I have long held the view that volatility is a major factor in trader performance and one day I hope to do some real research to see if that’s really the case. Certainly systems and methods that are based on trading narrow ranges will suffer when that isn’t the case and range trading systems will fall victim to trending markets.

There’s a problem with the data presented in the DailyFX article, though. It only shows the win % of trades done during those periods (though we don’t know if they are opened and closed, just opened, or just closed in the hours presented). As I’ve harped on here and in other places, win % alone doesn’t tell you anything. You need to know the average gains and losses as well.

To back this up, I once saw data on the performance of a large collection of forex traders. Over a given time frame (don’t remember how long that was) they traders were profitable on something like 60% of their trades. Even though that was the case, the group as a whole still lost money.

Now, the DailyFX article does show performance figures for a trading system when times of day are factored in which suggests better profitability. That would tend to support the overall hypothesis, though obviously it’s just one example. I’m not arguing the general point. It definitely does make sense to look at how the markets trade during certain times of day and not just go along with the matra of the London/NY overlap presenting the best trading opportunities. I want to make sure we’re looking at the data properly and applying it effectively to our own situations in a useful fashion.

This was when I first started trading forex. I’d been a forex analyst for a while, but to that point had stuck to the stock market for my trading. Spot forex trading hadn’t really developed yet, so I was doing it through the futures market.

I’d opened a $5000 account with a broker that offered online trading, though at that point it was just using the internet to submit orders rather than calling your broker, so the technology was nowhere near what we have now with real-time prices and instant notifications of fills. Even with market orders you had to wait to get confirmation. This was to play a big part in the drama which was to unfold.

My first trade in my new account was in the yen (for those forex traders unfamiliar with forex futures, think the inverse of USD/JPY). I can’t remember whether I was going long or short. I used the online platform to place a market order. After a spell in which I didn’t get a confirmation, for some reason I decided to cancel the order. I can guess what you’re thinking, but don’t jump ahead!

A short while later I reconsidered and put the order back in.

Naturally, as seems to always be the case when you’re nervous and indecisive, as I clearly was, the market went against me. I don’t remember where my stop point was, but obviously it got hit. Keep in mind this was back when you had to place entirely separate orders for stops and limits when you opened up a new position. You couldn’t do it all in one go the way you can these days.

So here I am thinking I’ve taken a loss, but not a horrible one. Granted, I was trading full sized yen contracts on a $5000 account, so even a small loss was going to be more than just a couple % (I think we’re talking $12.50 a tick). It was totally risk capital, though, so I wasn’t really sweating it.

Then I got the bad news. I still had a position on because in my addled state it hadn’t occured to me that you can’t cancel a market order. Duh!

I think the news came via a margin call, but I might be wrong. Maybe it was just a statement and a conversation with a broker rep. Either way, most of my account equity was now gone and I felt like someone had punched me in the gut. I remember feeling sick to my stomach much of that day. It was so bad that co-workers noticed and asked if I was OK.

I’ve done other stupid things in my trading, but this the only one that was so bad it made me sick. Between being so rattled and having flushed all that trading capital down the drain, it was a while before I got back into the market. I think it was about a year, at which point I opened my first spot forex account, though this was still in the phone call days. Things went much better the second time around trading forex.

So what about you? What’s been your most harrowing trading experience?

I have been profitable every month since and including August of this year. Month to date December I am profitable as well. Before that I saw trickles of black but was always losing on balance and never had two consecutive profitable months until recently. I would greatly appreciate if you could shed some perspective on how I am doing based on my results. I am taking the money up every month so the only way to assess my results is based on percentage gains for a given month based on the account size traded that month. 2011 is my 4th year as a developing trader. For August through December (MTD) I sat down to trade 76 days and took 118 trades averaging 1.55 trades per day. My win ratio is 55.78% excluding scratches. My winners are 43% larger than my losers on average. I am in my winners 2.68:1 longer than my losers. My average risk per trade is 1.02% of the account size for a given month. The max risk I took on a trade was 1.65% of the account size. Nothing crazy risk wise. I always have a hard stop in the machine -always…and I never ever cancel it. For the 4 months August through November (2011), I have an average gain of 2.32% of the account total for that month. (6.7% the best/August -3.3% worst/September)

There are a few things that can be extracted from this:

1. This trader has been going at it for several years and only now is finding his feet as a profitable trader. This is very common because the majority of folks who start trading really have no idea where they are going or what they need to do to get there. Figuring that out (usually through trial and error) often takes literally years.
2. The trader had spells of profits, but was generally losing until the last few months. This is the standard pattern because consistency is lacking and developing traders often don’t know why they are struggling. And even when they figure it out, they still have to consistently implement the required change to get things sorted out.
3. The trader understands the value of keeping track of his performance statistics, which too few traders do. The step he’s lacking here is the objective benchmark against which to measure his performance – at least so far as he’s communicated.

What this person is looking for from evaluators is whether he’s making enough from the markets – and also whether his performance has reached a level of predictability to suggest that it’s OK to add money to his account (that’s a separate part of the email). The numbers certainly look good. The problem is, though. we don’t have any way to tell him whether his results are good in the context of his trading method/system and repeatable or not.

