article, we will learn why you are not able to ride your winners and cut the losses.
And how you can do it by following a few simple principles.
Why Are You Not Able to Ride the Winners and Cut the Losses?
To understand this let’s first play a game
Choose either (A) OR (B) from both the cases
CASE A
A.) A sure loss of 10000 Rs
OR
B.) A 95 % chance of 12500 loss + 5 % chance of “No Loss at all”
CASE B
A.) A sure gain of 10000 Rs
OR
B.) A 95 % chance of 12500 RS gain + 5 % chance of No gain at all.
Let me guess, most of you will choose
Option “B” from case 1 and option “A” from case 2.
Why do most people choose option B from CASE 1?
The answer is “GAMBLING CHOICE”, They want to have a chance (5%) of making no loss at all.
Though 95 % chance is they would lose 12500 Rs, they still choose option B.
Option A is much wiser to choose than option B because in option 1 you will only lose 10000 Rs whereas in option B you have a High chance of losing 12500 Rs.
This is the opposite of “Cutting your losses short.”
Why do Most People Choose Options A From CASE 2?
They want to choose option A because they don’t want to lose the sure-shot money and don’t want to have a 5% chance of not gaining anything at all.
Even though Option B is a much wiser option as it has a 95% chance that they will make 12500 Rs.
But most people choose the sure-shot money, and that’s why they forget about the “RUN YOUR PROFITS RULE”.
These biases towards choosing small profits and big losses are the reason 95% of traders lose money.
So, How can you ride the winners and cut the losses?
1. Place the SL in the System
Yes, you heard it right, Place the SL in your system.
Most of the traders don’t place SL orders in the system.
Few think that they are being watched by the operators and their SL could be hunted.
Few just don’t even know what their stop is, so they never put the SL.
And the last category is who says they have Soft SL, which means their SL is in their mind.
Now you would say, How does placing the SL in the system help you lower your losses ?”
Let me give you an example
A guy named Raman has 1 year of market experience and has found his trading style, but he is not profitable yet.
He gets a buy signal in Reliance at 2000, his SL according to his analysis is 1950.
He doesn’t place SL in the system because he believes in SL hunting.
Reliance Initially moves in his favor but then starts to decline and reach towards his SL.
He is worried, as he doesn’t want to lose on this trade.
He turns on the Tv and watches a financial news channel, and he sees that everyone is Talking about Reliance because of some positive news.
One of the panelists even said that Reliance is about to go to the moon.
Raman is overjoyed after hearing this news, he calculates how much money he will make if Reliance makes a big move.
But reliance is still going down and about to reach his SL.
He thought that what if his SL level is wrong, and maybe he will get a good profit, so he held the trade without any SL.
The next Morning Reliance share falls 5%.
Raman is in shock, that how come reliance fell this much.
Though he is an atheist, he is now praying to God that if Reliance reaches his cost price, he will exit and will never make the same mistake again of not honoring the SL.
Reliance shares do not recover and Raman ends up selling his positions with a whopping 20% loss in his account.
So the first lesson is to always keep the SL in the system and not to interfere with it.
2. Do Not Carry Your Intraday Losses
I am telling this from my experience, after making and losing a lot of money in the markets.
That carried losses of intraday trades are more likely to give you more losses than profits.
So, if you are taking an intraday position into any stock, and it doesn’t perform to your expectations, it is better to exit with the loss at the end of the day.
Otherwise, be ready for a 10X more loss than that you would have made by exiting the loss on the same day.
3. Get off Your Screen
Though this advice may sound the opposite of that, you should have more screen time to gain more experience.
But, In my opinion, once you are in a position and you have placed the SL order, then there’s no need to watch the screen, especially if you are trading on time frames greater than 15min.
Let’s say you are in a trade and you keep glued to the screen to watch every movement of what your stock is doing after your entry.
Your position is going well and is up 3% from your entry.
You plan to Trail your SL with every higher low.
But then suddenly a Big red candle forms on the chart, and you exit in panic.
Though it was not part of your plan to exit before the TSL or SL hits.
So, you did not follow the plan because you are Reading “PRICE ACTION”
Now, just after your panic exit the stock moves back to the highs and closes the day with a whopping 10% move.
4. The Bigger the Losses the Harder it is to Recoup Them
A 5% Loss only needs a 5.3% gain to break even.
But, A 50% loss needs a 100% gain to break even.
And that’s what you have to keep in mind always.
We have seen many times stocks dropping 30-40% intraday.
Below are the two examples, when stocks fell 30-50% intraday, and one Wrong trade like this could wipe your account if you don’t cut your losses.
5. Don’t take Uneven Risks
Most of the time an average trader (Let’s call him Joe) ends up with more quantity when he is wrong and less quantity when he is right.
Why?
Because of uneven Risk-taking.
Sometimes he risks 1% on trade and the other time he risks 5% on a trade, based on his intuitions.
Let’s see how taking uneven Risk can ruin your capital, even if your analysis is correct
Let’s say his system has a win rate of 50%.
And this is the sequence of win and losses of his last 10 trades
The above Trading system looks profitable, Right?
As the win rate is 50% and he made about 3.7 R profit in 10 trades.
But wait, Joe has one problem, he keeps on changing the Risk on every trade, sometimes he risks more and sometimes less, depending upon his “CONVICTION”
So, let’s see how much he risked on these trades
So as you can see because of his conviction he risked more in some trades and less in others.
Due to this, his Total P&L % is negative 3.35%.
He would have made 3.7% returns if he had kept the risk 1% at every trade.
So, now you know it’s not a good idea to change the risk at every trade, otherwise, even a positive expectancy system can not perform well.
6. Make Rules For Your Exits
Not having any pre-decided exit rules is one of the reasons that Trader can’t hold their winners longer.
For example, you can make a rule to exit the trade when the stock closes below the 20 EMA.
Or, Exit when the stock breaks the Higher low sequence.
Or any Exit rule like that.
Having a Rule for your exits is better than exiting the trades intuitively, as when you have a rule, you have a sense of predictability and you will have consistency in your trades.
Find what type of exit works best for your trades and then just follow that sincerely.
If you follow all the things that are explained in this article, you will see a big change in your Trading results.
Greed and Fear drives the market, it’s really hard to control emotions during panic times. Even one of the richest investors in the world Warren Buffett make mistakes, you know what he did in 2020 Corona crash?
He admits he might be even happier if he had used that opportunity to invest some of the $145 billion of cash Berkshire Hathaway Inc. has been hoarding.
Berkshire revealed that it sold stocks again last quarter, bringing the total net value of equities it has dumped since the outset of the Covid-19 pandemic to more than $12 billion. The benchmark S&P 500 index returned about 26% over that span — double what Berkshire shares did. And as Apple Inc. gained 80%, becoming a $2 trillion c ..
