Becoming better trader

Many people started with trading or investing on stock exchange for one simple reason - to make money. This reason is valid, but will it help one to survive out there? I don’t think so and there are numerous reasons for that.

First and the most important is that one doesn’t have any experience or knowledge about the game and still wants to play with the pros. Following the same principle - Would you take boxing match against world champion and, on top of that, would you expect to win it? Would you expect to go into surgery and do heart operation and expect to be successful? I guess not. So, why trading is any different?

To become profitable trader one must invest time. First on to do list is to read as many books as one can. That way one will develop very broad knowledge about what is going on. Only after extensive education one will be equipped to make his conclusions on what is to be liked, if anything at all. Following step is to read as many book as possible on specific field of interest.

However, if one after all the reading realizes that one doesn’t like anything related to trading, then do something else.

Finally, after one finds niche and market that one wants to trade, that is when one more educational effort is to be undertaken as one has to find out as much as one can about it. After all of that, paper trading for few months in real market and day-to-day conditions is to be taken seriously, simulating trading as much as possible. Please note: It will never be the same with money on the table, but please try it.

So, let’s refresh - We want to trade to make money.

From day one money was not made, while a lot was spent on books and courses, while precious time was spent too. That is correct way, as at the beginning one should forget about making money. One should focus on becoming better trader; one should focus on following his system 100% of the time, while finding better ways of trade execution. Making money is result of all actions previously stated – it is not a cause! Simply, if one focuses on efforts to make money, one is placing the cart before the horse. One must focus his attention on improving his trading. To make money one must forget about making money.

Of course, one shouldn’t get stuck in his head. It is very beneficial not to get caught up daydreaming about all the different things one could do when first 1000 points winner is made. Grand plans and spreadsheets considering development are not to be created. Those activities may seem intelligent, but they don't actually help one become better trader and all they do is keeping one stuck.

Although, the road to making money may seem long, the process of getting there is actually quite simple: One should do whatever it takes to make a daily habit of improving his knowledge, even if baby steps are being made at first.

Again, this is marathon, not the sprint.

Trade with trend!

J200, End of the day chart

Let’s take a look at daily charts - J200 or Top 40:

First one is from February 2009 till Friday, September 4th, 2009. It is easy to notice that there is strong and obvious trend upwards from low that was made on March 3rd, 2009. Two black lines are parallel, making channel that was tested twice at the bottom and twice at the top. Also, we can see as well that there are some negative divergences that were developed before recent drop which was 7 days long with 6 red days and 1 green day. In the mean-time some hidden divergences developed on Stochastic and RSI. (Hidden divergences are when indicator makes lower low and price makes lower high.) Both of them are shown with green lines, with one that was on August 17th, 2009 and another that was very recent. These hidden divergences usually point towards another upswing on Top40 in weeks to come.

The other chart shows bigger picture for Top40. Starting from mid 2005, we see strong move up; then strong move down which is followed with trend that started in March 2009. This chart is telling us why market is so reluctant to go higher: There is a massive resistance around 22700-23000 (thick red line) which was tested 11-12 times from bottom and top (from December 2006) and it is coming into play again.

Looking as first chart, it is clear that area around mentioned line was tested so many times in last few days.

Of course, the most important is to see if that trend line gets broken. If it does, market will go up strongly and get to 24500-25000 area fast. However, if market decides not to go over resistance, then we will have big pull back that can take us all the way down to 21000.

In both cases, J200 will resume its direction shortly.

Trade with trend!

Long term success

From a very young age, we are ingrained with a powerful short-term reward system. We are incentivized to eat on day one with the reward of satisfying our hunger. Such immediate gratification teaches us to always eat when we are hungry. As we began with our education, we were rewarded to learn with grades in mind. And grades, we soon realized, yielded the reward of approval (and love, I suspect) from parents, teachers, and peers. We would study non-stop for days to take an exam, with the assurance that we will receive a grade within a week. As we entered the job-market, a day's work was rewarded with a monthly salary. In many cases, an immediate commission was rewarded for each sale - or aggregated into a bonus at the end of the year.

So, how all of this reflects on trading?

Very small percentage of people makes it in trading and my personal opinion is that most of the people who were bumped out of this game have placed short term rewards in front of the long term goals. Most of the people will take small profits instead of letting them go, just to be satisfied with their short term reward. They will keep losers for much longer then they should because they will not be rewarded if they close them early, so they chose to hope that positions will probably swing back to positive territory. This approach is absolutely wrong as in trading one must keep winners as long as he/she can and cut losers very fast. Only by doing this one has a chance to make it in this game. Problem is that there are just a few people who understand this and that is the reason why we have so many losers in trading game. But, I guess, this doesn’t apply only to trading – it applies to everything around us. Only few people make it in big league, starting alone simply because they were not satisfied with their salaries at the end of every month. So, they took bigger risks and started their own companies.