Just as a start, we don’t know whether he’s trading a consistent system or multiple different ones. We also don’t know whether he’s being consistent in the application of his system or methodology. An additional question is why he’s only traded 70 days during the period in question. What’s the cause for not trading on the other days and does that have an implications for his performance?

I can also think of these other questions:

• Do you ever have multiple positions on at a time?
• If you’re risking about 1% per trade, why are only only making about 2.3%/mo given the number of trades done per month?
• How much time is being put into the trading?
• Given the numbers provided, the trade expectancy is about 0.355%. How does that compare to prior performance of the system/method employed, or to how the system should have been employed over the time period in question?
• Can the system/method be used in a more frequent fashion to produce higher returns?

There’s a lot that has to go into actually judge trading performance. Just looking at the return figures isn’t going to be enough in a case like this. The best approach for any trader in this kind of condition is to try to figure out how they could/should have traded their system or methodology over the period in question and compare that to how they actually did. If the two are a close match, then you’re at least doing that part of it right. It then becomes a question of whether the system’s performance can be sustained and scaled up.

• Competitiveness
• Solid “fundamentals”
• Emotional toughness
• Focus on continuous improvement

Here’s where the author comes up a bit short in his analysis, though.

In sports the thing which tends to differentiate elite athletes from the rest is physical. The author uses basketball in his examples. Let’s face it, though. You can be the fiercest competitor, have rock solid fundamentals, be emotionally tough, and constantly work to improve your skills, but if you’re short with no jump and slow afoot you’re not going to make the NBA. Flipping that around, if you’re 7′+ you can get away with short-comings in many other areas and still have a good career.

I bring this up because the features noted above can be found in athletes at all levels. I certainly saw them in college volleyball players I coached, though none of them had the physical tools to be All Americans or National Teamers. That doesn’t mean they did not have enjoyable, satisfying careers, though. They just had to focus on getting the most out of what they had in the context of their limitations. In sports the mental stuff can separate an individual from others with comparable physical tools, just as superior physical abilities can separate an individual from peers with similar mental abilities.

This can apply to trading as well. We just need to replace the physical element with the financial one. After all, if you have a lot of money you’re able to make a lot of money from the markets, even if your rate of return isn’t very good. Flipping that around, if you’ve only got $1000 you’re not going to be able to make enough money to live on – at least not consistently or without being constantly on the edge of complete ruin.

Of course the difference in trading is that you can save up and use compounding to increase your account and maybe eventually become that 7-footer, though it takes a lot of time and effort is you’re only starting off as a 1-footer.

Why is this?

It’s because Chinese stocks fall not mainly because they are being sold, but because there’s fewer interested buyers. In the post Price Movement Causality – Not What You Might Think I wrote about how markets really move because of lack of buyers or sellers more so than because of their presence. This is very apparent in emerging markets where they rally on surges of foreign investment, then fade when that investment dries up.

This also happens in development markets when investors go on strike, though right now we’re in a phase where it’s actually selling interest that is helping to push them lower. We can see that in the volume spikes during down periods.

1. Find or develop a system you think will work
2. Trade the system
3. Experience a few losers and discard the system

Sound familiar? Probably so. It’s a very common loop new traders get caught up in.

Why is this so? Why do new traders give up so easily, when successful traders follow through?

The suggestion is that this happens because of a lack of confidence. While I can understand the case to be made for that being a problem, I’d take it a step further and say that it starts much higher up than that with the fact that new traders totally fail in the vast majority of cases to think beyond the immediate and develop a proper frame for their trading.

To put it simply, if you don’t know what you’re working toward how can you have any confidence that what you’re doing will get you there?

That’s high level thinking, of course. At a more ground level view, I’d contend that most new traders never learn what the elements of a trading system really are and how they contribute to its performance in different market conditions. They just want to plug-and-play and have profits come spilling out. The markets tend to disavow them of that impression quite rapidly.

Don’t worry if you miss a trade opportunity
In the beginning I was anxious to continually have trades open and I hated it when I saw big moves on the chart that I missed. Sometimes I would join trying to get a piece of the action but this was often a mistake. It took me a while, but I have now made peace with the fact that that missed opportunity isn’t the last.

Forex will continue to exist for the foreseeable future, and more opportunities will come.

The above has made a huge impact on my success, because I now am calm enough to not try to force setups when things don’t quite line up like I would like them to. I am now happy with not having a trade position open at all times, instead I simply try to find 1-3 good setups per week and try to make steady progress with almost guaranteed trades.

Furthermore, at the start I hated the higher time frames because I considered them so slow with few opportunities. With my new found patience I’ve come to really appreciate the 1D and 1W charts for how clean they are. I use the 4H a bit, but the trends are so much easier to see on the higher time frames, in my opinion.

This is a major developmental stage for this trader. Excitement is often a major driver of the actions of newer traders. They want the action and get frustrated when there’s nothing going on. This leads them to trade in shorter-term time frames that aren’t optimal, chase trades they have no business trading, and oftentimes trade either more positions or larger than is good for them.