“Looking back, definitely we could’ve done things better,” Buffett said, because many businesses sprang back astonishingly fast. That was thanks to the Federal Reserve’s extraordinary actions early on, which Buffett praised, and the relief checks that went to Americans, he told virtual listeners of his company’s annual shareholder meeting Saturday. Investing is “not as easy at it sounds,” he added, words of caution to the new generation of investors using commission-free apps such as Robinhood t ..
Trading is simple but not easy! It is simple because you can buy or sell stocks just at the click of a button, but what to buy and when to buy is a difficult ball-game altogether. 95% of people who opt for trading as a profession eventually, QUIT!
Keep these questions in mind before you end up losing your capital.
Do you have a robust trading strategy?
To be a successful trader, you need a robust trading strategy with a statistical edge — Something that is thoroughly backtested & works in most if not all market conditions.
Let us take the example of a Casino. Just by using the Roulette Wheel, casinos make billions every year. In Roulette, the probability of red to black is 50:50 right? Wrong! Casinos don’t beat players because they are lucky, but because the odds are tweaked in their favor. By introducing 2 green pockets, they enjoy a winning probability of 20/38 viz a player’s winning probability of 18/38. Casino’s edge over the player is just 5% but by exploiting this edge, ‘the house always wins.’ Similarly, the only way to make money in markets is to have a strategy with a statistical edge
2) Do you have savings for at least 2 years?
Unlike other professions, trading ensures no guarantee of getting a monthly paycheck. It is a game of probability and being able to let your edge play out. You may have losing streaks and sometimes even losing months but having enough savings keeps you afloat & going, even emotionally!
3) Are you emotionally strong and disciplined?
Trading is only a 10% strategy but 90% discipline. Trust your system, follow it and execute trades irrespective of the outcome of the previous trade.
4) Do you have a good size trading account?
Most traders who blow up, start with a minuscule capital and dream of turning it into millions. You should have reasonable capital and a realistic expectation if you want to make trading as a full-time career.
People keep looking for holy grail without realizing that Trading is more about yourself and less about strategies.
To summarise the article, the mantra for long-term trading is given as follows:
I’m sure you’d agree, being consistently profitable in the market sounds simple, and it is [in theory]. But in practice, it’s harder than it looks. Consistent profitability is so difficult not because the market is rigged against you, rather it’s because your own psychology is rigged against you.
Consistent traders know this. They know that often the only thing keeping us from letting a winning trade run or cutting a losing one or hesitating to initiate a trade is the stories we tell ourselves. And that’s why these traders have trading rules and principles they abide by.
Rules and principles are important and protect us from our own inconsistencies. Rules create a consistent market framework and way of behaving from which consistent results can be possible. Principles are fundamental propositions that serve as the foundation for our beliefs and behavior. They make sticking with our trading rules easier.
So, to break away from the pack and join the minority that wins, you need both rules and principles. Now, I assume you already have trading rules. Every serious trader does. But principles are a little less obvious. In this post, I share 12 principles that long-time pro-traders use to stay in the winner’s circle.
#1- You Do Not Control The Market
Like it or hate it, this is the truth. As a retail trader, your positions likely won’t move the market in any significant and observable way.
And so…
#2- Whatever Is Going To Happen Will Happen
Your job is never to react blindly, based purely on emotions. The trading game is all about strategic maneuvering in an environment with no absolutes or provable certainties.
#3- Trading Is A Journey Of Personal Growth
As a trader, you will learn lessons about the market, about yourself, about human behavior… essentially, you are enrolled in a full-time, informal school called The School Of Hard Knocks. The lessons will occasionally hurt. You may even think they’re irrelevant and stupid, but how you perceive these lessons and what you make of them will either make or break you.
#4- There Are No Losses, Only Lessons
Growth is a process of trial and error; it’s a process of experimentation. The failed experiments are as much a part of the process as the experiments that ultimately work.
There is a huge amount of freedom that is derived from accepting what the market gives, whether it’s profits or lessons.
#5- A Lesson Is Repeated Until Learned
Once again, you’re enrolled in The School Of Hard Knocks. And it’ll serve you lessons in various forms until you have internalized them. There’s no way around that. Focus on being a good student and you’ll grow faster.
#6- Trading Is Hard
It doesn’t matter how long you’ve been trading; how much of an expert you are, at times trading will be emotionally strenuous—it’s in the job description. So, you might want to add things like meditation, yoga, exercise, and writing to your routine as these will help alleviate some of the stress.
#7- There Are No “Expert Traders”
You read that right. There are no expert traders because the market never stops teaching. And it can be a stern teacher, especially to those who think they’ve figured out everything.
#8- There Will Be Drawdowns
Sometimes, you’ll go through periods of drought. You’ll put in the time and effort with no immediate rewards … nothing to show but losses. That’s the reality of trading. Patience, perseverance, and perspective are indispensable qualities of traders with long-lasting careers.
#9- There Is No Holy Grail
New traders often fantasize about a secret formula to trading success. In reality, there are no secrets. The market is a dynamic process―what has consistently worked yesterday may not work today. All systems and strategies go through winning and losing phases.
Consistent profitability is a balancing act. It’s about understanding the inevitability of drawdowns. It’s recognizing the market phase(s) you thrive in. It’s pushing the gas pedal when it’s easy for you to make money and releasing it when it’s hard for you to make money.
#10- Nobody Has A Crystal Ball
I’ve said this before, people who tell you that they actually know what the market will do are just throwing shit at the wall and seeing what sticks. Or they’re simply talking up their positions, hoping the chatter increases their profits, not yours.
Here’s how you make it in this field: You stay engaged, you cut out the noise, you remain humble, and you do whatever you can to stay in the game long-term. Essentially, you let the numbers work for you.
#11- Your Money Beliefs Will Make or Break You
Being too attached to money and unclear about your abundance and scarcity changes of heart gives way to flawed decision-making. As a trader, your job is to capitalize on other people’s fear and greed around money, and you can’t be good at that job if you yourself haven’t sorted out your own money insecurities.
12. Your Equity Curve is Your Mirror
When you look at your performance, do you see months of consistent profitability followed by massive drawdowns? This is a reflection of your inconsistencies. Your equity curve is your own image.
The answers to trading’s conundrum lie inside of you. All you need to do is look within and reinforce positive qualities and behaviors. If you can do that, money will eventually take care of itself.
The Bottom Line
Most traders fail to tap their full potential because they’re unclear about their principles. And they try to stick to their trading rules not knowing why they should. Sadly, it’s an uphill battle.
To become part of the minority of traders who are consistently profitable, you need to be crystal clear about why your rules are important—and principles help you know.
