Trading in the Dark

This is a great point and article shared in my Facebook trading group:

From Simon Vuko: The below principles have massive trading implications for newbies:

‘The Dunning-Kruger effect explains that the problem isn’t just that they are misinformed; it’s that they are completely unaware that they are misinformed. This creates a double burden.”

“Studies have shown that people who lack expertise in some area of knowledge often have a cognitive bias that prevents them from realizing that they lack expertise. As psychologist David Dunning puts it in an op-ed for Politico, “The knowledge and intelligence that are required to be good at a task are often the same qualities needed to recognize that one is not good at that task — and if one lacks such knowledge and intelligence, one remains ignorant that one is not good at the task. This includes political judgment.” Essentially, they’re not smart enough to realize they’re dumb.”

– Psychology Today, 13th September 2016

Too many new traders rush into trading after a string of luck confuse luck with skill. Or they study a bunch of information and confuse knowledge with experience, actionable skills, and the right process. One of the most dangerous things for new traders and investors is to be ignorant of their own ignorance. The first steps in education in the finance world is learning what the right questions are to ask. Then understanding that so much of trading and investing is a psychological game more than a game of math.

Here are some warning signs of new traders that are blind to important market dynamics:

1. They think big returns can be consistent and easy.
2. They do not understand that bull market and bear market price action is very different.
3. They do not see the importance of position sizing and risk management because they are over confident in their trading.
4. They see no need for talking about trading psychology.
5. They think trading is all about making a prediction and betting big on it and letting it play out with conviction.
6. They have never heard of the term risk of ruin.
7. They think successful traders are either flaunting mansions, girls, and sports cars or they are not successful.

40 Steps In The Trader’s Journey

40 steps in the trader’s journey from new trader to rich trader.

They are as follows:

1. We accumulate information, we learn- buying books, asking questions, maybe going to seminars and researching what really works in trading.
2. We begin to trade with our ‘new’  found knowledge.
3. We make profits only to give it back very quickly and then realize we may need more knowledge or information.
4. We accumulate more information.
5. We switch the stocks we are currently following and trading.
6. We go back into the market and trade with our improved system. this time it will work.
7. We lose even more money and begin to lose confidence that we can even be traders. The reality of losing money sets in.
8. We start to listen to other traders and what works for them.
9. We go back into the market and continue to lose more money.
10. We completely switch our style and method.
11. We search for more information.
12. We go back into the market and start to see a little progress.
13. We get ‘over-confident’ in a single trade and put on a big position believing it is a sure thing and the market quickly takes our money.
14. We start to understand that trading successfully is going to take more time and more knowledge than we ever anticipated. MOST PEOPLE WILL GIVE UP AT THIS POINT, AS THEY REALIZE REAL WORK IS INVOLVED AND THAT THIS IS NOT EASY MONEY.
15. We get serious and start concentrating on learning a ‘real’ methodology.
16. We trade our methodology with some success, but realize that something is missing.
17. We begin to understand the need for having rules to apply our methodology.
18. We take a sabbatical from trading to develop and research our trading rules.
19. We start trading again, this time with rules and find some success, but over all we still hesitate when we execute.
20. We add, subtract and modify rules as we see a need to be more proficient with our rules.
21. We feel we are very close to crossing that threshold of successful trading.
22. We start to take responsibility for our trading results as we understand that our success is based on our ability to execute our methodology.
23. We continue to trade and become more proficient with our methodology and our rules.
24. As we trade we still have a tendency to violate our rules and our results are still erratic.
25. We know we are close.
26. We go back and research our rules.
27. We build the confidence in our rules and go back into the market and trade.
28. Our trading results are getting better, but we are still hesitating in executing our rules.
29. We now see the importance of following our rules as we see the results of our trades when we don’t follow the rules.
30. We begin to see that our lack of success is within us (a lack of discipline in following the rules because of some kind of fear) and we begin to work on knowing ourselves better.
31. We continue to trade and the market teaches us more and more about ourselves.
32. We master our methodology and our trading rules.
33. We begin to consistently make money.
34. We get a little over-confident and the market humbles us.
35. We continue to learn our lessons.
36. We learn smaller positions lower the volume of our emotions so we trade smaller and this surprisingly makes us better with our discipline.
37. We learn that risk management is one of the biggest keys to winning as a trader, we start to understand that big losses will make us unprofitable so we finally trade a smaller and consistent position size.
38. We stop thinking and allow our rules to trade for us (trading becomes boring, but successful) and our trading account continues to grow as we increase our position size only as our account grows.
39. We are making more money than we ever dreamed possible.
40. We go on with our lives and accomplish many of the goals we had always dreamed of. Money is our new tool to do what we have always wanted.

