Excerpted from Essentials of Trading, It’s not WHAT You Think – It’s HOW You Think. Authors Larry Pesavento and Leslie Jouflas
It is a given that traders cannot win 100 percent of the time, because with reward comes risk, and losses are as much a fact of life as taxes and death. But there are highly valuable lessons to be learned about the trading process that go far beyond the dollar signs. How traders put reliable steps in place to ensure that their performance may be enhanced on the road to success is critical. For most success is dependent not only on what is done correctly but also on what potentially havoc-wreaking mistakes can be avoided and/or corrected.
There are three principles that can aid in anticipating and possibly avoiding mistakes, they are;
- Self Discipline
Probability; Trading is all about probabilities and while every trader encounters a losing streak or draw down of equity, success as a trader is measured by how well losses are handled mentally. A sure sign of potential disaster is holding large losses in open positions while at the same time taking many small profits. A trader mentally dupes himself into believing that the small profits will offset the large losses. This is working against probabilities and a winning strategy.
Most losing streaks are the result of probability distribution. As an example, in 100 trades a system should encounter a losing streak of up to eight trades in a row. This is usually the time the trader begins to question the validity of the system. It is also the worst time to stop trading; the trader must continue to follow his methodology, because it has been shown that winning streaks generally follow losing streaks.
Traders must train themselves to think in terms of probability for three very important reasons:
- No one knows with 100 percent certainty whether the trade will be profitable or not.
- No one knows how much money will be made or lost on a trade.
- If the trader does not control the profit outcome and does not know with 100 percent certainty which trade will work, then the trader should spend 100 percent of his time concentrating on the only element of the trade he can control – the risk.
Take care of your losses and your profits will take care of themselves. This is sage advice from Amos Barr Hostetter of Commodity Corporation.
Self Discipline; Trading is all about discipline; discipline to take the trade and more importantly to take the loss when necessary. If you possess the necessary discipline to follow a profitable methodology it can lead you to freedom – the freedom to make as much money as you need, work at a profession you love, and the freedom to do what you want to do!
Discipline is a two part process:
Preparation covers several aspects, such as mental preparation; thinking through what risks are present in the trade, knowing how to get out of the trade – this is very important. Getting in most times is much easier than getting out. It has been said that it is better to be out of a trade wishing you were in – than in a trade wishing you were out.
When the markets are closed, that is the time to prepare your self mentally for trading. You want to avoid making compulsive trading decisions while the market is moving. Your preparation prior to the market open should consist of your trading plan for that trading day.
We suggest not consuming alcohol during the trading week and getting adequate rest is important to preparing yourself mentally for trading and eating a healthy diet along with physical exercise. These will all contribute greatly to trading successfully and should be part of your personal discipline.
The execution part of discipline involves preparation for the actual trades, doing the technical analysis work or the fundamental work. Knowing what you are going to trade requires homework.
We are pattern recognition traders and routinely follow various stocks, futures and commodities. Each pattern we trade has its own probability of success and each pattern has its own measurement of risk control. You must have a plan for executing your trades and be able to follow that plan.
The mixture of the execution process is risk control and profit protection. Finely tuned execution skills are going to account for a great percentage of success in trading.
Risk is the only thing we can control in the trading process. We can never know which trades are going to work or how much we will make on a trade. Profit protection requires monitoring the price action in order to reduce risk as soon as possible. Once a trade begins to work, it is good money management to take steps to reduce risk in the trade. If you control your risk the probability of getting a winning streak is increased. If you don’t control your risk, the probability of ruin is certain.
Maintaining routines can be very helpful in developing discipline in trading. Every trader develops different routines they follow, but they should always include ample time for preparing mentally and technically for the next trading day. Another benefit to having a trading routine is that it will help re-center you when your trading is off or you are going through external pressures. We would strongly recommend doing some type of chart work by hand, this is a great part of a trading routine as it helps the trader recognize patterns and opportunities.
Responsibility; in trading this can not be emphasized enough. The trader must have an attitude that they take responsibility for their trading. The markets are not responsible, the brokers are not responsible, the computers are not responsible, only the trader. Once the trader adopts this attitude setbacks will be much easier to deal with. Of course the unexpected can and will occur in trading, but you must learn to take it in stride and go forward. Trading requires the ultimate characteristic trait of responsibility because markets are like a river and we have to jump in to be involved. Once we are in the grasp of the market and all of its forces only you can save yourself.
One excellent way to take responsibility for your trading is to keep a trading journal. The journal can review the days trading and set a plan for the next day, address trading errors with solutions and also record successful patterns from winning trades.
Probabililty, discipline and responsibility are all elements that go hand in hand with each other in trading. They each have many different levels and aspects that can aid a trader on his journey to success.