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You can eliminate the risks you can't see by removing names from your "watch list" or data that you've raked - the step before you run the data through your simulator.
Carbon Monoxide of Trading
Pro traders focus on "not losing" rather how much they can make. Of course we need to make money, but by preserving your capital and focusing on defense, you put yourself in a position to appreciate your money emotionally and financially.
Two invisible risks that you should be concerned with are below:
You can reduce correlation risk by NOT having all the metals in your data source. You can "rule out" correlation risk by saying "if long gold, don't take trades in silver," for example. Or, you can set a max risk per group, ie, social media companies, metals, softs, interest rates, so that one group or name will not become unwieldy.
When the markets turn, they will turn for the whole group. If you have large positions of highly correlated assets, you might be in a spot risk-wise to give back more than you want to...and that's having placed definitive protective stop orders in the market to get filled - it's worse if you use mental stops.
Volume is what you saw traded yesterday. Liquidity is what you need to offset your position when you need to do so. Big difference. The invisible risk here is that thin markets move sharply.
You don't want to be in a position to take larger losses when the market turns on you because everyone is on the same side of the market. That's the case with Bitcoin right now. When you're looking to sell, who will be there to buy?
You can rake your data to include only names that have a set criteria of trading volume so that you avoid problems before they arise. Commodity markets like oats, lumber, and cocoa can be problematic in that regard. Cocoa is not necessarily thin, but it does not have a daily trading limit so your loss potential can be much greater than you'd imagined when building your system.
"Mental stops" are not really stops, per se, but thoughts. It's a price where you are losing money, but aren't emotionally ready to take the loss, so you don't take it.
Maybe you're not willing to take the loss because you've done a lot of work to research the trade and you feel it's not fair that you didn't get paid. Well get used to it. Neither the market nor anyone cares about what you put into your trading.
Long term success comes down to your consistent behavior: putting in the orders and taking small consistent losses.
Mental stops are an emotional place where you want to re-evaluate the situation to figure out what to do. That's the point where your lack of conviction in your process is starting to work against you.
I think that's especially true for chart readers and discretionary traders. System traders put in their stops, get stopped, and wait for the next order to be generated by the system.
The reality is that you've lost money. End of story. You have lost the money regardless whether you've "locked it in." Don't let the accounting language dissuade you from trading the way that will impact your trading positively.
Yes, taking consistent small losses actually impacts your trading positively.
Amateur move. Put your stops in and take solace in the fact that you'll be automatically get taken out of the trade before I lose any MORE money.
Being able to take small consistent losses is the hallmark of a pro trader. Losing money does not mean you suck or that you are a loser at trading.
The stop price is the point at which you are willing to transfer the risk to someone else.
If you want to be a pro, losing money is part of the business.
Challenge your own way of thinking and let other traders help you uncover your blind spots. We all have them. I'm looking for people who think differently than I do so I can learn. I don't have a monopoly on ideas and I can be a bonehead at any given time.
I rely on systematized trading rules and by gaining new insight from other people (who are mostly much more intelligent that I am) I am better off because I can oftentimes reduce the wisdom into a trading rule to enhance what I already have.
I couldn't do that on my own - not without a great deal of random luck or perhaps a big loss that helped reshape my thinking. Below is a partial list - there are more coming.
David Aferiat - Trade Ideas
Tadas Viskanta - Abnormal Returns
Steve Sears - Barron's Striking Price
It's impossible to imagine the value of the blockchain and crypto currencies, so I'm a long-term investor at this point. I think the value is in my process, not the instrument that I'm trading.
Two, I'm not going to let any one security put my trading process in jeopardy. I've talked before about what I look at and how I rake the data to include instruments within my trading system. I'm not going to change those rules for any instrument.
I have not traded bitcoin futures and I won't be in the near term. There is not enough data and I don't know who has basis risk. It seems like the market is dominated by speculators and not hedgers, and they are heavily biased long.
When the market is lop-sided and fickle, it makes for a poor trading environment. That's why I'm invested and not trading at this point. It's too easy to lose money when I'm trading well...
The best that will happen is that I'll add it to my system and trade it among all the other instruments that are in there. It's not getting any special treatment, nor am I going to try to develop a dedicated system to trade bitcoin.
Use cold storage for your crypto currency investments - that means offline.
You can use a USB drive and drop that into a safe deposit box.
You can also use what's called a "hardware wallet" such as those below instead of an online wallet and exchange such as Coinbase or another online digital wallet that can be hacked.