Formulas for Managing Trading Emotions

I  truly believe the hardest thing about real trading has not been the math, the method, or picking the right stock, currency, commodity, or futures contract.  The most difficult thing about trading is dealing with the emotions that arise with trading itself. From the stress of actually entering a trade or the fear of loss as a trade goes against you. Even winning trades can be stressful as the fear of losing the paper profits that you are holding with a winner can even effect a trader. Then most importantly the ability of dealing with the emotional lows of a string of losses or the highs of many consecutive wins  can cause a trader to lose their confidence or discipline. The bottom line is how you deal with those emotions will determine your long term success in trading more than any other one thing.

To manage your emotions first of all you must trade a robust trading methodology after you have confirmed that it will be a winner in the long term with your edge if you stay disciplined. You also must trade your method with proper position sizing and risk management to keep the volume down on your emotions and ego. If you have that the next step is the management of your emotions.

We must understand that every trade is not going to be a winner and not blame our self for equity drawdowns if we are trading with discipline.

Do not bet your entire account on any one trade, in fact risking only 1% of your total capital on any one trade is the best thing you can do for your stress levels and to bring your risk of ruin to virtually zero. (This is based on your stop loss placement, not 1% position sizing).

With that said here are some examples of emotional equations to better understand why you feel certain emotions strongly in your trading: (The ‘=’ sign should be read as ‘equals’ and the ‘-‘ symbol read as ‘minus’ to understand the formulas here).

Losing Money – Trading Better = Despair

Do not despair look at your losses as part of doing business and as paying tuition fees to the markets.

Expectations – Reality= Disappointment 

Enter trading with realistic expectations. You can realistically expect 15% -20% annual returns on capital with great trading after you have experience and have done the necessary homework. More than that is possible but you will have take on more risk and be one of the very best traders or investors to achieve greater returns than this.

Disappointment in a loss+ Caused by lack of Discipline = Regret

If you followed your trading plan and lose money because the market did not move in your direction so be it, but if you went off your plan and traded based on your feelings and opinions then you should feel regret and stop being undisciplined.

Winning Trades – Fear of Ruin = Enjoying your Trading

Trading is much more enjoyable when you are risking 1% of your capital in the hopes of making 3% on your capital with a zero chance of ruin or have a very high winning percentage with very small losses when wrong. It is not enjoyable when you are putting a huge percentage of your capital on the line in each trade and are only a few bad trades away from your account going to zero or a big draw down.

 Understanding what makes money + Years of successful trading = Trading Wisdom

To get good at trading you have to trade real money. Wisdom comes from putting real money on the line for years and proving to yourself that you can come out a winner in the long term.

Belief through back testing + Experience of winning with it for years = Faith in your system

Whether  any individual trade is a winner or loser should not influence your faith in your system and trading method. You should trade in a way that each trade is just one trade out of the next 100. Much of emotional trading can be overcome when you do not have doubts about your method. When you believe in your method, system, risk management, and your own discipline, you will overcome many of the emotional problems that arise in the heat of trading during a live market.

Most new traders will be very surprised at the emotions that rise up during active trading when real money is at risk, I hope this blog post gives many a heads up on this factor and how to overcome it.

A Traders Diary: Guest Post

This is a fictional story.

Tom’s diary.

Year 1: I decided to become a trader.
I want to get rich quickly and easily and retire next year.
I always liked catamarans and maybe I can date models.

Year 2: Since I decided to become a trader, I lost $50,000.
I had a dinghy and sold it for $500.
I need that to open a micro-lots fx account.
I think I should read books on trading.
I met Stacey. She does photo-shoots of gardens and forests.
She is a part-time photographer…. she finds me ‘cheap’ and says I spend too much time with the markets & that it’s all a dream.

Year 3: Stacey left me. that has given me more time and I have read 82 books on trading, finance, economy, psychology.
I know technical indicators better than my own family.
I can compute and deduce. I can anticipate and react.
I can also say that I am a much better trader.
this year, I did not lose $50,000.
I eat well once a week.
My psychologist keeps asking me if it’s all in my head and that maybe I am refusing to leave this virtual reality.

