The Real Deal When It Comes to Trading
An Inquiry into Trading Systems, Money Management and the Human Psyche
At a recent seminar, I got involved in an interesting discussion with other attendees centered on trading success. More specifically, the percentage of successful trades and the percent of accuracy you should realistically expect from trading.
For whatever reason, our minds tend to focus on accuracy as the primary way of evaluating a speculative endeavor. True to form, accuracy – our mental magnet of making money – has very little to do with finding success.
Reality – No Great Expectations
By and large, the record of the past teaches us that on balance, the investment newsletter writers (commodity, stock or mutual funds) don’t do such a hot job. As a result, taking a quick peak at the advisors’ percentage of accuracy in picking winning trades should prove to be at the very least – interesting.
In looking into this I primarily focused on: Of the small percentage of winning services, what was the accuracy percentage of these most profitable advisory services?
I arbitrarily selected the March 1993, January 1996, March 1997, May 1998 and June 1999. What follows are the figures for the most profitable advisors / service for that month and their percent of accuracy of all trades for the prior 12 months.
Mar 1993 Commodity Timing . . . $60,939 . . . 51%
Jan 1996 Moore Research . . . . $84,643 . . . 52%
Mar 1997 Turtle Talk. . . . . . $79,244 . . . 42%
May 1998 Commodity Timing . . . $90,430 . . . 47%
Jun 1999 Moore Research . . . . $102,605. . . 54%
A key point to remember is that these results are the “best of the best” for the above time periods. On average these services were right 49.2% of the time – our first indication that accuracy percentage doesn’t necessarily have much to do with making money.
Consistent Winners
During the selected timeframe there were four advisors / services that substantially outperformed the others. In other words – they made money. Before we look at their figures, let me point out that none of the top four performers base their approach on the “magical and mystical” stuff like Gann, Elliot, Astrology and the like. In fact, advisor letters touting those methods have the worst performance. The winning letters are, by and large, trend followers to one degree or another.
With that in mind, here are the ones that I feel had the best performance. The market letters that had the most consistent and profitable performance and their percentage of winning trades. The dollar figures represent the money they made from their recommendations for the prior 12 months from each of the reporting dates listed above.
Top 4 Newsletters . . . . . . . . 5 Year Total Profits . . . % of Winners
Commodity Research Bureau . . . . . $158,840 . . . . . . . . 48%
Commodity Timing. . . . . . . . . . $224,239 . . . . . . . . 47%
Commodity Trend Service . . . . . . $214,858 . . . . . . . . 32%
Moore Research. . . . . . . . . . . $242,253 . . . . . . . . 51%
Clearly, the winners are not particularly accurate – just very profitable!
Now the question begs – What allows them to make money with what would appear on the surface as mediocre accuracy? The answer lies in one of the oldest adages on the street… let your profits run and cut your losses short. In terms of math, this simply means that their average profit per trade is substantially greater than their average loss.
The message should be clear and is one based on how real people did in real time and in real world trading – accuracy really doesn’t matter all that much. On a side note, the next time someone tells you that all newsletters are a bunch of hot air you may want to show them the figures above.
Of course, the counterpart is that you must not take quick little profits. To succeed in this business you’ve got to hold on for large winning trades because as you can see by these real world examples – accuracy doesn’t make you money.
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Learning from Trading Psychology and the Trading Environment
When it comes to trading, one of the most neglected subjects are those dealing with trading psychology. Most traders spend days, months and even years trying to find the right system. But having a system is just part of the game. Don’t get us wrong, it is very important to have a system that perfectly suits the trader, but it is as important as having a money management plan, or to understand all psychology barriers that may affect the trader decisions and other issues. In order to succeed in this business, there must be equilibrium between all important aspects of trading.
In the trading environment, when you lose a trade, what is the first idea that pops up in your mind? It would probably be, “There must be something wrong with my system”, or “I knew it, I shouldn’t have taken this trade” (even when your system signaled it). But sometimes we need to dig a little deeper in order to see the nature of our mistake, and then work on it accordingly.
When it comes to trading the Forex market as well as other markets, only 5% of traders achieve the ultimate goal: to be consistent in profits. What is interesting though is that there is just a tiny difference between this 5% of traders and the rest of them. The top 5% grow from mistakes; mistakes are a learning experience, they learn an invaluable lesson on every single mistake made. Deep in their minds, a mistake is one more chance to try it harder and do it better the next time, because they know they might not get a chance the next time. And at the end, this tiny difference becomes THE big difference.
