A Few Rules

Whilst at the AIA Conference I was surprised at the number of folks who did not have a coherent approach to the market. In fact I would say that a plan was a rarity. This prompted me to dig out this old ready reckoner of points I think should be somewhere in your plan. Its a collection of technical and philosophical ramblings

First things first.

Be absolutely certain that you want to be a trader. Markets have been traded for several thousand years and definitive records have been kept for in excess of 150 years. During this time the rate of failure among speculators seemed to have remained has remained constant . Yet in the past 150 years we have introduced new financial products, world markets have been globalised and the PC has brought the dealing room into every home. Despite this the majority of people who trade fail dismally. However this is not a negative message because it means that someone out there knows what they are doing and they are making all the money.

However the odds are against you succeeding. This is not mean’t to be a depressing statement it is merely a fact. Few people succeed at anything they do be it business, school, relationships or weight loss. Most people don’t have it.

Examine your motives

One of the things that sets highly successful traders apart from the losers that make up the bulk of the trading community is that they understand their motives for trading. They know why they are traders and surprisingly enough they are not traders to make money, the money is merely a side effect of trading well. If you are able to trade bear markets cleanly and precisely then the money will flow as a natural consequence of your skill.

Every trader should have listed the reasons why they want to trade and this should form part of your traders business plan. I very rarely use the word guaranteed in conjunction with trading but if your prime motive in trading is to make money, then you are guaranteed to fail.

You must have a method.

There are no shortage of indicators available, if anything there are too many most are rubbish and serve only to act as a crutch for those who don’t understand that price is the be all and end all of trading.  Irrespective of the method you generate your trading method must have a few basic rules.

• It must be trend following, you will never make any money if you do not understand that the trend is god. Trying to counter trend trade simply does not work.
• It must be robust, market conditions change over time. As we have seen markets can move from trending to congesting, your method must be able to identify these changes in market tone.
• The simpler your method the better. This is the reason I developed a largely mechanical system that removes me and my personality from the decision making process.
• Forget trying to predict the future both you and your system should be reactive traders. Your predictions as to where the market may or may not go are simply irrelevant. As a result you should forget all about Gann, Elliot Wave, astrology and all the other nonsense that permeates the financial markets.
• Your method must be testable. Traders by and large do not understand the difference between correlation and coincidence. For example if the Fin Review tells me something is going up and it does, I know from experience that this is coincidence. However if my system tells me to go short an index and that index subsequently falls then I know this to be a result of correlation.
• The approach you take to the market should also include strict rules for trade entry and exit.

You must have an edge.

Your method gives you an edge, if you do not know what your edge is then you don’t have and are guaranteed to fail.

Developing a coherent method is hard work.

To successfully engage any market with an adequate methodology takes time and hard work. Expect set backs.

Hard work versus skill

You can only get so far with hard work, it is possible to improve your trading , probably beyond any point you thought possible. But sooner or later you will plateau, this is simply the way the world operates. Some people will go further than others simply because of innate skill.

Trading should be effortless.

If your trading causes you pain or unsettles you emotionally then you are not equipped to be a trader. As an example consider this simple test, does your trading keep you awake at night. If it does then you should withdraw from the market permanently because you lack the required emotional and psychological skills to be a trader. This is nothing to be ashamed of, all of us have endeavors that we simply cannot do. But it is essential to realize that not everybody can be a trader and acceptance of this fact is essential to your emotional and financial well being.

Money management and risk control.

Etch this rule into your brain. TRADE TO SURVIVE, TRADE TO SURVIVE, TRADE TO SURVIVE. This rule should permeate everything you do in the markets, if you adopt this approach then you will be around long enough to make money. You must keep your position size as small as possible to minimize your risk of a catastrophic loss. Remember, if you lose 50% of your equity then you will have to make 100% to merely break even. Hands up everybody out there who knows someone who makes 100% per annum. I doubt many hands went up.

