Trading is a learned profession—no one is born a fully formed trader. Each response and subsequent activity is learned. The difference between a good trader and a habitually poor trader arises in the mechanism of learning and how they interpret the feedback from each of their actions. The matrix below shows the differences in how traders learn from their experiences.
If we break this matrix down into some points of comparison we can see the essential areas of difference.
The first point of difference to consider is how traders view their losses after a valid signal.
The first major point of divergence is in the response to a losing trade that arises from a valid signal. It may seem obvious but not all trades are profitable trades, this is a point of difficulty for many traders. It is at this point that traders will often begin to either tinker with a system in an attempt to minimise losing trades or abandon the system entirely and seek a replacement. Unfortunately, social media has convinced many traders particularly those who are starting out that you should not have a losing trade or enter into a drawdown.
I have shown the image below of a fake equity curve and statistics. Sadly this sort of data is repeated over and over again. Even sadder is that traders fall for it.
The second major point of difference that I want to highlight is the reaction to an invalid signal that leads to a gain. A balanced trader recognises that this is a less than desirable outcome as a poor decision is being reinforced. A poor trader makes no such discernment because the process is not important merely the outcome.
If we expand out the decision-making tree of a poor trader we can see the eventual outcome of this concentration on outcome rather than process leads to a catastrophic loss.
Trading consists of a series of processes that are derived from a feedback loop. If the loop is designed to reward outcomes without an acknowledgement of how the outcome was achieved then inevitably the system will collapse since there is no self-correction conducted by the trader. Good traders self-correct both their process and by extension their behaviour to optimise as much as possible the outcome. Get the process right and you eventually get the trading right.
Another brilliant lesson, Chris. Thank you
I so needed to hear this. Today I received an email confirming a closed trade hitting my initial stoploss. My first thought was ‘oh no, not again’. Was feeling a little sad. But after reading this I have changed it to ‘awesome that you kept to your stop loss and risk strategy’.