Trader who is just starting with trading should encounter many setbacks during which he/she must always keep long term goals in his/hers head. Short term reward will be so tempting (at the beginning) to take profit and to break system rules when you are in good trade. That’s when your mind must work towards achieving long term goals by following/respecting trading system, money management and trading discipline as long lasting success will simply wait at the far end of this endeavour.

Trade with trend!

Keeping Journal

“If you don't know where you are going, you will probably end up somewhere else.”

Laurence J. Peter
US educator & writer (1919 - 1988)

If one wants to be good trader and if one wants to make it in trading field, then one should keep his/hers trading journal. This is second step for every developing trader (as well as for established traders) and trading journal is to be created immediately after trading system with positive expectancy is in place.

I would suggest that one should have not only one, but TWO trading journals. First one should be the journal where one records all trading metrics - position, sizing, profit/loss and any other metrics that one can think of. Second journal should be the journal in which one will record one’s thinking, emotional state, etc. That second journal should carry honest information on how did one feel when trade was entered; how did one feel during the trade; what were the matters of discipline in terms of closing trade and disobeying trading rules; and anything that comes to your that will help you maintain your positive thoughts/actions in place, while providing feedback if something (that is not that good) should be corrected.

Both of those journals should be reviewed often - how often it does depend on one’s trading strategy: At lease once a day if one is intraday trader; every week if one is swing trader or once a month if one keeps his/hers positions over longer periods of time.

Please note that attached picture represents what I’ve came to after six years of trading. Shown example is trading journal in which trading metrics are recorded and please fell free to change what you want, but keep in mind that with more metrics you have more details to focus on in order to fine-tune your trading. Also, please feel free to send me e-mail and I will be happy to share this form of trading journal that I’ve designed in Excel 2007, which has some new features.

Top right corner shows T and F formulas, which are, as statistical formulas, very important for your trading.

For your system to be good, T (field BQ7) must be higher than 1.6. Just be aware that T formula is function of the number of trades, so more trades you have better you can judge your trading system.

F (BQ8) formula is something that is called Kelly formula and determines how much money (per contract traded) you need in your account to avoid risk of ruin. For example, if you have R100.000 on the start of the month you can trade R100.000/(R15.000+R13.661) and that is exactly 3.79 contracts. That number is shown in filed BQ43 .

Most of the fields are updating automatically so you should just put new trade in and check them from time.

In order to read full paper on T and F formulas, please visit:

http://www.verticalsolutions.com/notes/intro_to_testing.html
http://www.verticalsolutions.com/notes/simple_tools.html

The second journal is as important as the first one, but for that journal one should use blank peace of paper and keep his/hers thoughts – it is amazing what one is going to find there after few months of honest recordings.

Trade with trend.

When you have trading system

In my recent blog post I’ve stated that first and the most important step in trading is to have trading system, which matches your personality when it comes to instrument which is traded, gearing, time frame, intraday or swing trading, etc.

Let’s imagine that you‘ve done everything possible to find data supplier; you have tested many systems over different time frames and thorough different market conditions. At the end, finally, you have found something that you like and as all is looking good, the question is: What’s next?

Of course, you must find broker which you need to use in order to trade instrument(s) you are willing to trade. For my liking, broker must have online trading platform; over the phone support in cases when platform or your Internet connection are not working, and, of course, the most important one – BROKER MUST BE REGULATED, ideally with your money staying in third party account, which is usually some of the big banks. 

All in all, after you open your account you should deposit money and start trading. Yes?

NO !!!

This is where most of beginners make first mistake. After one has an account with broker which provides online trading platform; after trading system is in place, one should start to paper trade system in live conditions for, at least, 3-6 months, subject to time frame used, which shorter time frames (tick, 1min) asking for minimum of three months of paper trading, while longer time frame systems will ask for more practice time, if one assumes that longer time frame system is going to generate less trades per month than, let’s say, system used on 1min chart.

Main reason to paper trade system which has proven (during test phase) to be of your liking and profitability goals is that, both, beginners and seasoned traders should get experience and “feel” for trading system. Some of the questions that one should get answers for through live paper trade are: How a system behaves in the different market conditions? What it does when market gaps against the position? How it reacts to foreign and local news? Of course, these are just basic few questions that one can’t get answer for by just looking into numbers thrown by his/hers testing program.

In addition to all mentioned one should start trading like real money is on the line - With journal in which all entries and exits are recorded live with: corresponding dates, time, profit or loss, weekly and monthly results and any other measurement that comes to one’s mind. 

Just as peace of personal experience – boredom of paper trading and feeling of missing money making opportunity will definitely settle in, but your job as trader is to brush it off. Also, please note that for some serious statistical calculations you need to have minimum of 400 trades recorded during paper trade phase. The more you have - the more accurate results are due to general rules of statistics which are pointing to relation of sample size, margin of error and level of confidence. 