The trading plan

My rule for this is simple, proper prior preparation prevents piss poor performance. All trades must be planned in advance, this plan must include what your money management criteria are, how much are you going to risk on the trade. What reasons are you entering the trade, what are you going to do once you are in trade and what conditions will cause you to exit the trade. Your plan should also have follow up action should you make either a loss or a profit.

Discipline

No discipline, no profit it is that simple. Trading choppy markets is not something you make up as you go along. You must stick to your trading plan…no deviation should be tolerated.

Understand that you are responsible.

Everything that happens to you in the market is your fault. Traders by and large tend to abrogate responsibility for their to a perceived higher authority. The excuses as to why people lose money are many and varied and they range from statements such as my broker cost me money or only insiders make money. The common theme is a lack of personal responsibility.   These are your decisions, if you cannot come to grips with this most essential if features then you are not equipped to be a trader.

Be independent.

I shouldn’t really need to explain this. Your money – your system….

Losing is part of the game

All traders will lose money at some stage in their career, it is inevitable. One of the key psychological features that separates successful from unsuccessful traders is their capacity to deal with loses. Winning traders accept that they will have loses but these will not affect their long term viability. Losing traders operate under a completely different mindset, they assume that you must never lose money ever, this results in an inability to take small loses. So eventually these small loses become catastrophic losses that bring a rapid end to their career as traders. Secondly poor traders cannot see past their losses and envisage profitable trades in the future. They believe that one loss will be followed by another in a never ending continuum, if you have no trading system and no discipline then this is probably true. However if you do have a tested methodology and are disciplined in its application then you will have to accept that no method is perfect and you will get bad trades but this does not instantly invalidate you method.

Paradoxically successful traders believe that a trade where they have followed their rules and made a lose is a successful trade. Because they know that if they can follow their rules through a poor trade then they can follow them through good trades.

The virtue of patience.

The market will always tell you what to do, there are actually very few surprises in trading and this applies to holding positions. Too often traders set themselves narrow profit targets and then leap off the trade the moment these targets have been reached. Such traders then exclude themselves from the rest of the move, I have seen many traders take 50 points of a 300 point move merely because that is the arbitrary profit target they have set themselves. If you have a trend following method, combined with strong money management, then the market will tell you when to exit a trade. Trends exist to be followed, predicting how far a trend will take you in advance is rather like a surfer trying to predict how far a wave they are yet to catch will take them.

Learn to be disloyal.

The position is not your friend, it doesn’t even know you exist. When the market tells you to leave, leave.

Hope is a four letter.

There is no such thing as hope in trading, nor does the power of prayer seem to hold much sway with the market. If a trade has gone wrong it has gone wrong, all the best will in the world will not alter this fact. If it has gone wrong, exit the position immediately. TRADE TO SURVIVE.

You cannot win if you have to..or scared money never wins.

Do not play with money you cannot afford to lose, if you are becoming a trader in some desperate last ditch stand to avoid financial disaster then your failure is guaranteed. Only trade with money you can afford to lose. There is a simple reason for this, you will be more relaxed and you will be able to take losses when they occur. Trading with money you cannot afford to lose brings with it enormous stress and this in turn magnifies the chance of making an error that will on balance of probabilities be catastrophic.

The markets are an expensive place to look for excitement.

It has been my experience that trading is a fairly routine, boring activity. You analyze the markets in the same way using the same tools every day, there is very little variety. The popular image of trading is a group of individuals standing around yelling and wildly gesticulating about the price of pork bellies. This is not the world of trading, trade is calm dispassionate, disciplined and at times very isolated. If you wish to throw money around in a search for excitement then visit Crown Casino, they could do with the help.

Prices are not random.

This is an old chest nut usually trotted out by fund managers when asked as to why when they are paid $500,000 a year they cannot beat the All Ordinaries Index. The common response is that the markets are random, such an idea was discredited long ago. You can if you are willing to learn and apply yourself beat the market.