Year 4: I have decided to terminate my relationship with my psychologist. he was too expensive and I live on modest means.
I am writing articles for 2 blogs & I sound nice and professional.
people look up to me. that is good for my self-esteem.
But I refuse to tell anyone that my average gain is $120.00 and I rarely have losses but my losses are $2,000.00 easy.

Year 5: I don’t read books anymore. actually, I don’t read.
I have canceled my TV package and bought 6 monitors.
I am watching 12 markets, like a hawk, 18 hours a day.
I started photo-modelling on my spare time.
I was told I have a nice abdomen and they need people for pictures of underwear and boxer shorts & it’s easy money.
I reinvest everything in my trading account.
I have no car. no girlfriend. no friends. no life. no family.
But after 5 years I know that trading is all that matters to me.

Year 6: I am seeing the light at the end of the tunnel.
I now have a more normal life.
I know when to trade and when to step away.
I can manage decent profits and I keep losses tiny.
After having tried 127 ways to trade, I have kept the few things that make sense to me and that, on the long run, bring a profit.
I have finished paying off my student’s loan of 12 years ago and I managed to buy a small sailboat, nothing fancy.
I feel like maybe this is real.
I used to be obsessed with trading. I am more relaxed now.
I only think about it all through the day but more calmly.

Year 7: After 7 years, after losing pretty much everything, and not giving up, I have closed each month with a profit.
I can afford a small car. I am taking a small trip to see what’s out there… I will go to the next city and do a weekend of golf.
I am living the dream, ’cause I saw Donald Trump today and he said ‘kid, no matter what, keep going.”

Year 8: My income is now decent enough that I am starting the year with a 3-week all-inclusive vacation in the Maldives.
I booked a private suite.
the hostess here looks like a photo model, and when she found out that I trade for a living, she asked me on a date her interest was born in that single instant and she said:
”Wow! You trade for a living. it must be nice to get rich quick.
and to know that life always was and always will be easy.”…
I thought she was too keen and too pushy
and obviously, she has no clue as to what it took to get here.
I canceled the date.
I’ll probably grow old, with my 6 monitors and my cats, but hey, I chose this life. and I am not rich but I am happy. 

– Francois Normandeau

P.S. A fictional account, but not too far from how it all goes for thousands of real, dedicated traders out there.
A story on the real cost of trading, and the real rewards at the end, way beyond wealth and money.

4 Dangerous Emotional Indicators

Most traders are not undone by their method or system, but rather they are undermined by an internal struggle. Problems arise when the adrenaline starts pumping and emotions come into play; this is the time when bad decisions are made. Pride, Fear, Greed, and Hope are the most dangerous internal indicators to overcome.

Pride screams, “Don’t stop your loss! Prove you are right! It will come back, just wait.”

Fear advises, “Go ahead and take your profit quickly! We can’t let our winners run. Let’s take the small profit now, because the profit could reverse and we will end up with a loss.”

Greed assures, “This trade can’t miss! I am sure it will be a huge winner. Bet your whole account! We will be rich!”

Hope whispers, “I am not sure what a good entry is here, so I am just going to buy this stock and hope for the best.”

Below are some great videos about these emotions by Scott O’Neil. He is President of MarketSmith Incorporated, a stock research tool developed by a team of investment professionals at William O’Neil + Company, a Registered Investment Advisor for Institutional Money Managers. They provide equity market buy/sell recommendations and independent research. Scott is also a portfolio manager with O’Neil Data Systems, Inc. -Forbes

Winning Trader, Whining Trader

There are two very different types of traders, one that wins and one that whines. Whiners hardly ever win and winners rarely whine. Trading is a tough business and you have to be able to keep the right mind set to get you through the rough spots. When the markets start trying to knock you off your trading plan and system. Mental strength more than any other one thing will determine your success. You can come back from losing your whole account but you can’t come back from completely losing your faith and confidence in yourself. Your mind must be one of a winning trader . We should not entertain internal or external whining. Keep the faith, stay focused on your long term destination and what it will take to get there.

Winning traders take responsibility. Whining traders play the victim.

Winning traders take the right entries. Whining traders get in too early or too late and miss the opportunity.

Winning traders find a way to make money. Whining traders find an excuse why they did not.

Winning traders add value by entering a trading discussion. Whining traders add value by leaving a trading discussion.

Winning traders study ten times as much as they trade. Whining traders trade ten times more than they study.

Winning traders enjoy the game and the profits. Whining traders enjoy their delusions of the big score.

