So you want to become a trader?

I found this somewhere on the web and think its worth sharing…

I'm busy reviewing my trading in 2004, and thought I'd share some of the things I've learned because it might save another from repeating mistakes I made, goodwill to all men etc…plus I need to keep reminding myself. I'm not going go into huge detail on everything I learned, a man has to have some secrets :-) and please excuse spelling mistakes.

Most of what I learned really only applies to people trading, some of it may apply more generally, by trading I mean - People who have made hundreds of trades, likely making frequent 'trades', at least 1 a week, more likely 4-5 a week or much more. Using enough money to have a serious consequence to them i.e. it has to involve emotions, trading with little on the line is easy, whats hard is to trade the same way with alot on the line! ask any professional sportsman about that.

A little background/context. Never looked at the stock market before 1998. I started to get interested in 1998-1999 as I'm very interested in psychology and couldn't help but notice a mass psychosis around stocks LOL. I 'dabbled' on the side from my regular job until 2003, developing various systems. In mid 2003 I decided I'd had enough of my career, but wasn't sure if I wanted to try trading. So in 2003 I did swing trading, weekly types moves purely using Rydex, no trading account, only did about 10 swings using my top/picking tools, and 8 made money, heh heh I thought, so I decided I'd take a stab at a career trading in 2004, using my own money. Whilst I learned alot about market timing prior to 2004, what I'm focusing on here is what I learned about TRADING in 2004, which I now realize I knew little about.

Lessons -

  1. I was too Obsessed about Trading Setups/Market Timing
  2. I learned to Obsess about good Risk/Reward.
  3. I learned its even more Complicated - Position Size is Important
  4. **Story of 3 terrible trades I made, and I what I learnt from them.
  5. A bunch of short points/lessons.
  6. What I will be focusing on in 2005

1. I was too Obsessed about Trading Setup/Market Timing I spent way too much time trying to optimize the success rate of setups, and find highly predictive indicators etc. What I've learned in 2004 is that won't make much difference to profitability. Yes, you do need some method to identify a 'trading setup'. This is where you choose whatever tool suit you, I would loosely lump all of this together as 'market timing/prediction' - trending following( buying/selling trendlines, moving averages etc), technical indicators, chart patterns, sentiment …whatever. A setup is simply a trigger for the decision to make a trade. What I learned is -

1.1 Making Money isn't primarily the result of a setup, you can lose money with a 80% successful setup, and make money with a 20% successful setup. It took me many many MANY trades to understand thi…I still don't think I quite get it LOL!

What finally got it into my thick skull, was when I traded TASR during one particular week. I did about 5 trades, and 4 made money, making about 17% profit. I had 1 loss, for about 2%. Guess what? I lost money. I had a net 15% gain and lost money! I finally figured it out, making money isn't about being right about direction, it isn't about % profits, its about what's in the rest of the points below :-)

Highly Successful Setups become popular and stop being so successful You can spend hours and hours optimizing a setup to >80% success rate, then the market changes and its success rate drops back to a typical 60%, or sometimes LESS THAN 50%!! ( i.e. a coin flip)….yes that can happen, we all have seen a perfect contrary trader. I took a look at stock charts public lists recently, nearly every trader was using the same setup idea's, can that really work when we know roughly 80-90% of traders loose money.

** Psst. I figured out ideally you need a setup that very few are using, then guard it with your life….so then I realized, most truly successful traders aren't going to tell you their best setups , at least until their retired with billions on a beach…by which time everyone knows it and it won't work like it did for them LOL. Many will falsely claim to have the 'holy grail', but they don't, or they would be too busy making obscene piles of $$ rather than looking for flocks of sheeple followers.

1.3. Successful Setups/methods follow a Cycle like everything - Generating the Guru Cycle. We could categorize I suppose the various setup techniques - Trend following, EW, Sentiment Indicators, Volatility indicators, Edwards&Magee patterns, and an almost infinite set of others.Before 2004, I had already learned no magic indicators exist, markets are semi-efficient, and the majority using such technique's will lose.

However, what I learned in 2004 is very subtle -' its never the same people winning/loosing, it goes in cycles' It depends on if were in a bull or bear market, if were in an intermediate up/down swing, a trending or choppy market etc…and also how popular a certain method is.

