Find what you do best and fashion trading strategies around that.
Learning to Cut Losses
“It’s almost cliche’,” Chris points out, “but not many people can do it in any aspect of life. I have learned to cut losses in my trading, my career, my hobby of competitive poker, and everywhere else in life where the rule applies. Without this rule, there wouldn’t be a third rule.” Chris makes a valuable point: you can’t live one way and trade another. It’s hard to imagine being totally disciplined in trading and lax in other areas of life. Good trading practice is a philosophy of living: pursuing opportunity, managing risk, limiting losses, and diversifying positions. Chris trades the way he lives.
Study and Work Hard
It is difficult to find a successful trader who does not place hard work at the center of what she does. “It is extremely important to my success for me to continuously study the markets on a fundamental and technical level and learn from my successes and mistakes,” Chris points out. “Applying the knowledge gained from past experience allows me to properly analyze similar situations in the future with slightly greater odds of success. Never stop learning is a phrase I will never stop saying, as it proves to be truer as I get older.”
Notice how both Dave and Chris emphasize the importance of knowing when they’re wrong. This is an important difference between beginning traders and experienced ones. The beginners focus on being right, as Chris pointed out. Beginners try to avoid being wrong. The experienced traders know they’ll be wrong on a significant proportion of their trades and fully accept that. Their self-coaching is designed to help them anticipate and manage losses, not avoid them. They have a plan for each trade to deal with loss, and they have an overall trading plan to deal with periods of drawdown. Your assignment for this lesson is to use your trading journal to flag your fallibility, identifying the five largest losing days in the past year. What did you do wrong on those days; what could you have done differently? What were the problems that occurred on more than one of these losing occasions? The idea is to embrace your fallibility by turning it into an engine of learning. If you clearly identify the mistakes from your worst trading days, you’ll be better prepared to avoid them in the future. Your worst trades can be your best tool for self-understanding—and your best guide for self-coaching.
COACHING CUE
As you review your trading, make a special study of how you exit trades. Do you tend to exit too early, so that you leave potential profits on the table? Do you tend to overstay your welcome, so that potential profits are retraced? Take it a step further: what could you have looked at to stay in the trade longer or to exit sooner? How can you best adjust your exits to the market’s level of volatility? If you refine your exits, you can break your trading down into components and turn observations into goals for improvement.
LESSON 87: THE POWER OF RESEARCH
Rob Hanna is a trader and the writer of the Quantifiable Edges blog (www.quantifiableedges.blogspot.com), a unique site that tracks historical patterns in the stock market. His electronic newsletter goes out daily, detailing the trades he places from his research. For traders, the blog and newsletter are unique tools that can extend their market edge. I particularly find historical patterns relevant to discretionary trading, as we’ll see in Chapter 10. With a sound understanding of historical performance, we are in a great position to identify markets that are following their usual patterns and those that are not. Both scenarios can generate excellent trade ideas.
Jeff Miller is a money manager in Naperville, Illinois, who also shares his ideas about markets and trading through his blog, A Dash of Insight (http://oldprof.typepad.com). He frequently challenges accepted trading wisdom and offers perspectives on markets that reflect his disciplined analysis and understanding of economics. He has researched trading systems and uses those systems in his portfolio management. Like Rob, Jeff’s edge is that he tests ideas before he trades them, giving him confidence in risking his capital.
Rob’s answer to my question of what he’s found most helpful to his self-mentoring as a trader was quite simple: “Research, research, and research.” He explains, “I know that sounds like one answer repeated three times, but it’s not. It’s the top three answers . . .I’ve been through several stages in my career and traded using different methodologies. The one constant I’ve found with any method of trading I’ve employed is that it takes a substantial amount of research outside of market hours to successfully implement them.”
Rob Hanna started his career day trading, focusing on short-term setups, such as those described in Jeff Cooper’s Hit and Run books. What Rob found most useful was not the setup patterns, but the screening for volatile, trending stocks to implement the strategies. He began creating his own scans based on trading patterns, focusing on trades with the best risk/reward. “I wrote down each potential trade in a notebook along with the trigger price for the next trading day,” Rob described. “When the trade was done, I would log the results in my accounting software. I kept a field in the accounting database called reason. It was there I entered the name of the setup I used to initiate the trade.” This is a theme we see time and again with successful traders: they track their results meticulously to aid their learning curves.
Keeping records of trades that work cements success patterns in your mind.
Rob Hanna points out that keeping his trades in a database accomplished two goals: it forced him to have a reason for every trade, and it enabled him to track his results as a function of the trade setups employed. “It made it extremely easy for me to determine which setups worked best and which ones struggled,” he explains. “By doing this, I knew which setups I should continue to focus on and which ones I should scrap altogether.” When Rob didn’t have a solid reason for a trade, he simply entered the word Hunch as the reason for the trade. “It didn’t take long for me to figure out how much the Hunch trades were costing,” he recounts. He quickly scrapped trading from hunch alone.
