Reader Questions Answered

Live Trading Performance Not Matching Demo Trading Success

I have long been a proponent of new traders getting their feet wet in live trading as quickly as possible after they have developed the basic trade entry and management skills (albeit on a very small scale). My reason for that is the exposure to the prospect of real loss alters the psychology of things dramatically. This email I received is a very good example of that.

There isn’t really a question as such, although I suppose it is.

Its the mental attitude I’m finding difficult to resolve when I change from demo to live. Demo accounts I’ve doubled, live accounts I’ve lost to much money.

Someone said to me in an email its a case of just thinking your still on demo, I wish it was that easy. I feel its more a case of confidence in myself and sticking to my system rules no matter whether the trade goes against me or not. That’s the hardest part I think watching while it swings against you and hoping that you have allowed enough stop loss before it swings back, timing may be an area I’ll have to look into, dropping down onto a lower time frame possibly.

I’m definitely going to disagree with the advice this person received about “just thinking your still on demo”. That’s actually the reverse of what needs to be done, to my mind. Trading like you’re still on demo probably means acting in a riskier fashion than you can do trading live. You need to take the reverse view and trade demo like you would trade live. It’s not easy, though, to be sure. Trading real money and trading phony money will always be different. Demo trading is good for learning the ropes and testing strategies, but that’s about it.

Confidence is a big part of this all, as suggested by the emailer, and I definitely recommend giving a read to the Afraid to Trade? Build Your Trading Confidence post I wrote a little while back. It offers up some advice on how to build/re-build one’s confidence. For this particular person, one part of the equation could be trading smaller so that the swings that seem to be causing the strain aren’t quite so painful.

Reader Questions Answered

Looking at Risk and Stops Across Markets

Here’s the core of a note I received from a member of my mailing list a short while back. It speaks to a subject some traders struggle with.

Have been studying trading for several years, traded a bit with various levels of success. Looked hard at Forex, but am now rather taking a liking to E-Minis: reason is risk. I find it relatively easy to limit your risk by catching a move with a tight hard s/l & moving s/l in the E-Mini, but for forex all strategies I normally see require a s/l of 20 – 35 pips. I do not like that at all.

What is your view?

It appears as though this individual is caught up in a faulty perspective. He’s focused on points (or pips) rather than what they represent.

In an S&P 500 e-mini contract a single point is worth $50, with the minimum price change of 0.25 being equal to $12.50. By comparisson a 20 pip move in the forex market could represent any number of possible values. Taking EUR/USD as an example, if we are trading a micro contract (1000 EUR) it would be $2.00. For a mini contract (10,000 EUR) it would move up to $20. When we get up to a full lot (100k EUR) it reaches $200.

In other words, depending on the size of your position, a 20-35 pip forex trade risk could be substantially smaller than the smallest possible movement in the e-mini contract. If the trader above is risking 2 points on his e-mini trades (for example), which is $100, then he could trade 5 mini EUR/USD contracts risking 20 pips  and have exactly the same exposure.

You shouldn’t compare markets on point/pip a basis. Focus instead on a value basis, especially a % of portfolio one.

Trading Tips

Afraid to Trade? Build Your Trading Confidence

Confidence is a HUGE factor in trading. On the one side, the lack of it can create all kinds of anxiety and fear, over-thinking things, and not being able to pull the trigger (analysis paralysis). On the other side, too much confidence can lead to being cavalier with risk and taking poor trades. In this particular article, I’m going to focus on building confidence.

afraid-to-tradeStart Slowly
There’s no need to rush into trading. It’s really easy to get caught up in all the excitement of the financial markets, but try to avoid that. They aren’t going anywhere, after all. Give yourself time to learn and develop your skill set. A great many new traders see the dollar (or pound or euro or yen) signs and become blinded to all the rest of it, eager to get going and grab hold of their share of the winnings. It isn’t that easy. Trading is like any other activity. It takes time to get up to speed and develop the required competency.

Build a Strong Foundation
If you dive headfirst into trading without taking the time to think things through, you’re definitely more likely to be part of the majority who fail rather than the minority who succeed. I made a big deal about foundation building in The Essentials of Trading, and I harp on that repeatedly in my blog posts and other exchanges with new traders. Work your way through the process of developing your trading plan, including the best trading time frame, the optimal market, and the style of trading which best suits you. If you’ve taken the time to sort this stuff out, it will help to give you confidence in your trading as you move forward.