Winning traders build a mentor relationship. Whining traders think they are too smart for a mentor.

Winning traders are realistic about their possible returns. Whining traders are delusional about what returns are probable for them.

Winning traders are focused on their trading expertise. Whining traders are scatter brained and their style drifts to what they think will work.

Winning traders approach their trading as a business. Whining traders approach their trading as a hobby or gambling.

Winning is a state of mind as much as a winning process. Whining is trading with the wrong set of mind and feeling like a victim when the error was trading without a good long term process.

Good Trades are Never Easy

Traders may be waiting for the market to settle down and give them more clarity about the trend. For the moving average to hold, for volatility to decrease, for the economic numbers to be more positive, for oil prices to find a range, for your bad luck with entries to end….

The reality is, the market action will NEVER give you the perfect time. That right moment for entry never arrives. The entry will always be difficult; right at the peak of fear the bottom is reached. When the market feels like it will never stop going up a short term top is reached.

Good traders buy the fear at the right time, they sell the greed, they go against the majority when the trend bends and they enter trades that make them uncomfortable. The profitable traders trade a system that has a mathematical and emotional edge over their opponents. Trading is never easy because the profits usually arise from signals that are counter-intuitive. Buying momentum and greed can work in an uptrend and selling short can work in a downtrend. These signals work best in the beginning of that trend, when the trade seems particularly difficult.

Profitable traders take trades when their signals are triggered, even if they don’t believe in them at that moment. They understand the historical price performance and what is possible.

Their trading plan is their boss. Their signals are their gurus. Their trading system is what gives them the faith to click their mouse and put real money at risk in the belief that they can win. They have faith in themselves and their methodology. That is how they can click the mouse and make the trade. Can you?

7 Reasons to Never Give Up Trading

Photo Credit: BK

Early on, new traders will want to give up. Particularly when they figure out that the first few years are more about studying and paying tuition in losses, than in making money. Trading is a two-sided competition, and you have to be on the right side of the trade to make profits. Not only does this not happen all the time, but many profitable traders only have 60% win rates. Rather, it is the magnitude of their wins versus their losses, and their fortitude that make them profitable. Half of the battle of successful trading is never giving up. Perseverance in trading is about learning, implementation, and dedication.

7 Reasons to Never Give Up Trading:

1. Trading will educate you about yourself. You will learn your strengths and weaknesses.
2. Learning to trade well will make you a better person. Good traders do well with managing their ego, fear, greed, and with risk management in other areas of their life.
3. Trading is a good measure of your abilities. It is competitive, but happens on an even playing field.
4. A great trading system can be a stream of consistent income.
5. You can grow your capital through compounding, and significantly change your life.
6. Nothing else offers the personal control over your financial freedom like trading.
7. What else are you going to do? Work a 40 year career in a job you don’t like, making money for someone else?

Quitters give up when they are tired and frustrated. Winners don’t quit until after they have won.

Why Traders Do Dumb Things

Why do smart traders do dumb things? It is usually an issue with overwhelming emotions, and not intellect, when bad trades happen. Here are a few of the primary reasons that traders struggle.

~The biggest cause of trading a position size that is too big? It’s the greed of wanting the big win that makes you take on too much risk, rather than not having enough faith in your entry.

~Missing a great entry signal is often not due to being too cautious. Instead, it is usually the result of the fear of losing. A string of losses, a large loss, or a lack of faith in your trading system, leads to missing an entry that your trading plan indicates you should take.

~Not taking a loss at your initially planned stop loss, isn’t  because you believe it will come back, but is the result of having talked publicly about your positions, so that your pride keeps you from exiting and admitting that you are wrong.

“I think investment psychology is by far the more important element, followed by risk control, with the least important consideration being the question of where you buy and sell.” – Tom Basso

Trading Expectations: Keep It Real

Unfortunately, the retail trading world is full of false promises.  No other industry has as many snake oil salesmen, promising to make traders rich for a fee. The more a newsletter writer or trading system seller tells you how easy trading is, the more cautious you should be.

Consistently profitable trading requires a winning system that fits a traders personality, and they must have the discipline to follow it Implicitly.