Lastly, keep your mouth quiet about owning bitcoin or any other valuable cryptocurrency and how your store them. No one needs to know your personal business. Don't brag or bring attention to yourself (about bitcoin, art, or collectibles) so you don't tip off anyone to come and rob you.
Goals need to be realistic and attainable. You also need to consider the growth in competing areas of trading.
If you're making money, how do you know it's not random luck or a bull market?
I'd love it if everyone could turn $10k into $1,000,000 but the majority who try will lose all their marbles. Those that do will be lucky having been "in the right place at the right time."
Think of it's this way: if you turned $10k into $1 MM this year playing the lottery, and you had to live your life over 100 times, you'd never replicate doing that ever again. Same for following a set of rules that don't make money [have positive expected value]. You can trade those all day, and you'll do nothing but lose money on average over the long term.
You'd have a better chance of making 20% YoY if you followed a systematized set of rules with positive expected values and traded them over and over. I'm sure Taleb and Ariely have said as much.
Goals and systems need to be reviewed. You might not have hit your financial goals even though we're in a bull market. That might have to do with your risk per trade, overall risk in your portfolio, or markets to trade. It's possible to have too little risk as well as too much risk. You can trade good rules and lose money. That's bad luck, not a bad system.
Keep a goal for minimizing losses. Let your upside goals run, like your profits.
There are forces at work right now that are working to undermine your trading, more so if you are trading intraday or short term. Your trading should evolve with the markets. As Victor Sperandeo said in one of my interviews with him, "the markets are always evolving to try to kill you." He would know - he's been trading since 1968.
I am continually testing my models to find my blind spots. I'm also looking to see if I can minimize my risk to achieve the same expected return. I'm also looking to make sure that what I trade hasn't become too correlated with each other so that I don't have the effect of a concentrated position in my portfolio.
Don't be reasonable with your upside. Yes, "the market can remain irrational longer than you can stay solvent," but it also means that bull markets can run (while you're long) much longer than you think they can.
How many people called market tops in 2017? They were all wrong. And these are smart people.
My guess is that they felt the market had gone up enough so the "market callers" published their feelings about risk and what is reasonable to you in the form of a market call.
Remember, your emotions and psychology effect your attitude, your attitude effects your behavior, and your behavior predicts where you end up in life. From a trading perspective, how and what you trade can predict your net worth over time.
What you can do in 2018 to positively impact your financial future and net worth:
1) trade less frequently thereby decreasing commissions and slippage;
2) increase your holding periods by letting your winners run longer;
3) diversify across more markets to cut your overall risk;
4) learn to trade a new asset class to impact your reward to risk ratio;
5) rely on a system and stop drawing lines on charts thereby decreasing subjective reasoning in your financial decisions; and
6) make friends with 5 new people who are leagues smarter than you
Whenever you have a margin call, offset the instrument that is generating the margin call. Don't meet a margin call with cash.
CTAs with margin to equity ratios of 12-15% are considered aggressive in today's day and age.
Margin is set by the exchanges, but can be made more stringent by the IB or FCM.
Margin levels are set to protect investors as well as the integrity of the exchange mechanism. Margin is considered a good faith deposit on the full notional value of the contract.
Favorite Yoga Pose - Ardha Chandrasana
You have to practice your yoga the most when you're off the mat and not in class. That's the whole point. Like great trades, you have to take them home at night.
Trading begins the night before. I run my systems at 6 pm Sunday night for Monday's trading. Call in the orders by phone.
The orders are worked during the day and all I do is wait for the phone to ring with a fill. If I'm filled, I give them a protective stop immediately. Sometimes the there are no fills, then I repeat the process the next day with the same orders.
Most of the time I'm reading and studying. I don't have cable - I've cut the cord about 13 years ago. I practice yoga most days from 12 to 2 pm PT.
Risk Per Trade
In establishing a position, I risk 0.10% (10 basis points) per trade then it grows from there. I am willing to add continuously if the trade continues to work in my favor.
By risk so little at the beginning, I couldn't care less about any trade at any given time. I add when I'm making money, and that's how I decide.
We are powerless over the markets and how the instruments perform once we're long or short. With such small risk at the beginning, I'm not emotionally invested in the outcome of any trade. Even after adding several additional 0.10% units of risk, I'm still indifferent. For example, if I get to add 4 additional units, I'm only at 0.50% risk or 1/2 of 1%. Peace is a choice.
Too many traders are emotionally invested in having to be correct. I'd rather focus on making money over longer periods of time, and if that means having a commodity futures position on for 3 months, so be it. That does't make me an investor. Sometimes, it takes that long for "high tide" to come in.
