Having considered the marginality of trading in my last post #99, as promised then I will this time take a look at the notion that trading is largely a mental game.
Trading presents a rather interesting set of circumstances for us to operate in: it is inherently uncertain - nobody knows for sure what is going to happen next - and it involves a high degree of randomness/unpredictability that means even the most thorough analysis is going to be proved wrong over and over again. This combination is what makes trading difficult and very taxing intellectually and emotionally. You do your best to figure it all out carefully and - Oh dear! - wrong again.
It means you have to accept a lot of losing trades as a matter of course and we are simply not geared up mentally to deal with that well. Going back to basics, instinctive survival means not being wrong too often or you will end up as some wild animal's lunch. Moving forward a few millennia and being wrong too often will mean you are looking for a new job. We are hardwired to avoid being wrong, but being wrong is an inherent part of trading. Quite the mental conflict for us to deal with.
The trading solution to this is deceptively simple: accept you will be often wrong, and have the discipline of a small position size + rigid stop loss always in place so when you do lose you don't lose much. Look at trading as a series of trades that faithfully follow an underlying strategy that will result in a pretty random series of winners and losers. If your strategy has any edge and your discipline is good you will come out on top over the entire series.
Of course, if either your strategy has no edge, or your discipline is poor, you are likely to be a net loser. So I shall be taking a look at each of these elements in turn over the next couple of posts.
Hi all,
Following on from my last post #102, here I want to talk about the idea of having an edge in your trading method.
Markets are inherently unpredictable and incorporate a high degree of randomness. This means any strategy is at best likely only to have a small edge - something that makes it better than random. But an edge you must have or there can be no expectation of generating a net profit over time. But what makes an edge for you, exactly?
Essentially, it can come in only one of two ways. For a 1:1 risk:reward profile either: your win rate is better than 50%; and/or the average size of your winners is bigger than your average for losers. Of course, if your R:R is better than 1:1 then this reduces the win rate burden - at 1:2 (winners 2x losers) you only need a win rate better than 33% to be net profitable, for example.
Whatever strategy you use - and it doesn't really matter what it is as long as it suits your psyche and beliefs about the market - it must have at least one of these two positive edge attributes. Otherwise, you are just wasting your time, effort and money. So backtest, demo trade and small-size trade your strategy to death to prove it has a durable edge, and instill in you the internal confidence to keep going with it through inevitable and frequent losing patches.
Different strategies ask different things of a trader. Short term, high frequency, trading makes rather different demands on you than low frequency long term trend following. You will not profitably trade even a very high edge strategy if you are not comfortable with it. You are far better off trading a lower edge strategy that suits you than a higher edge one that doesn't. My basic method I know is sub-optimal, there is a better way to trade it. But I don't because the sub-optimal way suits me much more so I accept watching the bigger potential profits remain on the table. I'd rather sleep well than increase my edge. Each to their own.
All of which brings us to the second factor brought up in post #102, that of discipline. No edge is of any value to you at all without it, so next post we will look more closely at it.
I've been following the chat about trading strategies and having an edge. It's like finding your groove in a chaotic market, right? I totally get the importance of having a win rate above 50%. And that part about sticking to a strategy that suits your style? So true! It's all about finding what works best for you in the trading world.
I've been following the chat about trading strategies and having an edge. It's like finding your groove in a chaotic market, right? I totally get the importance of having a win rate above 50%. And that part about sticking to a strategy that suits your style? So true! It's all about finding what works best for you in the trading world.
Ignored
Hi lillian12,
Absolutely! It is all about finding what suits you and then being able to stick with it through thick and thin. Notice that this is rather more about you than the markets. People generally get it the other way round: they try to figure out the markets when they should really be trying to figure out themselves. Save yourself a lot of time, trouble and heartache and just call markets mostly unpredictable most of the time. Now look at yourself and try to figure out how you can make some money from that without torturing yourself to a stress ulcer. I can give you a clue: it's mainly about how well you handle the losers.
PS You don't have to have a win rate above 50%. I don't, I take a lot of scratches and my gross win rate is well below 50% but if you exclude the scratches then yes, I have slightly more winners than losers of roughly equal size. But that's not the only way, big trend following strategies for example work on the basis of a lower win rate but average win size being much bigger than average loss size. Scalpers do exactly the opposite. Again, whatever suits you.
Hi all,
This post I want to continue this brief look at the essence of trading started in post #99 by talking about discipline. Trading is a marginal game and edges are small. So to come out on top you really do need to be very disciplined in your trading. But what does discipline really mean here?
In a nutshell it means sticking faithfully to your method through thick and thin. You will have losing patches, in fact you will spend most of your trading life in drawdown, i.e. your account will be below its last achieved peak value most of the time. Your account doesn’t just keep going upwards in a straight line, it’s much more up to a peak, fall off a bit, plod on aimlessly sideways for a while before another leg up, and so on.
You can only live through this sort of experience if you have the discipline to keep trading steadily despite going backwards or treading water most of the time. This is why you must do everything you can to instill inside yourself an unshakeable confidence in the integrity of your method. Confidence in your method begets discipline, and discipline begets the steady trading over a long series of trades that you need.
Most failing traders fail not because their method is so poor but because they lack the discipline to see it through, typically by any combination of:
· jumping into poor trades outside of their method that they should never have taken
· raising the trade size too large for the account and so incurring too much risk
· running a loser rather than cutting at the stop loss and taking a huge, fatal loss
· revenge trading, i.e. trading emotionally (and inevitably poorly) to try to make up a loss
Keep trading small, keep to your method, keep your discipline whatever the market throws at you. If you can do this you have a chance. Most traders can’t manage this for any prolonged period and this is why most traders fail. Trading is truly a mental game above anything else. Speaking of which, next post I’ll tackle the unpleasant but rather necessary topic of dealing with losing trades.