Here are a few things that a new trader needs to understand:

1. No trader wins on every trade. The best traders in the world only have a 50%-80% success rate. 
2. Trying to get rich quick requires so much risk, that the probabilities of ending up poor is far greater than your chances of becoming rich. 
3. Consistent 15% – 20% annual returns are what world class traders and portfolio managers make.
4. Some of the best traders’ best years were 50% – 100% annual returns, in specific market conditions, that were conducive to their strategy.
5. Market conditions will have a huge impact on your returns each year, regardless of how you trade.
6. The higher returns you aim for, the more risk will be required, and the larger draw down you will have getting those returns. 
7. If you risk 5% t0 10% of your trading capital on every trade, your risk of ruin is 100% in the long term.
8. If you think that the above percentages are just too small, then it is very likely that your trading account is too small to make those percentages meaningful.
9. To trade for a living, you likely need a multiple six figure account, and a minimum of one years worth of living expenses to avoid the unrealistic expectations of small returns and the accompanying stress.
10. Trading is a profession like any other, and requires the same level of discipline and dedication to be successful.
11. All your profits comes from other trader’s losses. You must beat other traders to be profitable.
12. Trading is the hardest easy money you will ever make.

Why Trading is Like a Triathlon

“A triathlon is a multiple-stage competition involving the completion of three, continuous, and sequential endurance disciplines. While many variations of the sport exist, triathlon, in its most popular form, involves swimming, cycling, and running in immediate succession over various distances.” – Wikipedia

Trading is a three-dimensional competition that requires the management of three continuous, simultaneous, endurance disciplines. While a variety of trading methodologies and systems exist, profitable trading involves management of the trader’s psychology, attention to risk control, and dedication to trading a robust system over an extended time period.

Many traders make the mistake of thinking that simply knowing the right methodology will guarantee their success. In actuality, it is a three event marathon consisting of more than just entries; psychology and risk management have much more influence over longterm success. Entries have no meaning without the right exits, and no system is a winning system without the discipline to follow it. 

Here are the three events in the trading race:

A trader’s psychology has to be one of confidence in order to trade it with discipline. Confidence comes from doing homework, back testing, chart studies, and experience. A trader has to trade position sizes that turn down the volume on their emotions. They must have the mental discipline to follow the plan that they carefully crafted when the market was closed, when the market is open. When a trader drifts into greed, fear, and ego, they will likely wreck on the rocks of reality. A successful trader needs the psychology of an entrepreneur, cultivating the fortitude to get through the small losses so they can make it to the big wins.

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A trader’s risk management will determine their short term and long term success. Trade too big and the trader will give back all past profits with just a few losing trades. Trading huge position sizes insures that a trader will eventually give their whole trading account away to disciplined risk managers. If risk is not managed, no trading method will lead to profitability because some string of losses will eventually be too much to bear.

A trader’s methodology should be robust enough to have an edge over the markets and other traders. High probability entries and set ups based on historical price action is a good place to start. Planned exits to lock in profitable trades when right, and knowing where to get out if proven wrong, is critical to success. A good trading methodology is trading with a plan that defines entries, exits, and position sizing. Implementing a strong methodology increases the likelihood that a trader’s overall wins will exceed their overall losses within the timeframe for expected profitability.  

If you want to win the trading race, you must train for all three events.

7 Habits Of Highly Destructive Traders

As traders, we try to do constructive things that build faith in ourselves, and confidence in our trading systems. We want to stay on the right path and not wander into the wilderness of destruction. Here are the seven things that we must be cautious of for the sake of profitability.

1. Blaming outside forces for poor trading results is an incredibly destructive behavior. High frequency traders, market makers, and irrational markets, give an undisciplined trader license to make reckless trades. The less responsibility taken for results, the more destructive they can be with an account.
2. Trading with no plan and making decisions based on feelings, is a really bad idea. Letting opinions and predictions be a guide to entries, and emotions be a guide to exits, guarantees maximum destruction of trading capital.
3. Trade first and learn how to trade later. Traders who don’t spend time educating themselves before trading will learn the hard way, and give their trading capital to other traders as tuition.
4. Focusing on ego and the desire to be right, instead of profitability and big losses, will quickly destroy a trader’s account.
5. Traders that fight the trend and disagree with the actual price action will give their trading capital to those that follow the trend.
6. Trade without discipline and risk management and a trader will be destroyed regardless of their trading system or method.
7. If a trader doesn’t diversify their life with strong relationships, fun, peace, and health, their trading results become too entangled with their self worth. This can lead to mental and emotional ruin.

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The path to profitability leads away from these seven habits. In the end, traders are consistently rewarded for their good habits, and punished financially for their destructive habits. This is our stop list.