Practice, Practice, Practice
Athletes practice skills to gain mastery and to be able to execute them under pressure without thought. Traders should do the same thing. There are all kinds of different demo trading accounts available these days. No matter the market you trade, you should be able to find a free platform of some kind that will let you practice trading without having to risk real money in the markets. There are a lot of little things you can pick up demo trading. Some of it is the basic stuff regarding order-entry, prices, P&L calculations, and other mechanics. On top of that, though, you can also practice using your trading system or methodology to gain confidence in your ability to trade it effectively.

Go to Live Trading Early
I am a huge proponent of dipping your trading toes into the live markets as quickly as possible. That said, I’m not talking about jumping into the deep end without knowing how to swim. Once you’ve mastered the mechanics of trading using a demo account, it’s a good time to start playing for real. At this stage, however, it’s not really that much about profits and losses. It’s about your trading psychology. As just about anyone who’s ever made the transition from paper trading to the real thing will tell you, it’s not the same. When you’re money is at risk it can really change the way you think, and by extension, the way you trade. That’s why you should …

Start Small
When you make the initial move to live trading, do so with the smallest amount of money you can reasonably get away with. You are going to make mistakes. The cost of those errors can be thought of as trading tuition. You need not make that tuition bill a big one, though. A very small account means very small losses. How small an account you can get away with will vary considerably depending on the market you’re trading and how you trade it. And be sure to give yourself enough wiggle room in there to make sure a few bad trades don’t knock you out of the game.

Practice Some More
Once you’ve had a good taste of live trading, go back to the demo trading once more to really solidify your final trading action plan. Through the live trading experience you should learn what things you can and cannot handle or do in trading. Take that back to the demo trading and incorporate the new information into the way you set up your trading plan. This is just like being an athlete who using their experience in games to fine tune things during practice to get ready for the next competition. You should do the same thing as a trader.

Ease Your Way Into the Market
Working through the steps outlined so far should help you become less afraid to trade and more confident in yourself. Even still, you don’t want to go piling into the market. Take it slow. Allow your comfort and confidence in real-money trading to build gradually by starting small once more. You’re still going to make mistakes (though hopefully fewer by this point), so keep their cost down and their impact on your confidence to a minimum. You’ll also invariably take losses. That’s something you’re going to have to learn to live with. It will probably take a bit of time, but that too will be helped if the losses are small. As you feel more comfortable, gradually trade larger, working your way up to the level of risk and exposure which suits you best.

Final Thoughts
Trade Calmly and With Confidence The question is frequently asked how long it takes to get to consistent trading profitability. For some people it will happen relatively quickly while for others it will take longer. How long it will be for you will be impacted by things like the time frame you trade and your personal base risk tolerance. Don’t try to compare yourself to others. Go at your own pace. If you have the commitment to doing things the right way, to developing as a trader, and to being prudent in your actions, you will eventually get to where you can trade confidently.

The Basics

The Trade that Hurts the Most

Way back in the day I was a newbie trader. I know, it’s hard to believe, but it’s true. 🙂

One of the first trades I ever made that was actually based on my own market analysis (as opposed to getting trading ideas from other people) was taking a short position on the NIKKEI 225. This was back somewhere in 1990 when the NIKKEI was trading north of 30,000. I was very bearish, quite sure the Japanese market was in for a major tumble.

NIKKEI 225 Monthly Chart from the early 1990sThis chart shows roughly where I got short. I can’t honestly remember the exact level, but it was somewhere in there.

Now back then futures wasn’t part of the equation for trading the NIKKEI, at least not for me. I was a stock market player only in those days. That meant working through an instrument available on an exchange. In this case, it was a put warrant. The basic idea of the put warrant is similar to an ultra-short ETF these days. It rose in value if the associated market, the NIKKEI in this case, fell. The difference, however, is that the warrants had a defined life – generally three years from issuance.

I bought that NIKKEI put warrant somewhere in the $5 range. The market pretty much went in my direction straight away. Some point later on – I can’t recall how many months – I saw the price in the $9s and decided to take my profits. It was my first meaningful gain on a trade, so I was quite please with myself,….

…at least until I looked back at the price chart later. 🙁

After I closed out the put warrant trade I pretty much forgot about it. I was in college and not really doing a great deal of market watching. Eventually, though, just out of curiousity, I checked the prices. I knew the NIKKEI had kept tumpling in the interim, so naturally I expected to see those warrants have gone higher. When I saw $25, though, I’m pretty sure I moaned aloud.

I’ve made more trades over the years than I can even estimate. I don’t remember too many of them any more, but that’s one which will stick with me until I die. It’s the first “got the analysis right, but didn’t trade it right” experience I had. I hate those!

Trading Tips

Improving your trading by thinking less

Analysis paralysis. We’ll all heard of it. Have we all experienced it? I know I have.

