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Trading Tips

From the data: One reason traders struggle

Over the last couple of weeks I’ve been working with the forex trader data I’m going to be using in my PhD research. I included some of the figures I’d pulled out in one of my recent newsletters, but I thought I’d share some additional stuff here.

I’ve pull the following set of numbers on trades which include USD pairs (no crosses), of which my data contains over 2 million records.

Winners: 1,280,459
Average Profit: $60.03
Average Pip Profit: 28.20

Losers: 752,614
Average Loss: $105.14
Average Pip Profit: 63.88

Notice there are many more winners than losers. They represent 63% of all trades. These are retail traders, so it just goes to show that you don’t want to get too crazy about looking to trade against the collective.

Notice also that the average loss is about 75% higher than the average profit. That completely offsets the 63% win rate and results in a negative overall expectancy for the group.

It must be noted, however, that that average loss appears to be due to holding on to losers too long rather than risking too much money. Notice how the average loss in pip terms is more than double the average gain. Traders actually had lower pip values on their losing trades than on the winning ones (on average). They just held on too long.

Here is the problem is for most traders. They are quick to take profits and slow to take losses. This is referred to as the Disposition Effect in Behavioral Finance research.

Much more analysis of the data needs to be done, but these results are very interesting nevertheless.

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Trading Tips

Tips to keep the trading fires burning

Mike Bellafiore at SMB offered up a quintet of suggestions for traders the other day. They were aimed at traders who find themselves struggling with the motivation, or could be viewed as ways to help avoid that happening. Here’s his list:

1) Make sure you take some time off.

2) Do things outside of work so that you do not value yourself from your trading. Trading is the game we play. It is not who we are.

3) Be grateful for the privilege of trading. It really is so cool that we get to do this for a living. Be thankful for this opportunity, no matter how short or long.

4) Stop judging your trading by your PnL. For example that trader on our desk had a better month than the prior though he did not make more money. He worked on his sizing. There was less opportunity this month than the prior so comparable results are an improvement. He gained another month of experience.

5) It is ok to fail. How is Oprah doing with OWN? Remember that Michael Jordon commercial about all his failures before triumph. Oh man if you only knew how many stupid mistakes I make every week as a trader. Failure is a blessing to learn.

Now it must be noted that Mike very much looks at things from the perspective of an active day trader. That’s pretty obvious in #3. That doesn’t mean the same ideas aren’t useful for someone who only trades part-time. They definitely are. We all need to take a break from the markets from time to time. We all need to realize we are not defined by our trading. We all need to realize that mistakes and losing trades are part of the process and that we shouldn’t be looking at what others are doing to determine our success (which is something that get’s talked about in Trading FAQs).

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Trading Tips

Trader Psychology is NOT the most important thing

I came across a post on the FXStreet site with the following statement:

“The majority of trading success comes from the mental side of trading not the strategy…”

The article then goes on to say that psychology is 85% of the equation of trading success, with money management coming in at 10% and strategy at only 5%. I reject this completely.

To explain my own position (as I also did in a recent online panel discussion), which is one I share with Dr. Brett Steenbarger, who literally wrote the book on trading psychology ([easyazon-link asin=”0471267619″]The Psychology of Trading[/easyazon-link]), let me ask these questions.

If you don’t have a positive expectancy system, does your mental state matter?

If you don’t have the risk management side of things right, will it make any difference how strong your discipline is?

The answer to both questions is “No”.

Trading completely without emotion seems to be the ideal many folks are aiming for in their trading. You could turn yourself into a robot (or program a robot to trade your system), but that’s not going to turn a losing system into a winning one or overcome poor risk management.

It takes all three elements to be a successful trader. If you’re missing any of the three legs of that tripod, it won’t stand up. Psychology does become the thing you spend the most time on once you have a good system and risk management strategy, but that doesn’t make it more important.

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Trading Tips

Traders can do what athletes can’t

There’s a post on one of the BabyPips blogs which discusses the comparisons between elite athletes and successful traders. I will definitely not deny that there’s a lot in athletics which carries over well into trading. The aforementioned post mentions some of them:

  • 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. 🙂

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Trading Tips

Relaxing, not blowing up, and always learning

In this post I’m going to continue addressing points made by a new trader posting on the BabyPips forum recently, following along on yesterday’s post. After talking about looking to take the easy way out, the poster shifted to learning to develop patience.

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.

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Trading Tips

Getting sucked in by easy, automated trading

A poster on the BabyPips forum decided to share some of their experience as a developing trader. There are some lessons in the post that I think are of broad value, so I’d like to share them here – with my own comments added, of course. 🙂

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.

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Trading Tips

Learning from life, learning from trading

There was an article in the New York Times last week, which I think indirectly speaks to a major issue for traders. It’s the story of a financial planner who got in over his head during the housing boom. The basic thrust of the article is that even someone who should be able to make rational financial decision can end up doing stupid things.

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.