Saturday, December 08, 2012

Finding the right method - for you

Anyone who has been around trading for a while will know that there are literally thousands of different ways to make money in the markets. Whether it be using trend following, counter-trend trading, scalping, using support and resistance levels, indicator based or any other method, what can be great for one person can be poison for another. Go read a book like Market Wizards and see the wide disparity in the methods employed.

What ALL successful traders have done though is:
  • Found a method that suits THEM, in terms of the overall basis being used, the preferred timeframe, the inherent volatility, the amount of time required per day needed in front of a screen etc.;
  • AND combined it with rigorous risk control;
  • SO THAT by being applying the above factors, they are psychologically able to rely on the system, to stick with it when a run of losses occur (which can happen to anyone and any method) and to faithfully adhere to the entry and exit rules.
I could teach my complete method to 10 people who would be sitting in the same room at the same time, yet I can guarantee that the majority of those people who not be able to obtain the same results (even if we selected the same stocks to trade). Why is this? Because the ultimate discretionary factor when trading is the trader themselves! The trader may KNOW they should be following the entry rules, and the risk per trade they should be using, yet it is all to easy to put on a bigger position on the basis of a 'sure fire bet' or a hot tip, or to be too eager to open a position before the proper entry signal has been given, for example, rather than sticking religiously to a series of tried and tested rules.

Following on from that, give those same people some time, and I could also guarantee that they would have made some changes to the system (differing parameters, timeframes, entry/exit criteria), in an attempt to make themselves fully 'compatible' with the system they are using. The smart ones would only do this after a reasonable number of trades, and would slowly make any changes to quantify the effect, but would ensure that they still use appropriate risk controls at all times.

Because of the 'trader effect' on your results, this is why I place relatively little reliance on backtesting or paper trading. While they may give you a clue as to whether a system is basically profitable or not, there is a world of difference psychologically between paper trading and real trading. It's at this time whether a trader finds out if they are truly compatible with the system, and can faithfully follow the rules.

Even in individual realms of trading, such as trend following, there are a myriad of different ways to identify a trend, be it using price channels, moving average crossovers, volatility adjusted breakouts, whether to enter on new highs or pullbacks, and many others.

At the end of the day only you can make that choice, and determine whether the system being used is right - FOR YOU.

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