The second phase of Rob’s research occurred when he switched to longer-term trading that utilized patterns inspired by William O’Neil’s CANSLIM approach. Rob began to utilize technical screens with the TC2000 software from Worden Bros., with his final lists filtered through fundamental criteria. “With TC2000,” he describes, “I am able to easily place notes on the chart. This is incredibly useful. If a stock pops up with an interesting pattern, I may have already researched that stock in recent weeks. With the note feature, I can see if I already checked the fundamentals and rejected it for some reason. No need to waste time looking up the same symbol over and over.” As with the day-trading patterns, the setups were less important than the work that went into implementing them. “Once again,” he notes, “I found it was the research and not the trading that made me the money.”
In Rob’s third phase of research, he has formally back-tested his trading ideas, using Excel and TradeStation as primary tools. This back-testing has enabled him to generate actionable trade ideas. As he puts it, “I love taking these trades because I have a good idea of my success rate and profitability expectation going in.” Reviewing a variety of price, breadth, volume, sentiment, and other indicator data helps him develop a view on markets, but it also “helps me to unveil what is truth and what is lore with regards to conventional market wisdom. There is so much information out there. It’s difficult to know what’s valuable and what information is simply hype . . .There is great value in being able to test ideas and understand what indicators and setups actually provide a quantifiable edge, and what ones don’t.”
Much conventional trading wisdom does not stand the scrutiny of objective analysis.
For Rob, research has been his source of edge. “Whether my focus has been day trading, intermediate-term momentum trading, or quantitative swing trading,” he explains, “I have consistently found that it’s been the nightly research that has facilitated my growth as a trader more than anything . . .The ideas are all constructed at night. Market hours ar
e simply used for executing those ideas. Research (stock screening and charting), research (quantitative analysis), and research (results analysis) are the three things I’ve found most helpful in coaching myself as a trader.”
What I most like about Rob’s perspective is that it highlights the relevance of research for every kind of trader, not just those that trade mechanical systems. Rob has tested and traded setups, but he also has treated himself—and his trading—as a subject for study. When Rob identified the ideas that work best for him, he has been able to maximize opportunity and eliminate the hunches and market lore that cost him money.
Jeff Miller approaches markets differently from Rob, but his perspectives on self-mentoring are surprisingly similar. “The most important thing—by far—in my trading is having a system and/or method,” he stresses. “Without a system in which you have confidence, you are adrift. You second-guess yourself on every occasion. This leads to selling winners too soon, holding on to losers too long, and many other errors. You need to know that your basic method works. If you really understand and believe this, you can focus on making the correct decisions, which may not always be the winning decisions.”
The key word Jeff uses is know. Many traders don’t know their edge; they don’t know how well their methods work in different market conditions. They have beliefs, but not deeply held convictions about the ways in which they make decisions. As a result, traders lose discipline. This loss is not because they cannot follow rules. It’s because they don’t deeply believe in the rules to begin with.
Many times, poor discipline is the result of shallow conviction. If we don’t truly know our edge, how can we believe in it?
A second important element for Jeff Miller’s self-coaching is analysis and review. “Having a system means testing it properly,” he explains. “This is not back-fitting for a short time period. It is developing the method in one era and testing over out-of-sample data covering different markets. Only then can you be confident. Even with this method, you must do regular performance reviews to make sure that something in the world has not changed. There may be a tough decision about whether you are in a predictable slack period or circumstances that are really different.” In other words, trading is fraught with uncertainty; even the best ideas have a limited shelf life. The purpose of analysis and review is to generate an edge, but also to monitor changes in that edge over time. It’s not as simple as finding systems that make money for all time and all markets.
Jeff’s third area of self-coaching is learning to recognize exceptions. “Understanding your method means knowing when something truly exceptional is happening,” he points out. “We all know the danger in saying that, ‘This time is different.’ Keeping this in mind, there are exceptional trading opportunities lasting a day or a week, even for those of us with longer time horizons.” This thought gets us back to the excellent point raised by Henry Carstens: knowing when to turn your trading off. When markets are behaving in historically abnormal ways, the usual methods may not produce their usual results. Exceptional markets yield exceptional risks as well as rewards.
The takeaway from Rob and Jeff is the value of self-knowledge. The more you know about your trading methods, the more you can play to their strengths and avoid their weaknesses. Note that for both Rob and Jeff, this has meant considerable time and effort outside of trading hours to hone their edges and stay on top of how they change. I consistently find that a major predictor of trading success is the amount of time devoted to markets outside of trading hours proper. The time spent in defining and refining trading methods is a major part of this commitment. When you are your own trading coach, you are no different from a basketball or football coach: much of your success will come from the hours you put into recruiting new talent, practicing, and planning.