So, some techniques will work for a while, and a 'guru' will emerge who is using that tool. Then the market changes, and all the traders who seems like geniuses rotate into the dumb category, and former dumb traders become geniuses as they're trading setups work again and the sun shines on them.

** that's not to say there are no 'gurus', there are, but they are rare indeed, and require much experience, I would say 10+ years minimum experiece …you have to have gone through all the different market conditions and be able to recognize them as they occur.

2. I learned to Obsess about good Risk/Reward. Its taken me a long time to understand risk/ reward, its one of those things thats seems obvious but is a 'slippery varmit'. What I thought it was, is taking trades where I stand to make more than I can lose. Hmm…yeah, except how do you know that? Here's what I learned -

2.1 Risk = The Distance to your Stop loss. Which means you have to have carefully studied where is the best place to put your stop. Its the exact %loss that will occur if your stop is hit. If you hold positions overnight, this distance is less defined, since large gaps will widen stops, I guess put/call option hedges would be better than stops for large positions.

2.2 Reward - The Average Distance to your Profit exit or 'Stop'. There must be a specific exit point, otherwise you 'profit' may disappear as you hang on to the trade i.e. you have to actually take the profit when you get it, just as you would a loss - I learned that the hard way, countless times I had profits ( my entries are quite good), but then kept the trade rather than taking the profit, only end up with a loss…somehow that is more emotionally difficult than a straight loss.

Therefore if you don't use stops, or don't take profits when they occur, your risk/reward is undefinable. I now refuse any trade I can't define the risk/reward.

2.3. Good Risk/Reward = Greater than > 2:1 Lets suppose I used method X as my entry technique…and infact its performance of being right is about random, i.e. 50%. But, It is able to identify points where risk/reward is at least 2:1 in my favour… I do 10 trades…for theories sake - 5 hit my stop loss, and 5 hit my profit stop….i am even, though withl trading expenses I have a loss. But, of the 5 profits, the SIZE was 2 times the loss( 2:1). Lets say the stop loss was 1%, but the profit stop was 2%. I made 5x2% =10%, and I lost 5x1%= 5% + trading expenses.

Hence, risk reward is way more important than success rate of setups. If you can find 4:1 or greater, you can make money with a 20% success rate. *** But I learned this makes it sound easier than the reality is !! …see 2.4 below ***

2.4. Identifying Risk/Reward is Complex and tied to Stop Placement Of course, identifying risk/reward isn't easy, and it is tied into the methods used for the setup…so I'm simplifying. If I used say MACD crossover, I can define a historical backtest success rate say 55% e.g. Of the 55% success signals - Average Gain = 2% ie. I could have set an exit 2% profit an hit it 55% of the time. Of the 45% failured signals - Average loss =? it depends where your stop is!!! So now its more complex.

I've learned in 2004 that 'stop placement' is very key, and tied to risk/reward. If your stops are too close ( to reduce risk), the success rate will fall, you will be stopped out more often. If you widen your stops, success rate rises, but so does loss risk. ** psst. this maybe the important thing I've learned …working out ways to set stops so they minimize loss, but are rarely hit …funny how 99% of trading books cover predictive methods, and don't really discuss precise methods for stops placement.***

3. I learned its even more Complicated - Position Size is Important When I studied my TASR trades, it was clear. I had 4 trades of position size X, and 1 trade of position size 10timesX LOL, oh yeah, that of course was the loss !! Hypothetically - I made 15% on 10k = 1500$, and I lost 2% on 150k= 3K - gain of 15%, net loss =1.5K. I'm still studying position sizing, like stop loss setting, this is another poorly coveraged topic in trading books. Having read alot, advice is so vague and imprecise as to be useless - 'always use the same size', another idea is 'increase size after loosing streaks, and decrease after winning'. I'm not convinced by either - using the same size is kind of a cop out, it removes my mistake, but I don't think its optimal. Changing after winning/loosing streaks is interesting. Its exactly the opposite of what I did emotionally, I tended to increase sizes after success and reduced after losses. That's perfect for having maximum %profit with smallest position, and a loss with largest position LOL!

4. My 3 worst Trades of 2004 and what they taught me. Right off the bat, they taught me stop losses are the fundamental difference between amateur trading and professional trading, but it took some major trauma for me to get it, 3 ugly trades indeed. Despite the pain at the time, it makes me laugh now at my psychology at the time. I will share them but you might want a box of tissue's handy, I know I will LOL.