A Trading journal is a tool that you can use to keep track of all of the trades that you have made. It can be as detailed as you want and can be kept both digitally or on an actual journal. The surprising thing is that many people perceive trading journals to be a gimmick and thus forgo the benefits that they could attain if they kept these journals.
Trading journals have a lot of benefits such as giving you the ability to keep track of and monitor your progress, see which of your strategies and systems have the most amount of success, and help you determine areas which require improvement. Trading Journals can even be used to test the waters before you dive into an unfamiliar market!
Before we take a look at 10 benefits of using a trading journal, let’s take a look at how to keep a proper trading journal which can be useful to you in the long term.
How to Keep a Trading Journal
Trading Journal
A good Trading Journal is one that has information about each and every single one of your trades. You must not omit a trade because of any reason since the trading journal is not something that you keep as a source of pride or proof of your successes. The purpose of the trading journal is to help you review weaknesses in your trading methodology and help you bridge those weaknesses.
While writing your trading journal, remember to include as much relevant information about every trade as possible. Not only should you mention the profit/loss, but you should also include why you went long/short and what were the reasons for you being right or wrong. This way, you will have a lot of information once you sit down to review your trading journal.
Still, it is important to not be too detailed, since it might make it harder to stick to in the long run.
Here is some information about every trade that you could include in your trading journal:
Date
Name of security
Number of shares/Total investment
Description of trading signals
Description of the entry and exit signals
Stops used and reasoning behind them
Total gain/loss from the trade
One last thing that you should try to do while keeping a trading journal is to write down your emotions. It is best to keep track of how you felt both in general and specifically about the trade before, during, and after you placed it.
Keeping track of your emotions will be of immense help during the review phase as once you become aware of them, you will learn to control them. Once you have contained your emotions, you will be less likely to make rash decisions which can only impact your trades in a negative manner.
How Can You Benefit From Trading Journals?
Remember that in order to avail of the full benefits of a trading journal; you must be consistent.
Unless you keep a completely unbiased and comprehensive journal, you will not be able to utilize it properly during the review phase!
Here are some of the top benefits of a trading journal:
1. A Trading Journal Helps You Ascertain Each Setup’s Viability
Every trader has multiple different setups that they utilize depending on the situation. However, what many traders fail to realize is that they might better at using certain setups than others.
For example, some traders are bound to do better in trending markets than in mean reverting markets, while others might have skills more suitable for markets that are range-bound.
Once you have a few months of data (ideally at least 3 months) in your trading journal, you can open it up and take a look at each individual system to see how successful or unsuccessful it has been for you. 3 months is a fairly long time to determine the viability of a particular system, especially if you are someone who trades on a daily basis.
When you see that certain systems are more profitable for you, it is best to employ those systems at a higher frequency so as to turn a bigger profit.
2. A Trading Journal Can Help You Work on Your Weaknesses
Just because certain systems work for you, that does not mean you should only use those systems and forget about anything else. The fact is that trading systems take a long time to develop and have some sort of utility. All trading strategies fail eventually and need to be replaced. Keeping this in mind, it is important that you always strive to find new ones to replace the failing strategies.
When looking for new strategies you will find that trading systems can sometimes be quite tricky, even when it comes to easy strategies. As such, there is a possibility that you did not understand the system properly or you are not implementing it correctly.
Luckily, you have the trading journal at your behest. Thoroughly review all of your trades to see where you went wrong and try to account for your mistakes from here onward.
When it is time to review your trading journal once again, you can compare the performance of the two periods to see if you experienced any improvement.
3. A Trading Journal Helps You Set up Incremental Goals
Benefit: Setting Goals
You can set up goals which are marginally better than your previous ones so as to not put unnecessary pressure on yourself while you are still in the learning process.
A journal is a great way for you to decide what goals you are going to pursue, how you will measure your progress (e.g. the timeframe), and what you are going to do in order to achieve your goals.
A trading journal can help you in this regard as it can tell you what you need to work on if you want to hit your next goal. For example, it may turn out that you are not doing well in the stock market due to external factors, so it might be time for you to give stocks a break and shift your focus to other investments for a while.
4. A Trading Journal Can be Used to Keep a Virtual Portfolio
Although there are numerous programs available on the web which can help you set up a virtual portfolio, a trading journal can also be incredibly useful in this regard. Beginner traders can set up a trading journal with a hypothetical amount of cash to see if they are able to outperform the market or not. If you are able to do well in the market, then it might be the correct time to start using real money. Just be aware that the psychological pressure that you experience in live trading is absent when trading a virtual portfolio.
Even experienced traders can utilize the virtual trading journal to their advantage. For example, if you are someone who is experienced in the stock market but want to expand into the futures market, then a trading journal can be a great practice tool while you learn the ins and outs of the futures market. Eventually, once you are consistently able to generate a profit in your trading journal, you can begin using real money.
Do remember that if you are running a virtual portfolio in your trading journal, you must also factor in brokerage fees so as to have accurate returns.
5. A Trading Journal Holds You Accountable
Having a trading journal means that you are less likely to make trades that are not a part of your trading plan. For most traders, it is the impulsive trade that causes them to take a loss.
As such, being able to look back at points in time when you did not stay true to your trading plan and ended up taking a loss, will help you the next time you are ready to do the same.
6. A Trading Journal Helps You Manage Risk More Efficiently
Trading Journal Risk
Many people do not realize that their risk management technique is costing them a lot of money. For example, it is possible that you might have the same risk management strategy for both small and large trades. This could be a terrible idea since you need to be more prudent during larger trades as they could end up costing you a lot more money.
A trading journal helps you see where you might be making mistakes with the handling of risk. It could be that you are not taking a big enough risk to generate a substantial reward by setting the stop loss way too close to the current price, or you could have a position that is simply too small to result in any kind of meaningful gain.
The opposite may also be true, and after some time of journaling, you might decide to shrink your position size since you find that you cannot cope with the wild swings!
7. A Trading Journal Helps With The Psychology of Trading
Many people have mental blocks which do not allow them to take risks. Remember that in order to make meaningful returns, you need to take a sufficient amount of risk.
Emotions in general play a massive part in your trading (especially if you are a day trader). A trading journal can be a great way to see if you are letting your emotions get the better of you.
For example, a trading journal can help you see if you ever get angry after a loss and start making trades which do not make any sense so as to recoup your losses. A trading journal could also help you see if you end up making rash decisions after you have had a run of successful trades (and vice versa).
8. A Trading Journal Brings Consistency
Eventually, as you continue to use your trading journal, your bad habits will start to diminish and you will stop losing money foolishly as often. This is because you will be able to see the mistakes that you are making, and will make sure to try to avoid making them in future trading sessions.