Mistakes in the trading environment
Most of us relate a trading mistake to the outcome (in terms of money) of any given trade. The truth is, a mistake has nothing to do with it, mistakes are made when certain guidelines are not followed. When the rules you trade by are violated. Take for instance the following scenarios:
First scenario: The system signals a trade.
1. Signal taken and trade turns out to be a profitable trade.
Outcome of the trade: Positive, made money.
Experience gained: Its good to follow the system, if I do this consistently the odds will turn in my favor. Confidence is gained in both the trader and the system.
Mistake made: None.
2. Signal taken and trade turns out to be a loosing trade.
Outcome of the trade: Negative, lost money.
Experience gained: It is impossible to win every single trade, a loosing trade is just part of the business; our raw material, we know we can’t get them all right. Even with this lost trade, the trader is proud about himself for following the system. Confidence in the trader is gained.
Mistake made: None.
3. Signal not taken and trade turns out to be a profitable trade.
Outcome of the trade: Neutral.
Experience gained: Frustration, the trader always seems to get in trades that turned out to be loosing trades and let the profitable trades go away. Confidence is lost in the trader self.
Mistake made: Not taking a trade when the system signaled it.
4. Signal not taken and trade turns out to be a loosing trade.
Outcome of the trade: Neutral.
Experience gained: The trader will start to think “hey, I’m better than my system”. Even if the trader doesn’t think on it consciously, the trader will rationalize on every signal given by the system because deep in his or her mind, his or her “feeling” is more intelligent than the system itself. From this point on, the trader will try to outguess the system. This mistake has catastrophic effects on our confidence to the system. The confidence on the trader turns into overconfidence.
Mistake made: Not taking a trade when system signaled it
Second Scenario: System does not signal a trade.
1. No trade is taken
Outcome of the trade: Neutral
Experience gained: Good discipline, we only need to take trades when the odds are in our favor, just when the system signals it. Confidence gained in both the trader self and the system.
Mistake made: None
2. A trade is taken, turns out to be a profitable trade.
Outcome of the trade: Positive, made money.
Experience gained: This mistake has the most catastrophic effects in the trader self, the system and most importantly in the trader’s trading career. You will start to think you need no system, you know better from them all. From this point on, you will start to trade based on what you think. Confidence in the system is totally lost. Confidence in the trader self turns into overconfidence.
Mistake made: Take a trade when there was no signal from the system.
3. A trade is taken, turned out to be a loosing trade.
Outcome of the trade: negative, lost money.
Experience gained: The trader will rethink his strategy. The next time, the trader will think it twice before getting in a trade when the system does not signal it. The trader will go “Ok, it is better to get in the market when my system signals it, only those trade have a higher probability of success”. Confidence is gained in the system.
Mistake made: Take a trade when there was no signal from the system
As you can see, there is absolutely no correlation between the outcome of the trade and a mistake. The most catastrophic mistake even has a positive trade outcome, made money, but this could be the beginning of the end of the trader’s career. As we have already stated, mistakes must only be related to the violation of rules a trader trades by.
All these mistakes were directly related to the signals given by a system, but the same is applied when getting out of a trade. There are also mistakes related to following a trading plan. For example, risking more money on a given trade than the amount the trader should have risked and many more.
Most mistakes can be avoided by first having a trading plan. A trading plan includes the system: the criteria we use to get in and out the market, the money management plan: how much we will risk on any given trade, and many other points. Secondly, and most important, we need to have the discipline to follow strictly our plan. We created our plan when no trade was placed on, thus no psychology barriers were up front. So, the only thing we are certain about is that if we follow our plan, the decision taken is on our best interests, and in the long run, these decisions will help us have better results. We don’t have to worry about isolated events, or trades that could had give us better results at first, but then they could have catastrophic results in our trading career.
How to deal with mistakes
There are many possible ways to properly manage mistakes. We will suggest the one that works better for us.
Step one: Belief change.
Every mistake is a learning experience. They all have something valuable to offer. Try to counteract the natural tendency of feeling frustrated and approach mistakes in a positive manner. Instead of yelling to everyone around and feeling disappointed, say to yourself “ok, I did something wrong, what happened? What is it?
Step two: Identify the mistake made.
