The Essentials of Trading

Information and resources to learn about trading and the markets

Did you really make that market call?

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confused

A couple of different things came together to motivate this particular post. One of them is a post on the Pys-Fi blog from a few years ago I recently revisited. It’s on the subject of our memory, both in general terms and specifically with respect to our involvement in the financial markets. The driving thrust of that pieces is that we cannot and should not always trust our memories.

That’s right. Your memory is not nearly as solid as you might like to think. It’s subject to external manipulation and also your own internal issues like hindsight bias.

That article, in turn, reminded me of a resent EconTalk podcast episode on the subject of forecasting. In it, guest Philip Tetlock talked about reviewing the forecasts of a group of people who had been put through an experimental process. The subjects were asked to recall their prior forecasts and the degree of accuracy they exhibited. Tetlock found that the forecasters often were not nearly as accurate as they thought they’d been.

Can you see how this might be an issue in your trading?

If you can’t rely on your memory of your past performance making market calls, how much faith can your have in the methodology you are using? Not much, I’d say.

So might think that a way to avoid this sort of problem is to trade entirely mechanically. Maybe not, though.

In the final analysis, your faith in any system or approach is going to be reliant on your recollection of it’s performance. Selective memory could see you exaggerate the system when things are going well – perhaps leading to over-trading. Similarly, it could lead to not taking trades during draw down periods. Neither is an optimal outcome.

In the post Being a reflective trader from the other day I talked about the idea of reviewing your trading periodically. This is something which might help. Regularly looking back over prior trades will tend to help keep a realistic record of your performance – or your system’s performance – in your memory banks for future recall.

Something to consider if you’ve hesitated in keeping a trading journal.

A rookie trader’s plan

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rookie

A while back, Mark Wolfinger (a contributor to Trading FAQs) was asked by a rookie trader to comment on his trading objectives and plan. Basically, this newbie had set himself the nominal goal of making $2ooo/mo from the market trading options. At first appearance, an objective like that is nothing new, especially for those who have it in mind to reach the point where they can trade for a living. As the following question quickly made clear, however, this was a person with zero trading experience.

“Should trading be limited to strictly paper trading or is there an advantage to trading very small sizes with real money?”

I’ve already shared my views on demo vs. live trading before, so I won’t tackle that subject again here. Instead, I’ll piggyback on some of what Mark has to say in his post.

Firstly, he talks about the importance in considering what the $2000/mo objective is relative to one’s capital. As he notes, if your account is $20k then you’re talking a 10%/mo return, which is quite ambitious to say the least. And looking at things from the other side, if you’ve got $1mm then such a small objective is hardly worth the effort. You can make more with very simple investments.

The big thing in all this, though, is that if you’re a beginning trader you shouldn’t be thinking about anything above and beyond getting first to being a break-even trader. You’re going to make a whole bunch of mistakes that will cost you money. Consider that a given and you won’t be disappointed.

Once you’ve worked your way through that phase you can start focus on making any kind of consistent positive return – over whatever time frame is relevant to you. Having achieved that, you can then start scaling things up and begin to think about profit targets.

Personally, I’m not a profit target type of trader. But then I don’t trade for a living and have no desire to do so. For others, it’s a bigger consideration because they need the money to pay the bills.

Mark offers up some other good new trader advice, so definitely give his post a read.

Being a reflective trader

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armsraised

Brett at TraderFeed recently offered up a post titled How to Be Your Own Trading Coach. Seeing as he’s the guy who literally wrote the book on self-coaching as a trader (The Daily Trading Coach), the headline alone got my attention. 🙂

In the post Brett recommends a period exercise in which you pick out your best trade and your worst trade of whatever time period is relevant to your trading (day, week, month, etc.) and analyze them. Basically, what you’re looking to do is to identify what you’ve done well on the good trades so you can repeat that in the future. At the same time, you’re looking to pick out where you failed with the bad trades so as to avoid those same mistakes moving forward.

This, of course, is a very good bit of advice. It is only through reflection and proper self-analysis that we can develop ourselves as traders over time.

I have one thing to add to Brett’s suggestion, however. It has to do with the judgement of good vs. bad trades.

The natural inclination is to think of good trades as winning ones and bad trades as losing ones. This is too narrow a way to look at things, however. In reality there are four trade quality and trade performance combinations (excluding break-even trades).

Good trade / good performance
Good trade / bad performance
Bad trade / bad performance
Bad trade / good performance

In other words, you can do everything right and still have the markets go against you – bad luck. Similarly, you can do everything wrong with your trade and still end up making money – good luck.

When you examine your trades, be honest with yourself. Did you actually make a good trade or not, regardless of whether you made money?

Of course all this requires an understanding of what makes for a good trade. That’s a conversation for another post, though.

