Tuesday, August 23, 2011

You must 'own' your strategy

I got a message earlier today from a fellow trader which simply said "A friend panicked me out of my shorts today...". The implication was that he regretted exiting his positions almost as soon as he done it. I do not know if this was because he knew he had simply violated his trading rules, or that he regretted it when the market started reversing its intraday movement back in the direction he was trading.

At the end of the day, only one person must make trading decisions for your own account, and that is YOU.
Great traders may start out by looking at, testing, and trading other people's systems and rules, but these are then refined over time so that their system becomes their 'own', with all parameters (entry and exit rules, risk control limits etc) set to satisfy their own requirements. It is this refinement over time that 'personalises' a traders' set of rules.

In my own case, this refinement took about a year or so, and when I found I was happy with them, they stuck. No more time wasted testing, refining, trying different ideas - I could simply go trading, based on a set of rules I was 100% happy with.

Another important part for me in my progress was that I vowed to ignore information from other well-meaning traders, postings on other blogs or the talking heads on the TV - how do they know how I trade? Ask 100 traders their opinion on a particular market and you'll probably get 100 different answers, which can be influenced by whether they are personally trading that market, whether they are trading in the same direction in that market, or the timeframe they use, or possibly other issues.

There are several questions that set the framework for your system (refer to this post here) - you need to know all the answers before even thinking about trading that system. Think about it - you subscribe to a signal service which tells you when to get in a trade - great. This is the part where 90% of traders concentrate their energies. But, do they tell you how much to trade? Do you know the rules for exiting a position? Do you know the vendors appetite for risk, or allowable drawdown parameters? Do you know the overall expectancy of the system? More importantly, if you do know the answers to those questions, are you comfortable with those answers?

It is imperative that these rules are set in stone, and that you are 100% compatible and happy with each and every one of them. If not, then you need to change that parameter, until such time that you are happy. This will almost certainly have a knock-on effect on the other parameters, and it is critical to ensure that these changes, at a minimum, do not have an adverse effect on the overall profitability and expectancy characteristics - if they do, further changes may be required.

As one example, I know I am most comfortable trading on a daily timeframe - weekly I find is too slow, anything less than daily I find uncomfortable due to the possibility of whipsaws, significant reactions to news events etc. If I was changing to a shorter or longer timeframe, I would then need to adjust the risk per trade parameters until I was happy with them.

One of the reasons I like mechanical trend following systems is that they have very explicit criteria for each element that make up the overall system. They are simple to understand, and easy to implement. There are hard and fast rules, allowing the trader no scope to bend or break them. All emotion is taken out of the equation - if you get a signal, react to it accordingly, no questions asked. This may mean taking an exit signal on the same day you opened that position - it doesn't matter. You created the exit rule, tested it, were happy with it - so why would you ignore an exit signal? Also see this post.

As a post script, the trader mentioned above added to his original message with the following "Got caught in a weak moment. Now not sure what to do...". In the words of Old Partridge from Reminiscences of a Stock Operator, as a result of an emotional decision, he had now lost his position(s), and was stuck on the sidelines. There's nothing more frustrating (and I've been there on more than one occasion!), especially if the market shoots off in the direction you were trading.

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