**Actually, without these experiences I still wouldn't know what trading really is, I would be like so many I see - still in ignorantce is bliss mode. The key I realize is to not REPEAT the mistakes, and boy, there are plenty of mistakes to make without repeating any as it is LOL!

First, I think the psychology that led to my mistakes is important. I traded profitably in Jan-March 2004 right out of the gate, I thought all those stat's were b.s. regarding 90% of traders failing, taking 1000 trades to get profitable. Ah the cruel humor of the market. I think it gives you just enough rope. Second, I traded without stops and even though I was down large amounts several times, I held on and eventually turned profits, confirming my mindset that stops were for those that cant' stand the heat.( er, that would be me later LOL).

Terrible Trade 1 - The 'Quick Trade' turned 'buy and fold'.
All my indicators were in place, I knew a big down swing was coming. Whilst waiting for the optimal point to put on my sure thing short swing trade, I decided to do a litte long day trade. I put on a mid-sized long in the morning. By the end of the day I had a small profit, so I decided to hold it overnight. Lesson 1 - Never let a day-trade turn into something else, as its never a good 'else'. Lesson 2 - Have a stop. Have a stop…… … So, next morning it gaps down about 1% past my breakeven, its a large position so this is a sizeable loss, I decide to hold, because the 'big drop I'm expecting isn't quite ready yet'.

Lesson 3 - No one can predict when market swings move( week to month moves) will begin to the nearest minute LOL.

So, of course the big move down I was expecting had started, with me still long in a day-trade whilst waiting to go short. Lesson 4 - Focus on the big risk/reward trade, don't get cute around market turning points trying to play every little wiggle, at least without tight stops. I held this position a Looooong time, weeks, eventually got out for a smaller loss, which then compounded my flawed psychology about stops i.e. I still didn't learn I had to have stops…then came 'the big one'…see below.

Terrible Trade 2 - The 'market is oversold' trade.
Full of supreme confidence I entered my largest position by a factor of 4…no stop, because I was so sure 'the market would eventually turn my way, even if I had to sit through some pain'. lesson 1 - Have a stop …have a stop…. Of course, what happened, a news item occurred 'out of the blue', terrorist attack in Spain on a train, and the market took a huge dive against my long. Of course, I knew this was an emotional overreaction, and the market was oversold( the most dangerous word in trading LOL) . Initially it did recover so I held, but then down and down it went day after day. Lesson 2 - Stuff happens, have a stop …have a stop… Lesson 3 - If stuff happens it isn't bad luck, no-one is against you( except yourself LOL)……manage risk…manage risk!

The loss seemed big to me, too big too take a loss !! what? come again? Lesson 4 - A big loss can become huge loss, so huge it makes the former big loss seem like a profit LOL!

n 1 week I wiped out 3months SIZEABLE gains, and netted a 10% loss on my trading account. So, one position destroyed profits from about 3months trades, and dug a big hole. So that taught me no matter how confident, you need an 'I'm out' point…finally I understood why you must have stops .

-> It only takes ONE really big loss, to wipe out months& months of successful trading, and it WILL happen eventually, and from what I read, like mine typically at your nadir of confidence.

BTW - of course, I finally capitulated the position right at the worst point, and within weeks the market was back to what would have been my breakeven, so it is with the market.

Terrible Trade 3 - The 'safe small position' trade.
I traded my account back to even after the nightmare trade above. Then I was moving, but didn't like the idea of not trading, potential profits would be missed ! ( hint.greed) - Lesson 1 - Don't be compelled to trade to make $$$$, if you lose $$$ you'll wish you hadn't traded at all. Lesson 2 - Don't trade if you can't actively follow the trade.

So, I thought, use a smaller position, that way I can't runup a big loss even if I can't follow it. I was moving for about a week, by the time I could monitor the trade, I was down about 15%. Suddently 15% on a 'small position' was alot LOL.