FYI - I loathe having to look at a computer monitor or screen so I don't do it. My brokers are incentivized to fill my trades so I trust that I'll get filled when my stops are hit. That probably seems blasphemous to day traders, but I want to make money and have a high quality of life. Making trading look like blue collar despair is not what trading is about for me. It shouldn't be labor intensive. Hence most traders lack the emotional intelligence to be their own best coaches.
If you're struggling or not making money, do yourself a favor in 2018. Stop looking at 5 minute bars and start thinking longer term.
If the average person cannot explain to you what the blockchain is, how is the recent level of bitcoin a bubble?
I've seen this before in the commodity markets and although we're likely to see volatility that's uncommon in the markets, you can study the spread of viruses to get a better feel for this type of growth.
You can control the effect of volatility in your portfolio by decreasing your position size. You can further minimize your loss potential by using low to no leverage.
If Amazon or Walmart decide to take a crypto currency as a form of payment, demand for the underlying will explode as none are currently considered mainstream in terms of usage despite a steady stream of headlines about them.
Once this happens, I believe the best opportunity for adding crypto currency risk to your portfolio will be via an investment, not a trade. No crypto currency has gone mainstream yet, so all the talk is about "the trade" and that means the majority of people will leave the majority of the money on the table.
McDonald's went public in 1965 around its 10th anniversary. It was not mainstream until 10 years later and it still had a ton of growth to go. For example, they did not begin serving Chicken McNuggets until 1982, almost 20 years after IPO'ing.
If you'd bought 25 shares of MCD at the IPO price of $22.50 (a investment of $562.50 in 1965), your position would be worth over $3 million today at a price of $175 per share and adjusting for splits. That's more than 5,400 times your money over the same time period. That's also 50 years ago, so who can tell how they would have handled the position. MCD has split 12 times since the IPO.
Sure there had been some great trades along the way. There have also been some dead periods too, but when people who have not been trained to time the market or to trade, they leave the majority of the money on the table.
I think the reason is the people like to seem reasonable. Let's say you invested in MCD and you sold your entire position when it had doubled.
Maybe you felt at the time you didn't want to be greedy. Or you feared giving it all back...
What is the opportunity cost of that lack of emotional awareness or mindfulness around your process (or lack of one)?
Where is the opportunity in bitcoin or any crypto currency at this point? While I believe there will be parabolic moves, great trades, big drawdowns, the best bet is to invest in it and hold it for 20 years.
Focus on process and stay out of the results. Performance will show up if you trade a system with positive expected values. By focusing on the process or your system, you become the casino. Each time your system is open for business [trading], you are making money. You should strongly consider investing in a backtesting simulator.
When I started trading, I put a high level of emotion of making money on myself. That became expensive and I became frustrated about doing things that weren't paying off. They were never GOING TO PAY OFF, but I didn't know it at the time. I live by the adage that hard work will pay off...it was my turn. The thing is, I wasn't working smartly. And worse, I had no definable trading edge.
The funny thing is that as soon as I detached from the money spiritually, my trading improved in leaps and bounds, both emotionally and financially.
Nowadays, I think of the money as points in a video game. I don't actually play video games, but I still look at the net equity as how to keep score. As in poker, your money [chips] are your ammunition. I know when I make bad bets, I will most likely lose. Once in a blue moon, I'll get random luck and split a hand or everyone will fold to me. That's not a good business to be in though.
I can remember that as soon I had become emotionally invested in the outcome of a trade before I put the trade on...I could feel the disappointment before I offset the risk.
Losing Money But Making Good Mistakes
One good thing that I can say about this time was that I was risking real capital - not paper trading. I also was taking the risk home with me which is what I always advocate. New traders should not be focusing on 5 minute bars. Focus on the intermediate to long term moves, and once you master those [in 2-3 years] come back to shorter time frames risking 0.10% on trades so you don't do any lasting damage to your portfolio.
Holding a trade for three months doesn't make us investors. It says that we have stepped aside and let forces that are much more intelligent and powerful than us take over. All we can do is enter our stops and let the market go where it's going to go.
If you find yourself trading 100 shares but offsetting them before the market close, consider trading 20 shares and taking them home if you making money on them at the close. You will learn about your emotions from the experience which is invaluable and can only be done by living it.
If 20 is too painful, try 10. But I also ask you to do this: why the lack of trust? Is it you don't trust yourself or you don't trust your process? Where does that come from, meaning, what scientific study did you read where it delineated that you should offset winners NO MATTER WHAT at the close and go home flat?