Certain mistakes are only obvious after you have been using a trading journal for quite some time. As such, it is important that you keep an accurate trading journal in which all of your trades are accounted for so as to avail the full benefits of it.
Bottom Line
It is quite clear that keeping a trading journal has numerous different benefits. Keeping a trading journal is recommended not only for beginner traders but also for the advanced ones. The beautiful thing about trading is that no matter how good you are, you can never be perfect. Thus, there is always something that you can improve on.
Although it might be difficult at first to keep track of every single trade you make (especially if you are a day trader), remember that keeping a trading journal requires a fair amount of discipline, and discipline can only help you be a better trader in the long term.
“Is it possible to achieve all these from trading?”
Good question.
Then you’ll want to read every single word in this post because you’ll discover the myths, the possibilities, and most importantly… the truth about trading.
You may be surprised at what I’m about to share with you.
So if you’re ready… then let’s begin.
#1 You’re trading for passive income
trading myths
Passive income means receiving an income without doing “anything”. In reality, you either require a large capital upfront, or you work your butt off in the early stages and reap the benefits later.
So, can trading be a passive source of income?
Well, let’s see…
Year 1 – you’d probably blow up multiple trading accounts as you’ve no idea what the heck you’re doing.
Year 2 – you learn everything you can get your hands on
Year 3 – you throw out 90% of what you’ve learned and focus on the stuff that really matters.
Year 4 – you have a concrete plan on what it takes to succeed in this business.
Year 5 – you see some consistency in your trading.
Year 6 onwards – after being through the ups and downs, highs and lows, you come to the realization that the only thing passive is paying your brokerage fee on every trade.
If you really want something passive, you’re much better off investing in an index fund.
#2 You need to repay your debt
If you’re in debt and looking for a quick fix, maybe trading is a solution?
The answer is NO and it’s not even for the experienced traders.
Here’s why…
Trading requires emotional control. But when you’re in debt, whatever control you have is clearly out of the window.
Because you only have one thought in mind… which is to quickly make back the money you owe.
So what happens?
Well, you start taking a larger risk because you want to make money fast.
You’re unwilling to cut your losses because you don’t want to lose.
You have such immense pressure on yourself and things eventually spiral out of control.
Eventually, you blew up your trading account and you’re still in debt.
So, never trade to repay your debt because you are only digging a bigger hole.
Instead, get a job (pizza delivery or something) and pay off your debts.
It may be a slow process, but at least you’re climbing out of the hole.
#3 You hate your job
trading myths
Your job has no career progression. Your colleagues talk behind your back. Your work isn’t recognized by your boss.
You honestly hate your job and you want to find a way out of it.
So you think to yourself:
“Why not trade for a living?”
There’s no boss to answer to, no politics, and no restrictions.
All of it sounds good till you find out what it takes to trade for a living. So let me explain…
First, you must be a consistently profitable trader to start with. Else, it’s like saying you want to be a professional Golfer when you’ve never played golf in your life.
Next, you need sufficient capital. Having a $1000 account and trying to trade for a living is ridiculous, (unless you can survive with $30 a month). In my opinion, you’d need at least $100,000.
Also, your trading profits must be more than your opportunity cost of trading.
Because you could have been tucked in the office as a corporate slave and still be getting around $50,000 yearly. But in trading, there’s no guarantee that you will be earning $50,000 every year.
Lastly, you should have your living expenses covered for the next 12 months, which isn’t from your trading account.
This is to ensure your survival even if you didn’t make money this month.
Now…
If you meet these requirements, then you can consider trading for a living.
If you can’t, then you’re better off staying at your job. At least you get paid no matter how f***ed up things are.
#4 You want to make money
I know this sounds ironic…
…who doesn’t want to make money, right?
But here’s the thing:
If you trade just for the money, YOU WILL NEVER MAKE IT.
Why?
The reason is simple.
You will not persevere through the tough times to reap the rewards.
Especially when you blow up multiple trading accounts, when you suffer from analysis paralysis, when your fear is holding you back… what will you do?
As you’ve seen earlier, you can easily take 5 years or more to become consistently profitable.
Don’t believe me?
Check out Marty Schwartz, a stock “Market Wizard”, who took 10 years to become profitable in trading.
Marty Schwartz isn’t the exception.
Think about Bill Gate, Steve Jobs, and Warren Buffet.
They each took years before they had their breakthrough, and the thing that propels them forward is their passion, not the money.
So…
If you just want to make money, go drive an Uber, give tuition, or take part-time jobs.
These are easier methods to make money than trading.
But, if you’re passionate about trading, then you can consider walking down this path.
You have to have a lot of passion for what you are doing because it is so hard… if you don’t any rational person would give up — Steve Jobs
#5 You want financial freedom
Financial freedom means you have enough wealth to meet your daily necessities even without working.
It’s probably because you have assets that generate a consistent income (like owning dividend stocks, collecting rental from properties and etc.)
So, does trading give you financial freedom?
It’s a yes and no.
Let me explain…
Yes, trading can provide financial freedom if you use it to generate wealth over the long-term.
For example: Trend Following hedge funds generate an average of 10 – 20% a year.
This means if you have a $1m account and you adopt a Trend Following approach, the returns should be enough to cover your expenses (albeit you don’t require $50,000 a month to live on).
However, the catch is…
You need a large capital to start with.
If your fund is small, it’s not possible to achieve a state of financial freedom.
Remember, you need money to make money in this business and there are no two ways about it.
#6 You’re looking to make it big in a few short years
You should realize by now… trading takes time, patience, emotion control, frustrations, grit, and the ability to endure PAIN.
And that’s not all. You still need capital, the lifeblood of your trading business. Without it, you’re like a car without an engine. It’s not going to work.
Now… let’s say you took 5 years to see consistency in your trading results, and you make an average return of 20% a year.
With a $10,000 account, you can expect to make $2000 per year.
With a $100,000 account, you can expect to make $20,000 per year.
With a $1m account, you can expect to make $200,000 per year.
And It’s obvious the larger your account, the more money you can make. So, if you want to make it BIG as a trader…
Get consistent in your trading
Find ways to raise capital and trade larger
So…
Forget all the marketing gimmicks. Forget the get rich quick scheme. Forget about the fancy systems and that promise high win rates.
That’s not a path you want to walk unless you want to continue losing your hard earned money.
#7 You want to buy a new car, watch, or toys
trading myths
Repeat after me…
Your trading account is not an ATM.
Your trading account is not an ATM.
Your trading account is not an ATM.
Your ATM will always spit out money when you put in the correct pin.
But trading not only spits out money, it also EATS UP your money. A big difference.
So, if you think you can use your trading account to fund your latest gadgets, “toys”, or whatever… you are sorely mistaken.
Doing so is a recipe for disaster because you put expectations on the market.
