May 10, 2010

Most of the actions required to trade successfully are counter-intuitive

Extracted from the book: Trading in a Nutshell, Stuart McPhee

Like so many things in life, the path to success or the steps we need to take to achieve success are not obvious to us. So, if we don't take the time to learn the basic fundamentals of trading, we will most likely drift down the path of so many traders, which will result in frustration, emotional stress and almost certainly lost money.

The other thing to realise and appreciate is that so many decisions and actions that are required of us are counter-intuitive.
  1. As we are trading to make money, it is intuitive to think about and focus on making money. It is counter-intuitive to focus on protecting the money that we have.
  2. If we open a trade and it moves into a losing position, it is intuitive to hold on to that trade in the hope that it will soon return to break-even and we can close the trade with minimal loss. It is counter-intuitive to close that losing trade at a loss as it denies ourselves the opportunity of at least breaking even and getting our money back.
  3. If we open a trade and it moves into a profitable position, it is intuitive to close that trade to realise the profit and keep the money or, at the very least, move our stop close to the price. It is counter-intuitive to hold off from closing the trade, providing it the opportunity to continue moving higher.
  4. If we experience a losing streak of several losing trades in a row resulting in a decrease in our trading capital, it is intuitive to commit more money into the next few trades in order to win our money back sooner. It is counter-intuitive to scale back the size of your trades in order to manage your risks and protect your capital.
  5. Finally, when you first start trading, it is intuitive to think that your decision to enter a trade, being the first decision you make, is the most important and will ultimately affect whether your trade is a winner or loser. It is counter-intuitive to think that other things like the size of your trade and where your exit is are more important.

Do you get the idea? I certainly hope so. You see, I could keep listings all the things that are intuitive to do but have been proven over time to generally be the wrong thing to do when it comes to trading successfully.
The problem here is that if you tell someone who is starting to trade that their mindset or psychology is going to be the most important part of their success (and not their entry signal, for example), most would just laugh at you and think you are joking.

I will assue you don't fall into this category and therefore are willing to digest what I pass on as solid guidance for new traders.

Let me remind you of what I think is the great irony in trading. The primary reason why people trade is to make money. Yet, it is the money that often causes people to make all the mistakes and not to make mone, because their focus too much on it.

For example, the most important thing you can do when trading is to cut losses, yet deep down people don't want to because it appears to go against the primary reason of why you are trading - to make money. By cutting the loss, you are denying yourself the opportunity to make back the money in that trade.

The other thing about money is that I don't think there are many other things in life that affect our emotions as much as money does. So, when we are trading and our own money is on the line, it is difficult not to get too emotional with our decisions, yet emotions often lead us to making poor trading decisions.

Trading is decision making. Often you are faced with several alternatives of what you can decide to do; 

however, generally it boils down to two options. You either decide on the basis of what you feel like doing or on the basis of what you know has to be done to trade well. Most people select the former whereas those who are successful with their trading ignore what they feel like doing and do what has to be done to ensure overall long-term success. This is a key separator between successful traders and the rest.

Aside from the mindset response, I would tell a new trader that trading isn't as easy as you probably think it is. Many people think that trading is easy money., as I did easy on - it is probably the hardest easy money there is.

If a new trader can appreciate right from the start that trading isn't as easy as they think it is, they will most likely approach it with more committed effort and be prepared for the challenges that trading presents.
With the benefit of experience, there are so many things I wish I knew when I first started that I now just accept and take as 'the way it is'. So, here is my little list of guiding points for you:
  • Be humble - you are not going to get every trade right.
  • Be committed - trading is not easy and any half-hearted attempts will get you nowhere.
  • Educate yourself - there is so much to learn and while you can learn fom actually trading, you can save yourself a lot of money and stress by learning from someone else who has come before you.
  • Take it slowly/be patient - trading success is not going to happen overnight. For most people, this is a life-long endeavour, so it doesn't really matter if it takes you a few years to start trading profitably.
  • Keep it simple - people have a tendency to overcomplicate matters and develop intricate and complex solutions to problems. When we accept that trading is not easy, we think only a complex solution (trading plan) will work. In trading, simple does work. It also makes it much easier for us to follow the plan when it is simple.
  • Be realistic - having high expectations of yourself is good thing; however, having unrealistic expectation is not. Many traders when presented with the wonderful opportunities that the market offers can be very easily led to setting unrealistic goals for their trading. This can be devasting. It is vital to set your goals with your trading but it is equally vital to ensure that those goals are measurable and realistic.
  • Focus on the right things - don't focus too much on your entry signal, as most people do. Keep it simple and then move on to the more important areas such as position sizing, setting exits and preparing your mind for successful, disciplined trading.
  • Whatever you do, protect your capital - it goes without saying that if you got no money left, you can't make money. This is an important issue because any nre trader is not focused on protecting their money: they are focused solely on making money!

Action is the foundation key to all success. Pablo Picasso (1881-1973)

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