Wednesday, March 3, 2010

When to be afraid of next trade?

Last few weeks all trend following systems (which are on my screen) on shorter time frames of 15 minutes and 30 minutes behaved dismally, losing quite a big chunk of points. Current drawdown for most of followed systems is between 1500 and 2500 points. That correlates to about 15-40% of the equity for the period that is recorded. Number of losing trades outstripped winners by big margin when compared to previous longer performance periods. Simply, we had streaks of five or six losing trades in the row.

Of course, this is not what happens often, but it is something that will happen for sure once a year or maybe once every two years. Times like these are epitome of plans to stop using systems; tweak them and to look for holy grail of trading one more time. Many novice traders, who started with trading recently will place question mark and will start thinking about trading: How this is possible? Should I stop trading? Should I skip trade or two?

Many will stop with trading once the pain threshold exceeds level one is comfortable with. They will, in most cases, stop trading just before big winner comes in to wipe good chunk of painful losers. Many will be very afraid to place next order, knowing that it will/can be a loser, as they can’t take it any more.

Should you be afraid of placing next order?

Answer to this is definite YES. You should be afraid of placing new order every time when you are OVEREXPOSED to the market. This is the only case that you should be afraid of placing trades. Simply, if you have profitable system and you have strong belief, you should not be afraid to place new orders.

One should always look at this game as at game of averages. If your average trade for your system is, as an example, 50 points, then you should put yourself in state of mind that whenever you place the order you actually make 50 points. That way you will remove yourself from big strings of losers and for that matter you will mentally cut strings of winners, as these can cause overconfidence.

However, when you are overexposed it is different ball game. One should never be overexposed and should always be on the safe side. First rule in trading is to survive; second rule is to make money by consistently adapting and adjusting to new market conditions. So, in order to adhere to rule number one, one should never be in position to lose his own capital. Overexposure (due to overconfidence or other reasons) is probably the biggest killer of all traders - freshmen, seasoned, experienced, etc.

There are many formulas on the Net and in books where proper sizing for one’s trading account is to be found, but more about that next time.

Trade with trend!


8 comments:

RocktZAR said...

Thanks for the great blog, Alsi Trader!

I am one of those new traders (at least new to ALSI futures) you talk about, and I'm also trading a short time frame of 5 minutes. It has certainly been tough. So far, I've taken a small loss over the last 2 weeks, only about R1700 as I'm trading on a single contract basis. I'm certainly not over-extended, but still feel a lot of pressure to make profits.

I believe in my system, even over these difficult conditions it works great in backtesting! My problem is the discipline to stick to it at all times. I believe if I'd done so I would be at least neutral - probably up a few grand.

I find my fear of loss causes me to choke trades with over-tight stops and also skip signals, any advice on that?

Alsi Trader said...

Hello RocktZAR and thank you for the comment.

If you have valid system (which proved itself through backtesting and out of sample paper-trade and trading) and enough capital to trade that system on basis of one contract, there is no reason to second guess it.

If you can’t trade such system, in which you have belief, then trading is going to be source of frustration and guessing, which will impair growth and advancement.

What happens if football player doesn’t stick with game plan?
What happens if lawyer second guess his in-depth researched strategy in the middle of the trail?
What happens if out of fear pilot decides not to listen to the tower?

Maybe you should consider finding system, instrument and time frame which suit you more.
(Not necessarily in this order.)

Hope this helps.

RocktZAR said...

Yes, you're right, sticking to the plan is the key. When I'm more experienced I'll use my own judgement, but for now that is dangerous. I'll keep working on that "operator" part of my system. It's hard to backtest one's own patience, discipline and objectivity but these things are what make or break any system.

Anonymous said...

Hello Igor!

Thank for the great post.

I'm looking forward to your post on position sizing! :)

Alsi Trader said...

Thank you for the interest Anonymous.
Will try to post it over weekend or early next week.

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