If you take home 10 or 20 shares of a winning trade, you'll learn a lot about yourself emotionally as a trader. That wisdom is priceless to us. Learn and understand what your emotions are trying to teach you. They want to be advocates, not antagonists. If you feel the opposite is true, your process is likely the reason why.
The measurement for volatility takes into account the magnitude of the vol, not the direction.
You obviously don't want to be in high vol, directionless markets, unless you are trading option butterflies or condors that can take advantage of those types of markets.
For equities, you can deploy what's called a "pairs trade."
Anyone can gear their portfolio for 100% RoR, but you have to be willing to endure a 40-60% drawdown both financially and emotionally. Hard to do. Slower and steady growth might be a better fit for your tolerance for risk as well as what you are looking to do professionally, such as running public money.
[I have a documented 100% monthly return, however I was in fact coming off of a 40% drawdown so my starting equity was only up 20% by the end of that reporting period/month.]
Spread trades are about relative performance between the two instruments, meaning your are looking for the long to outperform the short. There has to be high correlation between the two instruments else there is no relationship. You can find good candidates for these types of trades by looking in each sector and going long the "best in class," and shorting the dog.
I wrote about pairs trading in Inner Voice of Trading where I was Long MSFT and Short NSCP figuring that Netscape was going to have a hard time getting clients to purchase a premium, albeit superior browser, while MSFT was giving Internet Explorer away for free.
One trade I'm in right now is Long PYPL and Short SQ in the mobile payment space. You have unlimited loss potential by being short a stock fyi.
You can learn a lot about commodity spreads at Moore Research. Commodity spreads are a great way for newer commodity traders to get involved with those markets as you are both hedged and you are afforded lower margin requirements since you are simultaneously long and short the same commodity, but in different months.
By trading equity pairs or intra-commodity spreads, you cut the volatility in your portfolio yet keep the directional bias that will bring the alpha.
By trading a complete trading system, you solidify places in your trading where your success can break down. Relying on system-generated trades, you get to focus on high expected value trades and eliminate the sub-optimal trades.
Benefits of a complete trading system:
A good cure for daily set-ups is a systematized set of rules. It takes out all the uncertainty around your decision making process. That can give you a sense of confidence and self-esteem.
You get to trade from a place of personal power. Hard to make money trading long term without confidence.
You won't have to interpret any chart patterns: the price will pick up anything about the instrument that is bullish or bearish. You will therefore be cured of the need to massage charts all day and night, thereby freeing up hours of time each day and the brain power that goes with it.
You can trade any market around the world.
You can blend several trading systems like an asset allocation to smooth out your equity curve. For example, you can put 40% in a breakout system and 60% in a moving average system. Or, you can put 50% in a short to intermediate trend following system, and 50% in a long term trend following system. Possibilities are endless.
You don't need subscriptions, chat rooms, or premium research.
Systems and Emotions
Systems don't remove emotions from your trading although that has been included in many marketing materials. I believe that began by a clever marketer who doesn't trade and wouldn't know if that statement was true or not.
You still have to put on the trades, and if you experience fear around losing money or greed around not making enough, you can hijack the system and blow up.
Ed Seykota set up the Incline Village Trading Tribe for traders to get in touch with their feelings and psychology around trading for this very reason. We never spoke about trades, set-ups, or chart patterns.
It was not only a complete snooze to do so, those don't help a trader become profitable. They do, however, provide fodder for good conversation and for building relationships and bonding I guess, but you can do that without becoming a trader if that's what your real goal is - to bond with people.
Lastly, I think trading a complete trading system can provide you with a great quality of life. It makes no sense to beat the crap out of yourself to make it as a trader.
Martyrs don't get paid and as Jim Morrison sang, "...no time to wallow in the mire..." Build yourself a simple system that takes care of your entries, exits, and position sizing, and in doing so you'll remove the weakest link in your trading: you.
Price targets cut your profits. Let the market tell you when the move if over.
Price targets are about predicting the future and human beings are horrible at that at best.
Read Expert Political Judgment by Phil Tetlock to get an idea of what I'm speaking about.
Intraday data is not statistically significant, so uptime your charts and begin to focus on daily, weekly, and monthly time series. Longer time frames remove the randomness of price.
Don't trail structure when you put on the trade. Focus on percentages - that's what professionals do. Once the trade is working in your favor, then you can trail structure if you want. But make sure you're looking at weekly or monthly support, not cloud-like chart patterns that change when you breathe on them.
When you let go of price targets, you'll focus on "best practices" and that means financially letting your winners run, emotionally letting go of control (you don't have any in the first place), and spiritually living a life that's worth living.