More trading resolution advice

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Trading Goals

Near the start of the month I talked about trading resolutions and some things that you can do to help keep the ones you make. Over at SMB there’s a recent post on the subject which provides a slightly different perspective on things.

The idea is the same – providing advice for keeping to your trading resolutions. The areas of focus are a little different, though. The advice offered is:

  1. Post in your journal
  2. Breathe
  3. Exercise

The first one is probably something you’ve come across before, and not just in terms of New Year’s resolutions. Keeping a trading journal is very often recommended as a way to keeping your trading on track in general terms. It’s a reasonable starting point.

How many traders would have thought that breathing would be on the list, though?

The focus at SMB is more toward day trading, so it probably makes a fair bit of sense that they’ve included a specific directive to decompress at a certain point during the day (or multiple ones, depending). Having worked in the market for many years, I can totally attest to how easy it can be to get yourself caught up in the day’s developments and wound up really tight. Definitely not a bad idea to schedule a bit of an unwind periodically.

Exercise, the third bit of advice, could probably be restated as something like “take care of your health and fitness” as eating well and getting sufficient sleep are all part of the equation. Obviously, that’s not specific trading-related advice. It’s very relevant, though. Your health and general well-being for sure plays a part in your trading performance. There’s no two ways about that.

One could perhaps chuckle a bit at these recommendations, though. If you think about it, for many people they represent things that should be resolutions in their own right. 🙂

Some more forex trading tips

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risk management

Mike over at The Financial Blogger recently offered up his seven tips for staying safe while trading forex. They go something like this:

– Stick with what you understand, from both a positive and negative perspective.

– Know your risk tolerance and how you emotionally handle your exposure in the markets.

– Have a clear strategy and stick to your trading plan

– Never add to a losing position

– Keep things simple

– The trend is your friend

– Control your emotions and minimize their effect on your decision-making

I can see folks taking some umbrage at the trend one. There are many who consider themselves mean reversion traders. Certainly, those types of strategies can work. The aren’t so good in trending markets, though, just as trend systems get hurt in ranging markets. That’s why having a multi-phase approach can be very beneficial.

The controlling your emotions advice is something you often here. The trouble is, it’s harder to say than do. Further, emotion is an important part of our decision-making process, whether we realize it or not. In fact, I’ve seen research which suggests we actually make decisions emotionally much more quickly than we can consciously, and as a result what we end up doing in what we think is the decision-making process is just rationalizing the decision. Something to think about.

Beyond that, Mike’s got some fairly good, if not particularly new, advice or traders – forex or otherwise.

Be cautious of low-observation statistics

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statistics

Last week there was some talk going around the markets about how the market had just experienced it’s second 10% correction in 6 months. A big deal was made of this because apparently such a thing has only happened on three occasions before. The first was in 1929. The second was in 2000. The third was in 2008.

Sounds pretty bad, right?

On the face of it, sure. Those are years noteworthy with respect to bad market performance. Any time you start drawing comparisons between current events and things which happened in those periods it’s natural to get a big nervous.

A bit of caution is advised, though.

Three observations is statistically insignificant. You can’t really draw any reasonable conclusions from such a small sample. That perhaps becomes even more the case now that the “pattern” has been publicized.

For that reason, I wouldn’t rush out and go all-in on the short side.

Ten habits of successful currency traders

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habits

Here’s another post motivated by something I filed away for future discussion some time long ago – like Ten rules for risk management from the other day. Sorry, I can’t recall from where these habits were taken. If you know, definitely pass it along so I can provide due credit.

Ten Habits of Successful Currency Traders

  1. Trading with a plan
  2. Anticipating event outcomes
  3. Staying flexible
  4. Being prepared for trading
  5. Keeping technically alert
  6. Going with the flow/trading the range
  7. Focusing on a few pairs
  8. Protecting profits
  9. Trading with stop losses
  10. Watching other markets

I think #1 is an absolute must. In fact, if well constructed your trading plan will encompass a number of the other things on the above list. It will address what you trade (#7), how you trade (#6), what you consume by way of information (#10), your exit strategy (#8, #9), and your overall preparation for trading (#4).

There isn’t a ton I feel like I need to add, but will say that #2 is worth giving a bit more consideration.

If done properly, anticipation can be a very good thing. It lets you prepare in advance for probable developments. That, in turn, allows you to have a good plan in place for reacting to what happens.

Where you need to be cautious is when anticipation leads you to do things before you should. Overly excited or anxious traders can fall into the trap of anticipating a certain kind of price movement that would generate a trade entry signal, for example, and trading ahead of the signal actually happening.

This tends not to work out very well, as while part of the time the signal will come to pass, other times it won’t. That means you’re not actually trading according to your system or method, which tends to be recipe for disaster. That circles things back to #1. 🙂