Truths about trading, published in the hope you will avoid learning this the hard way:
1. How to save a lot of money and increase your trading capital
(There is no Holy Grail) There is no magical mathematical system that will consistently make money in the markets. All mechanical trading systems experience periods of proﬁt and periods of losses. I’ve seen reports of the best trading systems having winning trades on average only 48% of the time. Winning 60% of the time is considered spectacular for mechanical systems. Most people lose money on trading systems, this is because they quit during a string of losses. If you follow a blind system, you have to stick with it, even during bad times; this can require deep pockets. Most people cannot do that, so trying to buy a “successful system” is futile for most people. For discretionary traders, there are also no magical indicators, which generate good signals all the time. The trader must learn to know when an indicator should be followed, and when it should be ignored.
Advice: Some people are far better suited to mechanical systems trading than discretionary trading. It requires complete conﬁdence in the system and suppression of emotions. The trader must execute every signal. If you are not such a trader, don’t waste your money on these systems/indicators, instead add the money you would have spent on such systems to your trading capital.
2. Discretionary trading can be very rewarding
But it is hard work, and can also be very stressful. Finding a style/methodology that suits your personality is difﬁcult, and many people lose a lot of money in the process of ﬁnding one. Don’t expect the ﬁrst book/methodology you buy to be the magic one. Finding/developing a good system for your personality is possible, but not easy. Even when you reach a degree of comfort with your style, the learning process never ends. Trading is not a low-stress easy occupation.
Advice: the best discretionary traders tend to have ﬁrm rules and strict methodologies in place (almost mechanical in many respects). In order to trade with consistency, they design a system that actually reduces the amount of discretion in their trading, but they retain input in key areas of their plan.
3. Backtesting and paper trading are valuable tools (and abused concepts)
A system/methodology that looks good in a back-test or in paper trading may not do well in real trading. Backtesting and paper trading are valuable tools. I paper-trade every new concept before committing capital to the idea. Backtesting and paper trading allows testing in a risk-free environment, can help you reﬁne your techniques, encourage discipline, and saves you a lot of pain/losses during the testing/educational cycle. But backtesting/paper-trading is not trading. During a paper-trading exercise, your focus is on testing for success. During real trading, your focus is often on preventing loss. Emotions come into play during real trading; no amount of paper trading can cater to this reality. Backtesting in the futures arena usually involves “back-adjusted” continuous contracts. These adjusted continuous contracts do not represent real prices, or a real trading environment accurately. All backtesting results should be treated appropriately. Also, most backtesting excercises dramatically underestimate trading costs and slippage.
Advice: Ask for a documented real trading performance history when reviewing mechanical trading systems. Then determine if the results are compatible with your objectives and personality. If real trading results are not available, you must determine if the system tester used an appropriate means of testing, as well as generous amounts for trading costs and slippage. Requesting documented results is not appropriate for discretionary methodologies because your own personality will affect the outcome.
4. How to dramatically reduce your trading costs.
The real cost of trading is very high. Commission costs are the least you should be concerned about. Slippage will be dramatically higher than you think. Most trading systems/methodologies will have you buying into an existing trend, and selling (or attempting to) into a price-decline or panic. Slippage can be horrendous in these circumstances. Most backtesting results dramatically underestimate slippage costs. There are other costs too, add commissions, slippage, computer equipment, quote service, software, communication costs, loss of interest on your trading capital, the cost of losing trades (lost capital), the cost of your learning process (those mistakes you made). Do you get the idea? Forget about commission costs, don’t quibble about the cost of books or courses, get ready to spend some real money if you want to trade well. Consider the emotional cost. How would you feel after losing 30 percent of your capital? Would you continue trading in that case? How would you feel after 4 losses in a row? How about 5 losses in a row, with your spouse consistently saying, “I told you so”? This serves to explain the concept of “emotional capital”. The beginner trader needs to ﬁnd a system/methodology that reduces both ﬁnancial and emotional costs.
Advice: look for a system that helps you buy dips in an uptrend, sell rallies instead of selling into a downturn, provided of course that your personality can accommodate this style. If you can’t handle a series of consecutive losses, tend towards discretionary trading (as opposed to mechanical) or consider earning a living in a different industry.
5. How to get rich starting with only $5,000
Almost all the successful traders I’ve met have suffered severe losses before they became successful. This means that you will most likely reach a point at which you have lost so much of your starting capital that you consider yourself a failure before you succeed. Your initial capital will probably be insufﬁcient to carry you through this process. Start accumulating more trading capital now. Your ﬁrst objective is to make your trading capital last through the learning process. Most people do not meet this test. You will therefore probably require more capital than you anticipate.
Advice: On the other hand, starting small is a great way to reduce your risk, learn to trade with smaller positions and build up some conﬁdence, before you enter a more demanding environment. Most traders do start small, because it makes sense. But you will probably not become wealthy on only $5,000.