Lesson 3 - small position times large % = big loss :-)

The Review
After this, I completely reviewed my little trading career from Jan to June 2004, trying to fathom how swing trading was so easy in 2003, and how this kind of trading was different. For 3months over the Summer I read all those books again and examined my trades, and finally alot of what I'd read about trading …i would describe this as 'arriving at square one' as opposed to square zero LOL. Fortuntely, I had read enough, to know this is all normal, and was thankful to have suffered relatively minor losses to learn alot of lessons, I could have gotten' massacred, that despite being right on my trades most of the time, and knowing way too much about market methods/predictions etc

5. Here are a bunch of other quick things I've learned

5.1 Believe half of what you see, and none of what your hear" ( courtesy of Marvin Gaye). This could be applied to so many things, but to name a few - a. Don't listen to other people predictions, listen to information they offer about HOW they are trading. In particular, don't listen to people who make wild predictions. b. Don't believe anyone's trading claims unless its comes with a verified trading record…which goes with c. It doesn't matter if they have 30years experience, or ten millions followers. c. People exaggerate their trading successes, and downplay their mistakes…that's particurly true of certain bull guru's, who stayed long all through the bear market 2000-2002 I notice….and bear guru's who haven't been long since 1982 LOL. d. Don't get caught up in the 'guru' game, there are no guru's period. If they were a guru, they'd be sitting on a sunny beach retired already, not touting for followers on websites.

…in general …be skeptical by nature, require evidence of claims, use scientific minded enquiry over 'taking things on faith' etc.

5.2. Reading others people's Advice/Lessons/Experience won't help until you make the mistake I read Jesse Livermore, I read all the great advice from experienced traders, and it is great advice. The trouble is, it only means something AFTER you have experienced whatever it is they are talking about.

5.3 Trading as you only income is nothing like investing or 'dabbling on the side'. Its the same difference as between 'playing sport for fun', versus 'trying to make it in professional sport' and the odds are about the same. I doubted those odds until I had more experience, I will say I think they only apply to people trading with large enough sums of money to cause emotions to come into play, and if anything from what I've seen of other traders, 10% long term success might be generous LOL. You can be a great trader, but just like sports, the guy 1000 in the world at golf is brilliant, but can't barely make a living.

5.4. Trading with alot on the line has high 'Performance pressures'. I read a great book from the USA Olympic sports psychologist who got involved with traders, and it helped me understand that the key to success in trading is mastering emotions under 'peformance pressure', much like you see great sportman who can't ever quite win - the difference is never technique, it is psychology. The winners play under pressure like they do in practice, the nearly winners can't produce the same peformance under pressure.

find my biggest stumbling block currently, is making the same decisions when using large positions, as I would small positions. I think of Phil Mickleson trying to win the masters for years, his has amazing talent but the mind games messed it up until this year when after certain life experiences, he didn't have the pressure to win so he did, its amazing the power of what the 'subconsious/emotiona mind' to effect your reasoning under pressure.

6. What I will be focussing on in 2005
Two things.

6.1 Trying to be a simpleton. The more indicators I tried to use, the less able I was to make a decision, even if these indicators were great…because it reduces decisiveness trying to figure out if they all agree! For example, I must have about 100 mojo swing indicators, but in reality, I only need about 3 that are more accurate than the other 97 put together LOL Infact, the other 97 just make me doubt the 3.

I now firmly believe, a so called 'simpleton' with a one simple indicator, can trade rings around the so called 'genuis' by applying it consistently, with careful stop placement and position size, whilst the genuis is buried in complexity trying to predict the market. The real genuis it seems to me now, is to be able to make money with the simplest approach, rather than a trading platform resembling a nuclear power monitoring station, this is something I'm guilty of, and am working to address.

6.2. Trade what I see consistently, not what I predict i'll see You hear some traders talk about not predicting, just trading price etc. Well, there's alot of word games here, but here's what I've learned. If you are trading timeframe of hours/days even swings over weeks - - forget about most predictive tools, it just isn't relevant. It doesn't matter what fundamentals do, where we are in the 'large scale pattern', what prognositicator XYZ says is going to happen.

What I'm learning is JUST FOCUS on what your indicators say NOW - thats what I mean by 'trade what you see'. If you use a MACD, and it crosses over, then thats what you see. What I did time after time, was to the say 'oh, but…this will happen … and then it will be a better oppertunity'. That is 'trade what I predicted I would see'.

If I had just traded what my indicator said, in hindsight a few simple indicator I have predicted every major move…but that was too simple LOL ( see 6.1). It took me a while to get the difference…i find this hard, I think people who are good market predictors, are naturally poor traders for this reason. If your good at prediction, there is a constant temptation where you can see where things are going - but as a result, you miss where they are !! trading I realize is the exploitation of 'where you are'.