You expect the market to give in to you. You expect the market to give you profits. And this is when you break your rules by trying to bend the markets to your will.
So…
You shift your stop loss to prevent a loss. You average into losers hoping you can make it back quickly. You revenge trade and hope to make back your losses.
In other words, you break your trading rules that were meant to protect you.
The outcome?
You destroy your trading because you treat the market like your ATM.
The bottom line is this…
If you want to make a purchase, don’t rely on your trading profits.
It’s wiser to save your money and buy on a separate account.
Conclusion
1. There’s no such thing as passive income when it comes to trading. If you want something passive, you’re better off investing in an index fund.
2. Don’t trade to repay your debt because you’ll only make matters worse. Get a job, save money every month, and repay your debt.
3. If you want to quit your job and trade for a living, make sure you have sufficient capital and expenses covered for the next 12 months. That is the bare minimum.
4. Don’t trade just because you want to make money. If you just want to make money, there are far easier ways like driving Uber, giving tuition and etc.
5. Trading itself won’t give you financial freedom. You need sufficient capital, the skill to generate a positive, and your expense must be lesser than your return.
6. Trading is not a get rich quick scheme. If you’re looking to make it big in a few years, look elsewhere.
7. Your trading account is not an ATM machine. It can spit out money, but it also EATS UP your money.
Traders that have the right mind set, money management, and winning method make money, those that are missing even one of the three, will eventually ‘blow up’ their account. This applies to both professionals and amateurs.
I believe these are universal principles for all traders, many professionals have proven they are not bigger than these laws of trading, by destroying the capital in hedge funds and even entire banks.
Trading Methodology:
Winning system-Only trade tested systems with a positive expectancy in the long term.
Faith– Your system has to allow you to trade your beliefs about the market.
Risk/Reward-Never trade unless your profit expectations are greater than your capital at risk.
Trader Psychology:
Discipline-You have to keep trading your method even when it doesn’t work for a given time period.
Ego-Admit when you are wrong.
Emotions-Trade the math not your emotions.
Risk Management:
Risk of Ruin-Never risk more than 1% of your total account capital on any one trade.
Position Sizing-Use your capital at risk to understand the right amount to trade based on the securities volatility.
Capital at risk: Never put more than 6% of your total capital at risk at any given time on all positions.
stop Loss – Always have an exit strategy to cut losses short
Everyone makes mistakes! That’s normal and that’s good. If you make mistakes it means you are doing something. But it’s important that your mistakes have a small impact on your trading and life. Otherwise you have a problem …
What’s a trading mistake?
A famous trader said that everything is a mistake until you follow your rules. Sounds simple, but it isn’t easy.
A losing trade is not automatically a mistake. Only if you broke your rules and the trade is a loser, it is a mistake. But winning trades can be a mistake, too. In that situation you only had luck.
In short: Trading mistakes are based on not following your trading rules. Besides that there are mistakes in order execution or technical mistakes. For example you can make a mistake while entering an order. But in that situation your process or routine is not good enough, because normally you should double check your orders.
Why reducing trading mistakes?
Mistake mostly cost money! It’s unimportant if it’s a losing trade or an execution error. If you reduce your mistakes, you will save money and improve your trading statistics.
In addition you will strength your mindset and improve your psychological situation. You gain self-esteem and you can rely on yourself.
10 tips to reduce trading mistakes
Here are a few tips how to reduce trading mistakes. They will help you to improve as a trader financially and psychologically.
Make mistakes transparent: Collect every trade in your trading journal and diary. Analyse them afterwards and find improvements.
Create a ruleset matching your personality: A lot of mistakes occur because the trading rules are not compatible with the trader. You have to change this! The rules must use your strengths and not your weaknesses.
Build and improve processes: Everything you do as a trader should be based on processes. Only if you have a defined process, you can repeat it again and again. Over time you must improve that processes with learnings and new information.
Use automation: You can automate a lot in trading, f.e. scanning for stocks, alarms or entering orders. This helps you to reduce mistakes.
Work on your mindset: A lot of mistakes are based on wrong imaginations or values. In example: If you think that a trader has to be in action all the time, you will force trades. Instead you could have a different picture of a trader as a focused and calm person.
Checklists: A checklist can help you to stick to your rules. It’s simple and very effective.
Use statistics to find mistakes: If you collected hundreds of trades in your journal, you can use this data to find mistakes. Often mistakes have something in common. Analyse your journal and find the commonalities of your mistakes regularly.
Score tradesafterwards: If a trade is closed you should not only put it in your trading journal. Review the trade and score it: Was it a good trade? Was there a mistake? Were all rules fulfilled? Would you make this trade exactly again?
Review your trading journal with a second person: This helped me a lot! I sent my trading journal to a previous mentor and he reviewed my trades for me. He found a lot of things to improve and commonalities of bad trades.
Quality instead of quantity: Work on your quality everyday! If you improve your quality, it’s only a question of scaling to make a lot of money. Reduce bad trades, select the right time to trade and select only the best trading candidates. Then increase position size and use your edge.
Stock trading systems give you a huge advantage in the markets. My goal is to show you how you can use trading systems to improve your results, increase your confidence and reduce the amount of time your trading takes.
All traders need 3 things
There is a huge amount of literature about what you need to become a profitable trader. The hundreds of books and blogs basically boil down to the same three things. We all need:
A profitable trading method
Risk management rules that keep us in the game
Solid trading psychology to stick to our rules
If this is all it takes then why is it so difficult to make money trading?
After trading for almost two decades, my conclusion is that you need to ensure that your trading method fits your personality, objectives and lifestyle or you will make mistakes. You need to ensure your risk management fits you, or large drawdowns will cause stress. Finally your trading psychology must be underpinned by extreme confidence in your trading rules so you don’t quit at the wrong moment.
Most traders take years to develop these areas and become profitable. Luckily for us there is a shortcut which shaves years off this learning journey.
That shortcut is systematic trading.
What are trading systems and systematic trading?
A trading system is a complete set of objective trading rules that defines every action you take in the market. Emphasis should be placed on the words ‘objective’ and ‘every’.
Objective means there is no discretion, the rules tell you exactly what you should do without needing any subjective judgement or external insights to make your decisions. Every action means exactly that. The trading system defines exactly when to buy, how much to buy and when to sell.
In order for a trading system to be complete it must at least have the following components:
Trading System Component
Let’s use a simple example to illustrate the concept:
Setup: The setup is the conditions under which we will consider trading a particular instrument.
For example, the stock must be liquid enough for trading with an average daily turnover of over $500k for the last 20 bars.
Entry: The exact point at which we will enter a trade.
For example, buy tomorrow at the open if today’s close is the highest close of the last 500 bars.
Exit: The exact point at which we will exit a trade.