Look at your equity curve like a price chart. You want the slope to be positive and upward. What the trajectory? Your equity curve can help you target your goals.
Start by putting all your trades and the costs into a spreadsheet:
Column A is today's Date
Column B - Entry
Column C - Exit
Column D - Commissions
Column E - Fees
Column F - Final Balance
Then you can chart the last column against the Date - Columns A and F. Do that every day and update the chart. You can study the results at the end of the month.
Your Equity Curve shows you the efficacy of your process and trading rules. What does it tell you if you are afraid to create one? Not worth your time? My guess is that the truth might be hard to acknowledge and we can bullshit ourselves to eternity.
The first step in getting healthy and making better trading decisions is to discover your truth. Nothing illustrates a failed or successful attempt at trading better than an equity curve.
Drawdowns are not failure - they just delineate those times when your system was out of sync with the market. This will happen frequently, but if you've backtested your rules, stick with them as you'll trade yourself back to new highs by sticking to your rules.
I find that day traders are fearful of this process. Position traders will find that their equity curves make the biggest jumps. Let the market and leverage work for you and you'll see those efforts and results on your equity curve.
Use your breath to control your breathing. In the process, you will quiet your mind over time and not need to fill your day with kinetic energy.
For me, that includes making too frequent transactions. If you're in good trades, keep them, take them home with you overnight and over the weekend.
Inhale on a 4-count and exhale on a 4-count. You can increase your breath to a 6 or 7-count if you can slow things down enough.
A variation of this is inhale on a 4-count and exhale on a 6-count. Yogis and buddhists find that if you can slow your breath down, you quiet your mind in the process.
Inhale on a 7-count, hold your breath for a 7-count, and exhale for a 7-count. It might take you a few times to "catch your breath" so to speak.
Try this for 2-3 minutes if you can and do this 3 times per day. You might try this for 2 weeks before you feel anything material - it's different for everyone - but you should feel more relaxed, calm, and more energized.
Smartphone Meditation Apps
Enter Buy Stops above the market and let the market come to you.
Do this for every trade you have and then sit back. The good news is that you don't have to look at the chart once you're Buy Stop is entered. This is huge in that it frees up your time and energy.
You'll get an alert once the order is filled. Then place your protective Sell Stop at your predetermined price level.
Don't use price targets either. Once the underlying is up 2 ATR, move your protective Sell Stop to breakeven and let it ride. Make sure that you are not looking at intraday data either.
The key to all of this is to take yourself out of the equation. The more you are hyper-vigilant the less you're going to make on the trade. The more you watch the chart, the more you're likely to impose your will into the trade and cut yourself at the knees.
The overall markets are in strong uptrends, so let your trades run in this type of environment. Let go of trying to guess where the move is over - the market is much smarter than all of us and humans are horrible at best at prediction.
Having your Buy Stop orders entered will always have you in the right place at the right time. Why? Your orders are already in when the market moves and momentum hit and you can't possibly enter that many orders by hand in the heat of the moment.
You're already positioned. If the moves don't rise to your Stop levels, you won't get filled - and that's a good thing. At the end of the day, the orders will cancel because they are only good for the day.
Develop a systematized set of rules that you can count on. You can calculate your levels the night before and execute the rules the following morning.
The key is that you don't want to have to think in the morning - just focus on executing the plan. That means entering your buy stops to enter long and sell stops to protect your equity.
Here are the components of a complete trading system:
Breakouts - trading above previous highs or below previous lows;
Trailing Stops - to protect your equity after your initial order and also once the trade starts working out in your favor (see Exiting Winners);
Position Sizing - calibrated for volatility and your overall account equity;
Adding to Winners - systematized so that you don't join the hubris or factors that you can't prove scientifically;
Exiting Winners - getting out with the majority of your unrealized equity;
Also to consider is the correlation risk between the instruments that are in your universe.
These must all be conjugated to work together. One without the other is nothing - they are just data points. Think of them as a perfect complements to one another, like the starting 5 of your favorite basketball team or 9 players on the baseball diamond.
For example, your position size only matters to the extent you know how much you are willing to risk per trade, where you get in and where you exit.
Knowing how much silver is correlated to gold or how much or Facebook is correlated to Amazon will help you see the unseen risk in your portfolio before you add it.
You can't get this level of thoroughness from chart reading or understanding set-ups such as cup and saucer. It's only achieved from backtesting through a simulator that lets you simulate at the portfolio level, not one instrument at a time.
Examples of those are Mechanica and Trading Blox.