Your assignment for this lesson is to treat yourself as a trading system, so that you can research, research, research your performance over various markets and market conditions. For this assignment, pay particular attention to the kinds of trades that make you most of your money. Do they occur at particular times of day, or in particular market conditions? Do they occur primarily in a few markets or stock names? Are they primarily short-term trades or longer-term ones? Are they mostly reversal trade, or are they trend following? Your goal is to clearly identify your bread and butter as a trader, so that you can allocate most of your risk to what you do best and reduce the risk associated with trades that are outside your wheelhouse. Understand what you do—especially what you do best—as it is the most effective means for developing and sustaining confidence in your work. Weekly and monthly reviews of each of your trades by categories are a great start in this direction.
COACHING CUE
Track the number of trades you place that break even or that make or lose only a small amount of money. Many times, this is a sign of good discipline in cutting losers (although it can also reveal problems with exiting winning trades far too early). Recognize quickly when a trade is wrong to help keep the average size of losing trades below that of winners, an essential ingredient of trading success.
LESSON 88: ATTITUDES AND GOALS, THE BUILDING BLOCKS OF SUCCESS
Ray Barros wears many hats as a money manager, trader, blog writer, book author, and trading coach. He is one of the very few coaches that I know who incorporates a keen awareness of psychology with a sound understanding of markets. His Trading Success blog (www.tradingsuccess.com/blog) is notable for trading and psychological insights, and his book The Nature of Trends is an excellent tool for mentorship. It explains his ways of analyzing markets, his risk/money management ideas, and his trading psychology tools.
John Forman similarly combines a wealth of roles. An athletic coach, he also mentors traders and offers his insights in The Essentials of Trading blog (www.theessentialsoftrading.com/Blog). His book by that same name is an excellent introduction and orientation to markets, with valuable views on analyzing markets, executing trades, and developing trading systems. He is keenly aware of the importance of skill development and psychology to the evolution of traders.
When I asked Ray for the three things that have most contributed to his self-coaching, his number one factor was attitudes. Among the attitudes he views as essential to trading success are:Honesty
Ray defines this as “the value of never consciously faking reality. If there is one trait that has proven critical to my success and to the success of my students, it has been this one. Successful students are brutally honest with themselves. Failed students tend to provide excuses and rationalizations for their failures.”
Responsibility
“I learned to take full responsibility for my successes and failures,” Ray explains. “With successes, my question is: How can I repeat this? With failures, my question is: What can I learn from this?”
Tenacity
“I’ll do whatever is necessary to achieve my goals,” Ray emphasizes. “This includes constant learning by first learning the material, then adapting it to suit my needs. I notice that failed students tend to resist the material whenever that leads outside their comfort zones.”
Learning requires a willingness to venture outside one’s comfort zone to see and do things in new ways.
Discipline
Ray stresses, “I am disciplined enough to write out my trading rules and execute the rules consistently. I am disciplined enough to keep my psychological and equity journals so that I can learn from my trades. And I am disciplined enough to celebrate my successes and take time from the markets to recharge.”
Citing Linda Bradford Raschke, who has mentored many traders over the years through her online trading room, seminars, and books, Ray Barros stresses that coaching is only valuable if its insights are implemented by traders in their 3-Rs: routines, research, and reviews.
Among the routines that Ray finds essential to his lifestyle as a trader are:• Updating data and journals.
• Reviewing trades.
• Preparing for the coming d
ay, “including visualization of entries and exits.”
• Balancing other duties and responsibilities with trading regimes.
• Staying on top of personal and business finances.
• Completing commitments, including writing articles, preparing for talks, and so on.
He notes that his self-mentoring blends review and research. “I may notice a pattern in my journals that needs attention,” he explains. “It may be that I am suffering losses or experiencing profits beyond the norm. In the former case, I would need to research the context that is leading to the loss. I’d need to determine whether it is incompatibility between my plan and current market conditions, or whether I am breaching discipline. In either case, I have to decide what to do. If current market conditions do not suit my plan, I’ll cut down size or take a break. If I am breaching discipline, I identify the context/contexts within which the breach/breaches occur and take remedial actions. I then review the actions to see if they have had the desired results. If not, I change the actions.”
Ray also carefully reviews and researches periods of unusually positive trading performance. “If I am making above normal profits, I determine if current market conditions happen to suit my plan or if there has been a fundamental shift that is leading to greater profitability. In the former case, I increase my size and ensure that I maintain my discipline before I take a trade. I have learned that, in my case, I need to be more vigilant when I am having a great run than when I am suffering a drawdown. If there has been a fundamental shift, I seek to identify what I have done to cause the shift, and I seek consciously to continue the new behavior.”
The Daily Trading Coach Page 39