Simply, by paper trading, among other benefits I’ve mentioned above, you will get more chance to understand your system and your emotional reactions to it. Also, paper trading in live conditions will teach you DISCIPLINE which then you need to bring when money gets on line, as you will be in much better position to stick to the system, once you start trading it and when system hits some rough patches, that could be reversed before you know it.

Finally, with good trading system that you paper trade in live conditions and with numerous trades that you have collected, you are going to be in better position than probably 95% of people (didn’t want to call them traders) that are starting on stock exchange.

Trade with trend.

Is trading gambling?

As I was at the very beginnings of my trading endeavor, I had many of my friends saying something along these lines: “It can’t be done!”; “You are going to lose money.”; “It is gambling and nothing more!”. 

Five years later I am getting various questions from the beginners and one of the most frequently featured question in regards to trading is if, eventually, trading is being just another form of gambling. Through this Q&A involvement I’ve also realized that, somehow, from my experience, wives of successful people are the most skeptical about trading. 

Looking for outside of trading arena, I assume that trading might and probably does look like gambling. On another hand, by being a trader for half of a decade now, I know what the difference is between gambling and trading:

Gambling is gambling for gamblers only! So, when one steps in casino and when he/she places money on the table or in the machine, that’s when one becomes gamblerer. At the same time, Casino/House is involved in the process and the question I need to ask is: Do you consider Casino/House to be gambler too? I shall say no, because Casino/House has exactly calculated odds and mechanics of winning: Simply, every casino in the world will earn exactly 55% of every coin that one places on table or in the machine. Somewhere and sometimes, casino is going to earn every coin that gamblers or bored tourists donate and sometimes and somewhere casinos are going to pay somebody millions, but on average, over long run, they are going to earn 55 cents out of everything that was used on the tables or machines.

Trading is kind of similar. Our job is to turn ourselves into Casino/House. Sometimes, we are going to have big winners; on other occasions we are going to sustain big loses (within our stop-loss levels or even more in unfortunate black-swan events); while most of the time winners and losers will be average. Finally, when we add all of this together at the end of every day, week, month or year, one should make more than he/she lost. 

Logical follow-up question is how to become Casino/House?

It is very simple – We need to have trading system/approach with consistently positive expectancy; sound money management rules and we need to be able to consistently execute our trading and money management rules. If one would check Casino/House when they pay out, let’s imagine, one million rand jack pot and if one takes that single event and judge their business sustainability, then chances are exactly 100% that business will not be sustainable for longer period of time. The same is with trading - If one measures his/hers trading by looking at losing trades only, or after losing stint, as an example, of five trades, then one would guess that business is not sustainable anymore. What actually matters is to check your trading business after X number of trades and to understand if you are making money or not.

If one doesn’t know what he/she is doing, then we are talking about gambler in trading or, in deed, in any other field. Let me be free to even more stress my point - in life as such!

When/if you become casino, then trading is going to be easier.

Trade with trend.

How David Beats Goliath

Trading is the game in which Goliath and David are consistently fighting: On one side we have institutional traders, mostly banks, with all computing power of the world; with best quants on the world; with guys that are paid millions of dollars to make decisions. On the other side, there are small guys, operating in small rooms, armed with one or two PCs and Internet connection.

If you face and ask any of these Goliaths if there is a way for David to beat them consistently and survive in trading game, they would probably simply say that such path doesn’t exist. Is there truth in it? For sure there is! Big institutional traders think that small retail trader cannot make money consistently enough to survive. (I guess, statistics is on their side too.) I kind of agree with such thinking, but I would say that retail traders can’t make money if they are to play the same game that institutional traders are involved with.

History is showing us many examples in which David beats Goliath and one simple recollection from the top of my head is from the world of sports - as small teams do beat big teams often enough. How they do it, and how retail trader can make money in the game where his odds are much smaller than odds of big guys?

I believe that first and most important decision is not to play the game in a very same way institutional traders play it. They move millions or billions in one transaction. Retail traders don’t have that capital, so there is no reason for massive movements to occur. Big guys make decision based, mostly, on fundamental information - small guys don’t have to do that. Big guys must buy newest and best performing PC systems every few months, while small guys don’t have. Big guys must pay massive salaries to all those cleaver guys working for them - small guys don’t have to fork out fat pay-cheques at the end of every month.

Even though big guys have big advantage, they still have more than few disadvantages stacked against them. So, don’t worry what institutional trades are saying and simply go and find a way to attack them when they are the weakest. And then, just take portion of their money.

Many wars were won by smaller and less equipped armies and numerous underdogs won in sporting events when nobody gave them a smallest chance of winning.

It was done, it is done daily and it will be done as long as we are around.

Trade with trend.