My personal tendency in all aspects of life is to be very analytic. That has some nice advantages, but it also as some nasty drawbacks at times as well. I’ve been told on more than one occasion that I think too much, and while it was not normally meant to be a deragatory thing, it is indicative. I do think alot, and probably would be considered by many an intellectual – for better or worse.

The “worse” part is something I became aware of many years ago, early in my professional career as an analyst. My job required me to product commentary quite frequently. It was actually too frequently in many respects because I found that by being forced to revisit the price action I wasn’t able to allow the market moves I had previously outlined to properly develop. I was instead coming up with new analysis at each point, often to the detriment of producing quality trading ideas.

This is something which has from time to time carried over into my trading as well. There have been spells where I have allowed myself to get sucked way into the fine details of things. Sometimes I catch myself before much damage is done, but often it ends up becoming a hindsight sort of thing. Basically, the more I think about trading, the less well I tend to do, which is definitely part of why I’ve tended to perform better taking longer-term positions where the decision-making is more spread out and less at risk of turning into over-thinking.

The funny aspect to this whole situation is a bit of a paradox. I find that my gut generally gives me the right read, but if I consciously check my gut it nullifies things. In other words, I can’t think about what my gut is telling me. I just have to accept it’s influence when it chooses to speak up.

And by the way, the gut thing is something I definitely believe to be reflective of experience. It’s not something people are just born with. It’s a question of having seen the patterns of how the markets move many, many times such that your waking mind doesn’t even have to register them at all. This tends to go along the lines with what Brett Steenbarger has been writing about in his blog of late – how expertise comes from frequency of repetition, not time.

My point in sharing these things is to encourage you to look at your own work in the market to see whether you might be over-thinking things to your detriment at times. I’d love to have you share your own experiences through a comment.

Deep Posts Trading Tips

Trading discipline isn’t a matter of just deciding to be disciplined

The other day, Brett Steenbarger posted something which I think really is worth some thought and follow-up. Brett made the following statement:

We talk about losing discipline in trading as we might talk about losing our car keys or our way out of a forest. But losing discipline is not about a simple act of forgetting. It is an active process of refusing to act upon one’s knowledge, of blotting out uncomfortable realities.

One of the big gripes I’ve always had with trading psychology discussions is that most of them in some way boil down to the idea that discipline is the key to trading success. I won’t argue that discipline is important. You need to execute your plan consistently to expect consistent results. Otherwise, you’re just shooting in the dark. As Brett says, though, it’s not as simple as saying “Be disciplined.”

When I first read The Psychology of Trading, Brett’s first book, my major thought was that finally someone went beyond the whole “Be disciplined” mantra. In that book I felt like he addressed the deeper issues, the root causes why people failed to achive trading discipline. Most of those were psychological, as the title would imply.

I’m not really qualified to speak with any authority in that regard. What I can say, though, is that from what I’ve seen many people struggle with the discipline when they attempt to trade in a way which doesn’t fit their personality or situation. I’m talking about things like folks with a low tolerance for drawdowns employing trend trading systems, or folks who don’t have the ability to follow the markets steady attempting to day trade.

If you’re having a problem with sticking to your trading plan (assuming you have one – which is another topic all together), then take some time to understand why that is. Don’t just think it’s something that you can pick back up again when lost. There’s generally a reason for the problem. Figure out why you lose it and work on the root problem.

Reader Questions Answered

I’m a stressed out investor!

A question got asked on Jason Kelly’s blog recently.

I’m new to investing, and having trouble dealing with market stress.

This is something we all deal with somewhere along the way. Jason’s first response that investing isn’t for everyone is fair, though I don’t think that’s what the questioner really wanted to hear. He hits on one thing that can help a bit later, though.

Education can go a long way toward reducing stress levels. The more you know, the more comfortable you’ll be playing the markets. I don’t mean you need to go out and read every book ever written or spend loads of money attending seminars and courses. Just focus on things specific to your situation, trading style, the market you’re in, etc.

And keep in mind that at a certain point it’s all about experience. At some stage you just have to get in there and trade.

That all said, some of the stress undoubtedly comes from the fear of losing money. A very simple way to settle those fears is to trade smaller. That’s generally a good idea for anyone new to the market in general – once one has gotten to the point where it’s time to make the jump from demo trading, that is.

One last thing worth mentioning is the fear of being wrong. I’ve seen that paralyze people, even in a demo trading account. Every trader has to get to the point where it’s not about right or wrong. It’s about doing the things that will make money, consistently. You can’t control the market, but you can control whether you follow your plan.