For example, sell tomorrow at the open if the stock closes below the 200 bar moving average.
Initial Stop: The level at which you will exit the trade if you are wrong. Some systems do not need a stop loss, however exercise caution if you are not using one.
For example, place a stop loss in the market 6 times the average true range below your entry price.
Risk Management: Limit the amount of risk taken on each trade and the total exposure so that you can stay in the game and the maximum drawdown is tolerable.
For example, risk 0.5% of your account on each trade and do not trade with leverage. Give highest priority to new trades which have moved by the greatest percentage over the past 200 trading days.
Note: This is an example of a simple trading system which captures long term trends. It cuts losses and lets profits run. I am not recommending you trade with it, let’s just use it as an example for now.
Here is an example of a solid winning trade generated by the system (I did say this was a long term trend following system!)
Long Term Trend Following
This is clearly a well-chosen example, so the obvious question to ask is how does the system perform when traded in a portfolio. This brings us to one of the main advantages of trading systematically.
Backtesting – The systematic trader’s advantage
While most new traders using technical analysis spend months pouring over charts, looking at indicators and paper trading to get a general idea whether their rules are profitable, the systematic trader can test their trading rules over thousands of trades, and decades of market history in just seconds. This process is called backtesting.
At a high level this is how it works:
You define your trading rules in backtesting software such as Amibroker
The software uses historical market data to identify the past trades generated by your rules
It calculates the entry price, exit price, position size and profit for each historical trade
It assembles the trades into a portfolio and gives you a detailed performance report
To perform this sort of backtest and then trade systematically for yourself you don’t need real time data, complex computing infrastructure, automated trading or a computer science degree. You just need a laptop, end of day historical data and trading software such as Amibroker and your trading account.
The great power systematic trading gives you is the depth of analysis you can do very quickly. Using this trading setup it takes less than 30 seconds to test our rules on all Australian stocks over the last 27 years. The backtest generates a portfolio with over 1000 historical trades and a detailed performance report.
Here is a selection of results from the performance report of our example trading system (including 0.5% per side for slippage and commissions):
Compound annual return: 17%
Maximum historical drawdown: 30%
Average profit per trade: 20.4%
Percentage of winning trades: 37%
Average win / average loss: 4.4
The equity curve generated from the backtest is below.
Equity Curve
At this point some might jump up and down saying past profitability does not guarantee future profitability. While that is true, I will say this:
“While a profitable backtest does not guarantee future profitability,
an unprofitable backtest certainly guarantees future losses”
Done correctly backtesting will help you design robust profitable trading systems that will generate profits for years or even decades. We will explore backtesting principles in future articles.
The many benefits of systematic trading
Trading systematically gives you far more benefits than simply the ability to backtest. Some benefits include:
Shorter learning curve because you find profitable methods and build confidence sooner
Repeatable results because you make consistent decisions
Reduced impact of your psychology because the system bypasses your biases and fears
Lower risk because you can diversify more broadly
Reduced time because the software scans the market to find your trades
Perhaps best of all, systematic trading empowers you to answer all those niggling questions you have like “should I use a profit target?”, “should I place my stop loss in the market?” or “how big could my drawdown get?”
My goal is to empower you to backtest your trading ideas correctly, answer questions like this for yourself and show you the path to profitable systematic trading.
You may think managing risk and position size is not needed because you will always be right, but in trading, literally anything can happen. Black Swan events are the new normal. You must use risk management to protect yourself through position sizing, stop losses, or trailing stops at ALL times. If you don’t, you will eventually blow up your account. A maximum of 1% of your trading capital should be at risk on any one trade, and no more than 3% of your capital should be exposed to losses in your total portfolio at one time. You will over shoot if you are on the wrong side of days like today, even at the opening bell. Agility is key: adjust quickly if that is the case, sell and start over.
Those who focus on making as much money as possible while ignoring risk will invariably lose the majority of their accounts. No matter how talented you are, you will face ruin, just as Jesse Livermore did and Victor Niederhoffer did on several occasions. Even the best traders like Alexander Elder and Nicolas Darvas blew up accounts when they first got started. Why? You simply can’t out trade the risk of ruin. If you risk a consistent 20% of your initial starting capital per trade you are done after just 5 losses. Everyone who has traded for any length of time has had five losses. If you risk 1% of your total starting capital per trade, 15 losses in a row will only bring you down 15%. Of course you can risk less in a drawdown or more with a proven robust system, but the key is risk management.
Seven Easy Steps to Blow Up your Trading Account
1. Don’t cut your loss, just hope it will come back.
2. Do not plan your entry and exit before you make a trade; make those decisions when your emotions are affecting you.
3. If you are unsure of what to do, just take a stab at it, go with your feelings.
4. Trade randomly with no defined edge.
5. Don’t track your trades. If a strategy loses money, just keep doing it.
6. Don’t focus on potential losses, but only on potential gains. Trade bigger and bigger as you lose money.
7. Don’t use a stop Loss, let profit disappear or turn into a big loss because you want an even bigger profit.
Follow these steps and your account will be at zero in no time!
Trading for a living is a professional endeavor like any other. It requires a large amount of capital to go full time like any other business and the returns are irregular much like being a commissioned sales person. It is less about trading from a lap top on the beach with a Lamborghini in the garage and more about taking on the risk, managing the uncertainty along with the stress and being rewarded for good trades. Also aspiring traders have to understand that you don’t just make money and receive a regular paycheck of profits, there are also losing trades, losing weeks, and losing months for any real trader.
You have to purchase private medical insurance as you have no employer plan. In the U.S. this is usually double what you paid through your employer.
You will likely need a Certified Public Accountant (CPA) to do your income taxes due to the complexity, since you will not have a W2 from an employer.
You will be your own boss so you have to make yourself do the needed work of research, screen time, and trading.
The lower your living expenses are the less you need to make to trade for a living.
You should never attempt to trade for a living until you have a record of success trading part time over multiple types of market environments.
The amount of capital you need for trading is based on your return expectations and living expenses. If you need $50,000 to live off of and your annual return expectations are 10% you will need $500,000 to trade with.
Don’t think trading for a living will be less stressful than your job, it can be more stressful than most jobs due to the uncertainty and mental stress of trading to pay bills.
Trading for a living is a lot less stressful if you have minimal monthly bills, no debt, and a year’s worth of living expenses saved before you begin.
If your spouse works it can be much less stress as you have another source of income and access to healthcare and 401K benefits.
When you trade for a living you not only have drawdowns in capital during losing streaks but also have the monthly drawdowns in capital due to having to pay your monthly living expenses.
Multiple streams of income make trading for a living much less stressful. The average millionaire has seven sources of income.
The freedom of trading for a living is worth the journey.