All of this can be avoided by learning to relax and realize that there will always be opportunities in the markets.

The mystical ‘newbies always blow their first account’
So far I’ve been successful without blowing an account. I’ve even made 29% profit since I started live, but to be honest some trades were luck. I am still a beginner and am still learning trading psychology, but who knows, I might still succumb to poor trading behavior and end up blowing an account. But I think the ‘newbies always blow their first account’ is a bit of an overstatement. This goes back to what I wrote above about trading not being easy. Trading isn’t made for everyone, but I think anyone who is sufficiently educated to be able to think logically is capable of conducting proper technical and/or fundamental analysis and can be successful rather quickly.

I will certainly agree that there’s nothing that says new traders have to blow up their account. Yes, it happens a lot. It doesn’t have to though. As I noted yesterday, a major factor in this is simply approaching trading with a totally inappropriate state of mind – chasing the winners rather than viewing things from a much broader context.

Even putting mindset aside, the simple act of trading very small to start will go a long, long way toward protecting a new trader from themselves.

There is always more to learn
Again, after only 2 months of trading there is still clearly a lot for me to learn. I see it as a process which you slowly improve in. My trading method is price action without indicators. I’ve found good setups so far but there is plenty for me to learn, for example: being able to identify and become more aware of support and resistance levels; not closing trades to early because of fear that it’ll reverse even though the setup is good; and journaling my trade and progress better.

There’s no doubt about this. I’ve been trading myself for over 20 years and have followed the markets for even longer than that. I learn new stuff all the time, either about the markets our about myself and my trading. If you don’t have the mindset that you’re going to keep learning and developing over time you won’t be around for the long haul.

EA Robots
When I made the move to get into forex I was convinced that I could build an EA robot that would trade and make profit for me. In the first few months I spent my time learning to program in mql4, building robots, and testing them in the strategy tester. I learnt the following:

1 – The robots do marginally well, at best, and that is after a lot of tweaking
2 – Because so much tweaking is required, I believe it is impossible to make one that will work out of the box for multiple currency pairs
3 – Even if you get a robot doing well for you, it doesn’t mean it will make profit forever, you need to monitor and tweak it continually

Expert Advisers (EAs) are a major lure to especially new traders who see them as an easy way make money. For those readers who don’t know what they are, basically think of them as completely automated trading systems traders plug into their trading accounts and let run with little or no interaction. Thus the term “robot”. The system trades for you, so you can go about doing whatever it is you do and don’t have to worry about the markets and coming up with good trades yourself.

Sounds great, right? I mean who wouldn’t want to put their trading on autopilot?

The problem is point #3 above. Mechanical systems suffer from being rigid. They are not adaptable and the markets are incredibly dynamic, constantly shifting and changing. The chances of you finding or developing a single system that you’ll be able to apply automatically forever with good success is just about nil.

Trading isn’t easy
Just because of the fact that everyone has internet and that there are hundreds of brokers, doesn’t mean that forex is for everyone. It wouldn’t surprise me if most successful forex traders are well educated, but more often than not people who maybe aren’t suited to be traders are trapped thinking “That looks easy.”

I figured this out shortly after I stopped trying to make a robot. Although I quit trying to program the perfect machine I was still looking for the ‘set it and forget it’ holy grail. I was looking for the perfect combination of indicators that would give me great entry points frequently. I never traded live with any of these systems but I did backtest a few, but I quickly learnt that there was no guaranteed way to deal with whipsaws and incorrect signals.

You can easily substitute “forex” above with stocks, indices, commodities, or whatever market you like. They are all the same. The act of trading is very easy – just point and click. As everyone eventually figures out, though, trading successfully – no matter how you define that – takes effort and dedication.

Those who don’t go into trading with the right mindset can waste literally years and untold amounts of money chasing all kinds of quick fixes – systems, software, applications, courses, etc. Those who never get their heads screwed on right eventually flame out. It’s only those who eventually figure out how to properly frame their trading will have any shot at long-term success.

Kahneman has come out with a new book titled Thinking, Fast and Slow, which is receiving a great deal of attention. A short while ago he agreed to answer a bunch of quick questions posed to him by readers of the Freakonomics blog. Those answers can be found here. The questions are all over the place, and mostly not specific to trading or markets (though a couple are), but there’s some really interesting stuff in there about decision-making under uncertainty, which is what we are doing as traders, so I encourage you to give it a look.

It comes down to emotion. The article’s author allowed himself to be swept up in the emotion of home buying. He got excited about it and factored in expectations of where his income was going to be in the future. In other words, the realtor acted on the emotional triggers related to home ownership and the “greed” that introduced overwhelmed risk considerations (I wrote about this in Lessons for traders from neurofinance research)

I think we can all probably think of times when this sort of thing has happened to us on some level or another. I certainly fell victim to it in a business venture a while back, and I’m still paying for that mistake. The trading business is replete with marketing that’s intended to act on emotional triggers to get you to buy a system or software or whatever. And of course on a trade-by-trade basis we deal with it when we think in terms of the potential gains and not the risk.

This is one of those ways trading can help with life in general.