Define the mistake, find out what caused the mistake, and try as hard as you can to effectively see the nature of that mistake. Finding the mistake nature will prevent you from making the same mistake again. More than often you will find the answer where you less expected. Take for instance a trader that doesn’t follow the system. The reason behind this could be that the trader is afraid of loosing. But then, why is he or she afraid? It could be that the trader is using a system that does not fit him or her, and finds difficult to follow every signal. In this case, as you can see, the nature of the mistake is not in the surface. You need to try as hard as you can to find the real reason of the given mistake.
Step three: Measure the consequences of the mistake.
List the consequences of making that particular mistake, both good and bad. Good consequences are those that make us better traders after dealing with the mistake. Think on all possible reasons you can learn from what happened. For the same example above, what are the consequences of making that mistake? Well, if you don’t follow the system, you will gradually loose confidence in it, and this at the end will put you into trades you don’t really want to be, and out of trades you should be in.
Step four: Take action.
Taking proper action is the last and most important step. In order to learn, you need to change your behavior. Make sure that whatever you do, you become “this-mistake-proof”. By taking action we turn every single mistake into a small part of success in our trading career. Continuing with the same example, redefining the system would be the trader’s final step. The trader would put a system that perfectly fits him or her, so the trader doesn’t find any trouble following it in future signals.
Understanding the fact that the outcome of any trade has nothing to do with a mistake will open your mind to other possibilities, where you will be able to understand the nature of every mistake made. This at the same time will open the doors for your trading career as you work and take proper action on every mistake made.
The process of success is slow, and plenty of times it is attributed to repeated mistakes made and the constant struggle to get past these mistakes, working on them accordingly. How we deal with them will shape our future as a trader, and most importantly as a person.
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How to Achieve Currency Trading Success: Part 2
Choosing a Trading Method
While there are many ways to achieve currency-trading success, all methods have the following salient points in common:
1. Simplicity
Most of the best trading systems are simple.
There is no correlation between how complicated a strategy is and how successful it will be.
In fact, the simpler a system the more likely it is to be robust in the face of changing market conditions.
Some of the most successful systems of all time have been extremely simple and you don’t need much mathematical knowledge to understand them.
2. Liquidate Losers Quickly and Run Big Profits:
The basis of any successful trading systems that deals in leveraged products is:
You need to be able to run the big profitable trends and exit losers quickly.
All good trading methods do this, and use strict money management rules, to ensure preservation of equity.
3. Understand your Method
This may sound obvious, but you need to understand your trading method, and the logic behind it, so you can execute it with confidence and discipline.
4. The Importance of Discipline
Currency trading success is rooted in a successful method applied with discipline. This means a trader has a method and follows it. This however is much harder in practice than many traders believe.
When money is on the line all traders emotions come into play and unless they can maintain discipline, currency-trading success will elude them.
Let’s look at some ways to maintain self-control and discipline when making trading decisions:
Firstly, you must be confident in your trading method. You should know exactly what you are going to do:
· When a signal indicates that you should enter a trade
· When a signal tells you to exit
You must execute your trading method in a disciplined fashion; if you don’t, you won’t have a method in the first place!
Secondly, and perhaps the best way to maintain self-control and discipline, is to feel confident in your trading method from the start.
If you have confidence when you execute your trades, you will “know” that over time they will be successful – even if you are suffering a string of short-term losses.
You must execute the buy and sell signals with confidence – these signals will lead to currency trading success in the long run, as you rigidly adhere to your method.
You need to stick with your method through good and bad times, and confidence in the underlying logic, will help you remain disciplined.
The more disciplined you are in trading, the more profits you will make longer term.
You should not underestimate the need for discipline, if you want long-term currency trading success.
If you read Jack Shwager’s Market Wizards, and the New Market Wizards, where he interviews the top traders of all time, you will see how all of them place an influence on discipline.
Currency trading success relies on a number of factors and these are:
Robust trading method + discipline = currency trading success
Remember, when trading any method, it will be of little use to you, unless you have confidence in it and can execute it with discipline.
There are a number of variables involved in longer-term currency trading success and the above are the salient points to keep in mind when deciding how to trade currencies.
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Forex trading is one of the largest trading industries which involve transactions of currencies up to even 3 trillion a day. These are a high risk factor game and at the same time yield the maximum profit too. The trading is done only through forex brokers. Forex brokers are highly experienced and would help in providing the necessary tips for transactions.
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