For the majority of people trading to compound capital gains part time is the best strategy. Trading for a living requires a lot of capital and minimal expenses along with a long term track record of successful trading to have a chance. Trading for a living is very similar to being an entrepreneur as you risk a lot of capital for the chance at freedom, being your own boss, and unlimited profit potential. Keep your risk/reward ratio favorable if you go full time, avoid the risk of ruin by making sure the math works before you make the leap.
I was reading the book ‘The New Market Wizards’ by Jack D Schwager. In this book the author interviews some of the Super Traders. One of the Super Traders is Randy Mckay a veteran futures trader in currencies. He is among the few who have gone from a starting account of several thousand dollars to double-digit million dollar gains. Over his entire career he has been profitable for his own account in eighteen out of twenty years. It will be more than worthwhile for traders like us to learn how he could do this.
One of his advice for traders is “Never let a loser get out of hand.” As a trader we can be wrong even twenty to thirty times in a row but we should be sure we still have money in our account to trade. This is possible only when we don’t allow losing trades to get out of our hands. He goes on to explain how he does this. According to him he risks 5 to 10 percent of the money in his account. If he loses in a trade, no matter how strongly he feels, on his next trade he will risk no more than 4 percent of his account. If he loses again, he will drop the trading size to about 2 percent. He will keep on reducing his trading as many as three thousand contracts per trade to as few as ten when he is facing a cold spell, and then back again.
This drastic variation in his trading size, he says, has been a key element in his success. There is a logical reason for this, according to him. When we are trading well we have a better mental attitude. When we are trading poor we begin to start wishing and hoping. Instead of getting into trades we think will work, we end up getting into trades we hope will work.
In other words, by following this strategy, when our trading is going through a poor stretch, we want to wait until we get back into the proper frame of mind.
Source: The New Market Wizards by Jack D Schwager.
We will never find a trader who has not faced a losing trade or lost money. It is futile exercise to avoid loss making trades as it is impossible to predict the markets.
While we are paper trading or doing mock trading, everything goes efficiently and it makes us believe that trading is not so difficult as we had thought. But once we switch over to live trading all that changes. We become tensed up and our mind starts working overtime. When the trend is in our favor we are at peace and in a happy mood. When the trend is against us we sit up and begin to think whether we should close the trade, wait for some more time with the hope that market will reverse, or buy more to average out. These are only a few of the thoughts from the many others that cross our minds. Each one of us is different and the thoughts are also different. Why is it so different now while it was an easy ride when we were doing paper trading? We believe we are all mentally strong and have control over ourselves. But when we begin live trading things change and our real self emerges, our emotions take over us.
It is very important that we learn how to control our emotions. We should look at trading as a mechanical activity. Our trading plan should tell us what we are supposed to do and we should follow our trading plans with discipline. In the long run, this will lead to handsome profits.
A little bit of introspection is required before we begin trading. We should be able to answer the following question in the affirmative.
Are we able to trade with a clear mind? Thinking clearly and not being influenced by emotions. We should be able to become emotionally detached from our trades. Dr. Van Tharp, a renowned investment expert, breaks down the trading process into three categories as follows:
Trading strategy (10%)
Money & Risk management (30%)
Psychology (60%)
In live trading major role is played by emotions like greed, fear of losing and impatience. Ego is another factor that effects our trading. The markets are not bothered about what we are doing. We should look at the market as our friend and not our enemy. Egoistic traders usually look at the market as their competitor and they believe they will have to win over the market. Such an attitude is a sure path to failure. Successful traders move along with the market. By doing so they take advantage of the price movements and earn profits.
The solution to trade with a calm and emotionally detached mind is by becoming disciplined. We should have a tried and tested strategy. We should follow this strategy at any cost. We should not keep tinkering with it every now and then. Losing trades are inevitable and we should learn to take them as a business loss.
Trading Plans, exit strategies, entry strategies, risk management, stop loss limits are all very important to trading. Many of us fail to realize that over and above all of these we should learn how to trade well. Greed is one factor that most of the time tries to overcome us and we land in trouble. In trading greed is the worst enemy for a trader. Greed while trading leads to pecuniary losses, we lose money when we are running after profits.
A sure fire way to learn to trade well is to take little baby steps and progress higher and higher. In this strategy the first step is to begin paper trading. Initially when I began to trade I could not understand what paper trading meant. It was something new to me. I still find some of my friends who trade are not aware of paper trading and its advantages. Paper trading is very simple to understand. In paper trading we carry out all the activities that we do while live trading except investing our precious money in these trades. We begin paper trading after our trading plans are ready. We carry out the trades as per our plans and watch the results. There is no specific period for which one has to do paper trading. It all depends on the confidence you have in your trading plan and the results of paper trading. If we find that the plan is working as we had expected then a couple of months paper trading should be more than enough. If we find that the plan is not yielding the results we were expecting then we may have to think of changing our trading plan and then begin to paper trade all over again. The best thing about paper trading is we can trade and see the results of our trading without losing any money.
When we are satisfied with the results of our paper trading we should move over to the next step of live trading with money. We have to be careful and start with one lot of the instrument that is commensurate with the capital we have deployed. We should not plunge headlong into investing all our capital. We should always remember that we are there to remain in the market and continue trading and not to shut shop and go home when all our capital has been lost. Any amount of paper trading will not be equal to live trading with money. When we do live trading with money all the emotions that were lying dormant while paper trading will begin to rise and control us. If we begin to trade in small amounts then we can easily learn how to control these demons. As we go along and gain more confidence we can scale up the trading lots gradually. What this all means is nothing but patience. For successful trading one has to have a lot of confidence in himself, his trading plans and more than anything tons and tons of patience. We should never trade with trade signals from a purchased system or tips from the news channels. Just think for a moment, if these things worked then why would someone propagate it and sell it when he can make all the profits for himself. Trading is a very personal activity. You should have your own plan that reflects your personality and takes care of your emotions and feelings such as risk taking capability or how much of loss you can take before going mad with rage.
Most of us while trading become tense and some of us even begin to worry about the results of our trades. This is because we are trying to control the trades. It is human nature and we always tend to control the environment. Trading is something like a roller coaster ride. In a ride what we do is simply try to enjoy the thrills of riding and do not try to control the roller coaster. This is because we cannot control the roller coaster. To enjoy the ride we just have to take it as it comes, feel the ups and downs and let the curves take us rather than fighting them.
I committed many trading mistakes in my early trading days. I thought why not summarise them so that they will be like a lesson to me which I can read again and again. This may also help those new comers entering into the markets for the first time. It is a series and here I am going to cover the Money Management Risks that I commited.