6. It can be done
I know several people who have become successful at trading. Read published interviews of these traders. Yes, it can be done! All of the traders I know do not consider it an easy stress-free source of instant riches. They treat it as a serious business because they are trading with real money. Some of the best traders burn out periodically, and need to take a break.
Advice: Successful traders tend to strive for balance. They do not trade all day every day, and then study charts after hours, then take a few trades in the aftermarket, and talk trading all their waking hours, etc. Most successful traders tend to have a balanced life-style with varied interests. Some have other businesses; many obtain revenue from training other traders, selling systems etc. Good traders need to counter the stress of trading in healthy ways. Trading is a psychological adventure, manage your mind and emotions. Take vacations regularly, and get physical exercise, in order to ﬁght stress and burnout.
7. Following someone else’s advice most often leads to failure
A newsletter subscription will not bring you easy riches. It is very difficult to trade on someone else’ advice. You will not have the same degree of confidence in each trade as the advisor does, you do not have the same ﬂoor connections, your slippage will vary, and you may close the trade inappropriately due to fear.
Advice: Guru’s are great for education. If the advisory service has good and practical educational content, it could be worth the subscription, but following someone else blindly usually fails.
8. Locals and specialists are not “out to get you”
This section only applies only to the trading of liquid instruments. (Do not trade any other kind!) Locals and specialists do not “gun for your stop”, unless it is within easy reach and in an area where many stops reside. There are many stops at different prices in the market at any time, if your stop is located inappropriately, your stop will likely get hit. This is not the fault of the locals, it is your responsibility to place your stops appropriately. Yes, locals will try to trade in an area of clustered stops, but only if the equilibrium of buyers and sellers permits it to happen. Locals have a privileged position, being able to proﬁt from the spread between the bid and ask. Too many traders think this is an unfair condition. It can be unfair if the spread is manipulated. But bear in mind that the locals assist in creating an orderly market. They provide liquidity, they take the other side of your trade. Locals take risks every day that you would not be comfortable with. Don’t begrudge them their ability to trade the spread. It is to your beneﬁt, and you would not do it for the same beneﬁt. Think of working hours each day in a very loud sweaty pit with these aggressive sharks. Better them than me! Recognize that we beneﬁt from their activities.
Advice: Visit an exchange, spend some time there. Even ﬁnd employment at an exchange, if possible. Try to befriend a local, you will learn a lot! Too many people trade with a very limited knowledge of market mechanics. Knowing how the “locals” exploit their edge is valuable, you can make money with that information (this is particularly valuable to the day trader).
9. Take responsibility
It is OK to be wrong, you will make losing trades. You cannot control the markets, in trading there is much beyond your control. You can only control yourself and your actions. Take responsibility for your own actions. Don’t blame your broker, your software, your quote service, or the leader of any country. It is YOU who makes each trade. If you have a losing trade because you were bumped into it because of a bad price tick, tough! You made the trade. The more you take responsibility, the better trader you will be. Don’t blame everyone else!
Hint: In reality you cannot be responsible for everything, and you can’t attempt to control everything. Part of trading is to jump in and make a trade with what information you do have. Don’t be so careful that you are paralyzed! You have to take some risks (within your loss tolerances).
10. Fear of capital loss it the greatest cause of failure
The emotion of fear causes traders to make mistakes. It is normal to have your emotions effect your trading without being aware of it! Fear will cause you to miss good trades, enter and exit trades too early or too late, and make silly unexplainable errors. Fear will cause a beginner to quit trading just after an important lesson has been learned. Many traders quit along the path of success because of fear. Trading under the inﬂuence of anger or euphoria is very dangerous too. As soon as you are overconﬁdent, wham! The market teaches you a severe lesson. Remember, never trade when you are angry.
Advice: On the path to success, there are some key concepts that can reduce fear. First, build conﬁdence, paper trade, and then trade in small quantities. Second, shift your focus from money, focus instead on what you have learned from each trade (both proﬁtable and unproﬁtable), and what you have yet to learn. Focus on the path to success, instead of money. Learning is a positive experience; success and money will follow naturally.
11. How to consistently make good trades
If you are hard on yourself unnecessarily, you will fail due to lack of conﬁdence and fear. If you derive enjoyment from trading you will do better. Do not strive for the enjoyment of making money. Instead, strive for the enjoyment of trading professionally. Redeﬁne (in your mind) what a good trade is. A good trade is one where you traded according to your plan/strategy/methodology, regardless of proﬁtability or loss. Accept that losses are a cost of doing business, not personal failures.
Advice: Reward yourself for making a good trade, regardless of proﬁt or loss. Talk to others about how your strategy ensures your success because it protects you during a losing streak, rather than complaining about a losing streak. Of course, this requires that you have a good strategy and conﬁdence in it. When you have reached this level, you will know you are a professional trader.