OK - this is long. If you're trading you probably have the time to read this, because you're twiddling your thumbs waiting... 
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"One of the aspects of poker that Don Harrington points out is that your job is to cause your opponents to make mistakes and your opponents' job is to cause you to make mistakes. In trading, however, we don't need to have others cause us to make mistakes because our natural inclination is to make lots of mistakes."
- Van Tharp - "Trade your way to financial freedom"
I don't know about you, but this certainly applies to me.
I had a slow day yesterday, waiting yet another day for my latest mistake to come home.
The sad story: Last Friday, I placed a GU order splitting the pullback in progress, way too soon. There was no evidence suggesting that the pullback was over, but I was being proactive - Mistake #1. Then a news spike triggered my order. Then pullback changed its mind and turned into a full blown down swing. Where was my stop? Oh yes, way down there, 1000 pips away, because of a damn typo - Mistake #2. By the time I realized what was going on I'd compounded the error by not checking more frequently - Mistake #3. Mistake #4 was the decision not to take a 100 pip loss and instead to wait it out. One mistake had turned into 4. This prevented me from taking the two very nice swings during the four days it's now taken to recover. For want of a 50 pip stop a couple of hundred went waltzing by, waving to me. Still, I consider myself lucky to have been able to recover.
So, yesterday, while I was twiddling my thumbs I thought about the quote above and quantifying the effect of mistakes in trading. This is probably impossible to do except as a back of an envelope first order approximation. But even a rough number is enough to give a feel for the impact of mistakes.
I have a simple spreadsheet with the calculation for various success rates from 50% up to 100%. The details of the model and the results are below. You can quibble about the model and the various details. After all, it has to be simplistic. I think it probably impossible to model much more accurately without being so complex that no one can understand it. Also, the assumptions are wrong, of course. Anything subjective is going to be wrong. Still, I'm not really too interested here in anything more than a rough indication. If someone wants to discuss creating a more sophisticated model, I'm all for it, but this here is just ballpark stuff. For your info.
What is interesting is that these results show that making more than 1 mistake in every 5 trades can turn a successful system into a losing system. Ask yourself, how many mistakes are you making?
The message for me is clear. You may already be, or worse, have been, as close to the perfect system as you're going to get. And you wouldn't know it, if the mistakes that inevitably occur are messing with your results.
So, what to do? Obviously, don't make mistakes. Yeah - right. Switch to an automated system which doesn't make mistakes. I'm planning to work on this one day, but now I'm still in the direct experience capture mode.
We need to differentiate between those losses caused trading the system, and those caused by finger trouble. The system losses aren't mistakes, they are normal, expected results. How do you know that you're making fewer mistakes? Think about that. If you're not tracking your errors, you don't have a direct measure. With time (and funds) things should get better, but there's nothing tangible to show the improvement.
Ultimately, it all boils down to experience. The more you have, the more mistakes you've met, identified and learned to avoid. I suggest that if you're ignoring your errors instead of examining them in minute detail, you're doomed.
Trading 100 Challenge
One idea I'd like to suggest is to start the Trading 100 Challenge, along the lines of similar online systems used for tracking things that span a longer periods of time, like fitness training/dieting and so on.
Everyone starts each month with 100 points. Every time you make a mistake you deduct a point. The log is updated daily showing the day's results. Those that enter the monthly challenge have to post daily. Not posting costs one point.
Each month resets. Each entrant decides on their own criteria and does their own scoring.
Make fewer mistakes and your monthly challenge score gets higher. When it gets to 100 you're disqualified because you're cheating.
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Here's the very simple model of a trading system:
Winning Trades: 50% of trades make 2R.
Losing Trades: 50% of trades lose R.
R is the amount at risk, usually somewhere between 0.5% and 5% of trading capital.
Not bad as systems go.
Note, a losing trade is NOT a mistake. It's part of the system and to be expected.
With this system after 100 trades you should be up, on average, 50R.
Now we add mistakes to the mix:
Mistakes are difficult to quantify. My mistake above ended up not costing me anything. In fact, it should count as a plus, as I turned a 50 pip loser into a 20 pip loser. Theory says that I'm actually up 30. From another view one could argue that the mistake cost 300 pips instead of 50 because of the lost trading opportunity. Van Tharp claims mistakes cost somewhere between 2R and 5R. I'll make it simple.
A mistake loses 2R.
A mistake can happen to a winning trade as well as a losing trade.
Table below shows the result for someone making a mistake every 2nd trade (50% success ratio) all the way to perfect.