Daily Loss Targets: I had my daily loss targets. They were 2% of my capital. But on many occassions because of greed and fear I would never stick to this limit. It used to be 4% or 5 % sometimes and on one occassion I remember it was nearly 10%. Because of this the profit I used to earn in a week or a fortnight used to be wiped out by this one single loss.
Fear of losing: There were occassion where I used to move the stop loss further in the hope that the market would reverse – but it never happened. My loss grew more and more. When my trades were in profit I used to fear losing the profit and get out of those trades with a smaller profit. I used to then sit and watch as a fool the price reach my profit target.
What I do now: I strictly follows my plan. Entry, exit and stop loss according to my plan. I never keep watching the charts after entering into a trade and placing a stop loss. When the trade is in profit I see that I allow it to continue upto my target. These changes have brought major benefits to me. I don’t say that I don’t make losses. I make losses but they are as per my trading plan and small when compared to the profits.
I ensure that I read a book or watch a video on subjects like option trading, trading strategies, trading psychology, risk and money management in trading. This is something I do every day. I set aside about two or three hours just for this. I believe that irrespective of our level of knowledge we should keep ourselves updated and be eager to learn new things.
It may seem like an elementary question that is quite straight forward. But in order to be a successful trader we should know ‘How to Trade’. Most of the traders do not give the due importance to this question before they begin to trade. Then when the markets begin to behave in strange ways and not according to what they thought they become confused. It is always better not to look for solutions on how to trade after we are hurt in the market. But most of the beginners are in a hurry to make money in the markets. They fail to understand that trading in the markets is not easy but calls for a lot of work and dedication like in any other profession or business. Without knowing this they plunge into the market and when they begin to lose their capital wisdom begins to dawn on them.
The first step is to understand the market. We should learn about the market timings, what is traded, how it is traded, what is the margin we require, what are the options that we can trade. Since option markets trade only contracts and not actual physical securities we should know the terms of the contract, their settlement and expiry date. If we don’t exit out of the position before their expiry, some contracts call for physical delivery. We have to watch out for such contracts.
Next comes the reason for trading. We should be aware of why we want to trade. There are day traders, and long-term traders who hold on to open positions for longer periods. We should know what type of trader we want to be. It will depend on the time that is available for us to devote for trading. If we have a full-time job then we should not think of day trading. Day trading is for very short period that are minutes or hours. Swing traders hold trades for days or weeks and long-term traders hold open positions for months. This is an important decision to make before we begin to trade.
While trading we traders desire that we make profits everyday in the market. Whether we trade stocks, index, commodities or something else. But to our utter dismay we find that this is not possible. There are profit trades and there are losing trades. Sometimes losing trades continue for a stretch. Then our mind begins to ruminate on this. It begins to frighten us and tells us to forget about our trading plans and take decisions that are inconsistent and not according to our plans.
Now the question arises: Is it not possible to make profits in the market through trading. It is possible. We can make consistent profits over time. The problem is we want to earn profits from day one we begin to trade and from the very first trade that we make. This will not give us the result that we are looking for. What is required is consistency. When we have a tested plan, we should follow the plan irrespective of what other information comes to us. We are barraged with information from the TV, Newspapers, the Internet and from all the trading gurus. Now if we begin to hear them and follow them too then we will never make profits let alone consistent profits. We must be committed to our trading plans.
Laird Hamilton, an American big wave surfer. says “Make sure your worst enemy does not live between your two ears.”. Our minds are like small chatter boxes. It is the inner conversation or inner monologue that goes on constantly in the mind. … It is a sort of inner voice that constantly analyses everything about our life. When we give more attention to the external information about trading, price movements, etc., thoughts in our mind begin to happen automatically. When we realise these thoughts are not us, they are just thoughts that happen without our doing anything, it becomes easier to trade. We trade without any stress or fear. Losses will be there we can never wish them away. But when we trade consistently with a commitment to our trading plan, we will make profits. The winning trades will automatically take care of the losing trades.
Trading is simple. When prices are going up we buy, when they stop going we sell. In the same manner when they are going down we sell, when they stop going down we buy. We unfortunately make it a complicated activity and mess up the whole thing when we are not consistent and committed to our trading plans.
With a tested trading plan that tell us when to enter a trade, when to exit from it and where to place a stop loss order we should be able to make trading a joyful activity with consistent profits.
What is straddle strategy? Is straddle a good strategy? How can we make money using straddlestrategy in option trading?
A straddle is an option trading strategy. It is a non directional strategy. In this strategy we short a call and a put option at ATM. They should be of the same exiry, same security and same strike price.
Since statistically it is proved that more than 70% of the time the markets are sideways ie., non directional, definetly this is a good strategy. We can make money on account of the theta decay. The premium of the options keep falling down daily and finaly reach zero on the day of expiry if they are not In The Money – ITM.
We should devise a plan with entry time, exit time, stop loss, profit target. We should also have risk management and position size in place taking into account the capital we are investing to trade.
Thereafter we should back test our plan for at atleast with past five years data. See the result, such as profitability, drawdowns, and other factors. Once we are satisfied, forward trade (paper trade) for a month and then start trading with one lot first. Once we gain confidence and we are satisfied that the plan is working according to the test results, we can scale up.
Then comes the most important prerequisite to be a succesful trader with consistent profits. We should learn to keep our emotions, greed and fear in control. We should never fail to follow our trade plan and be disciplined while appraching our trades.
Option give the best opportunities to trade with less margin and less risk.
I am an option trader and I can tell about options. The less risky strategies in option strategies are the Iron Condor and Iron Fly. In both these cases you risk is limited and as the risk is limited the profit is also limited. But if you trade this strategy over a period of time say in a year you can make a return of around 20% or more if the market is kind to you. These are positional trades.
If you wish to trade intraday then Strangle and Straddle are the best strategies with proper stop losses in places. They will give an average return of 0.3 to 0.5 percent a day if you trade consistently over a period time.
There are a large number of other strategies but as they are complicated I have not mentioned them. The strategies mention above are very simple, especially even for beginners, and easy to use. The added advantage is that you don’t have to sit in front of the computer and monitor them.
The lessons I learnt are mostly what I knew already. I have mentioned a few of them.
To be successful in trading we have to be disciplined. I was not able to strictly follow my trading plan. On many occassions I could never restrain myself from tinkering with the open trades and that would only result in more losses. After the market closed and when I went over my trades of the day I could see that if I had not made the changes in that emotional moment my trades would have been more favourable to me. My losses would have been considerably low.
2. Failing to stick to my trading plan. When there used to be two or more consecutive losses I began to lose faith in my plan and I started to tinker with the plan and this resulted in more losses.
These were the two major lessons I learnt. Now I trade like a computer. I strictly follow the plan. I don’t look at the profits nowadays but only see if I am meticulously following the trading plan.
I am now consistently profitable for the last one year. I never feel tensed up while trading.