-
"One of the aspects of poker that Don Harrington points out is that your job is to cause your opponents to make mistakes and your opponents' job is to cause you to make mistakes. In trading, however, we don't need to have others cause us to make mistakes because our natural inclination is to make lots of mistakes."
- Van Tharp - "Trade your way to financial freedom"
I don't know about you, but this certainly applies to me.
I had a slow day yesterday, waiting yet another day for my latest mistake to come home.
The sad story: Last Friday, I placed a GU order splitting the pullback in progress, way too soon. There was no evidence suggesting that the pullback was over, but I was being proactive - Mistake #1. Then a news spike triggered my order. Then pullback changed its mind and turned into a full blown down swing. Where was my stop? Oh yes, way down there, 1000 pips away, because of a damn typo - Mistake #2. By the time I realized what was going on I'd compounded the error by not checking more frequently - Mistake #3. Mistake #4 was the decision not to take a 100 pip loss and instead to wait it out. One mistake had turned into 4. This prevented me from taking the two very nice swings during the four days it's now taken to recover. For want of a 50 pip stop a couple of hundred went waltzing by, waving to me. Still, I consider myself lucky to have been able to recover.
So, yesterday, while I was twiddling my thumbs I thought about the quote above and quantifying the effect of mistakes in trading. This is probably impossible to do except as a back of an envelope first order approximation. But even a rough number is enough to give a feel for the impact of mistakes.
I have a simple spreadsheet with the calculation for various success rates from 50% up to 100%. The details of the model and the results are below. You can quibble about the model and the various details. After all, it has to be simplistic. I think it probably impossible to model much more accurately without being so complex that no one can understand it. Also, the assumptions are wrong, of course. Anything subjective is going to be wrong. Still, I'm not really too interested here in anything more than a rough indication. If someone wants to discuss creating a more sophisticated model, I'm all for it, but this here is just ballpark stuff. For your info.
What is interesting is that these results show that making more than 1 mistake in every 5 trades can turn a successful system into a losing system. Ask yourself, how many mistakes are you making?
The message for me is clear. You may already be, or worse, have been, as close to the perfect system as you're going to get. And you wouldn't know it, if the mistakes that inevitably occur are messing with your results.
So, what to do? Obviously, don't make mistakes. Yeah - right. Switch to an automated system which doesn't make mistakes. I'm planning to work on this one day, but now I'm still in the direct experience capture mode.
We need to differentiate between those losses caused trading the system, and those caused by finger trouble. The system losses aren't mistakes, they are normal, expected results. How do you know that you're making fewer mistakes? Think about that. If you're not tracking your errors, you don't have a direct measure. With time (and funds) things should get better, but there's nothing tangible to show the improvement.
Ultimately, it all boils down to experience. The more you have, the more mistakes you've met, identified and learned to avoid. I suggest that if you're ignoring your errors instead of examining them in minute detail, you're doomed.
Trading 100 Challenge
One idea I'd like to suggest is to start the Trading 100 Challenge, along the lines of similar online systems used for tracking things that span a longer periods of time, like fitness training/dieting and so on.
Everyone starts each month with 100 points. Every time you make a mistake you deduct a point. The log is updated daily showing the day's results. Those that enter the monthly challenge have to post daily. Not posting costs one point.
Each month resets. Each entrant decides on their own criteria and does their own scoring.
Make fewer mistakes and your monthly challenge score gets higher. When it gets to 100 you're disqualified because you're cheating.
---
Here's the very simple model of a trading system:
Winning Trades: 50% of trades make 2R.
Losing Trades: 50% of trades lose R.
R is the amount at risk, usually somewhere between 0.5% and 5% of trading capital.
Not bad as systems go.
Note, a losing trade is NOT a mistake. It's part of the system and to be expected.
With this system after 100 trades you should be up, on average, 50R.
Now we add mistakes to the mix:
Mistakes are difficult to quantify. My mistake above ended up not costing me anything. In fact, it should count as a plus, as I turned a 50 pip loser into a 20 pip loser. Theory says that I'm actually up 30. From another view one could argue that the mistake cost 300 pips instead of 50 because of the lost trading opportunity. Van Tharp claims mistakes cost somewhere between 2R and 5R. I'll make it simple.
A mistake loses 2R.
A mistake can happen to a winning trade as well as a losing trade.
Table below shows the result for someone making a mistake every 2nd trade (50% success ratio) all the way to perfect.
