Friday, March 14, 2014

What is your definition of a good or bad day?

Occasionally you will some traders say "Had a great day today" or maybe "Terrible day - got clobbered in several positions".

When most people talk about having good or bad days, they are talking about an increase or decrease in open equity.

When trend following, you need to concentrate on three factors, which are:
  • determining when you want to open a new position;
  • determining your position size and initial stop placement;
  • determining your trailing stop levels which will take you out of a profitable position.
This is all part of taking responsibility for your own actions, as these are the only factors you have control over.

Everything else is out of our control. The market will do what it wants to do. You are only one participant in that market - there will be thousands of other participants who have positions in that same stock or instrument. 

All of them will have their own reasons for opening or closing positions which will affect price. How can you possibly influence what the market does? Therefore, it is a waste of time and effort to fret about that, and whether the price movements are moving for or against you.

This is where skilled trend followers have developed their necessary mindset to succeed. The basic tenet is to cut losses short and let profits run. Cutting losses is determined by accepting when you are wrong on a trade, and adhering to your stop levels. Keeping losses to a minimum is determined by good risk control and appropriate position sizing. Both these factors are fully within your control.

Letting profits run is at the whim of the market - it will go where it wants to go, and just as importantly, trend followers do not care how the price action develops within the context of a develpoing trend. Some trades may develop quickly, others slowly. Some may meander around not going anywhere until you are stopped out. You can't do anything about that.

To be successful in trading, you have to accept those facts.

My own approach is that, providing the trend remains intact, and does not trigger a trailing stop, then the position is left to its own devices.

When a trailing stop is hit, based on your system parameters, then that stop placement will signal that the trend has extinguished itself.

Perhaps not surprisingly, my own definitions of what constitutes a good or bad day are different to the majority.

To me, a good day is when the system rules have been followed, either in identifying and opening a new position, or, updating an existing position (adjustment of a trailing stop). You have stayed fully in control of those elements that you can control.

If you must look at the monetary aspect, then again a trend follower or a systematic trader should have a different mindset.

A good day is when a profitable position has been closed. Remember that one of the three things you can control is stop placement, so therefore you determine the level when you will exit a profitable trade. Even then, you are not fully in control due to the possibility of a stock gapping through your intended stop levels. But more often than not, you determine the price level to exit a position. 

Banking a profit, after faithfully following the system rules, means that cash equity has increased. If you use a fixed fractional basis for your position sizing, then banking a profit would allow you to increase your position size (in terms of number of shares, pounds per point etc) on any subsequent new trades.

A bad day would be when you are be stopped out of a number of positions for a cash loss. A loss of open profits on a bunch of existing positions may be frustrating, but it does not mean it's a bad day. After all, you specified the system parameters, and your trailing stop allows for a certain amount of volatility within the context of a trend. Therefore, your decision to allow a certain amount of 'wiggle room' on the trade means you have to accept that open profits may be eroded, or even eliminated.

Similarly, if you are simultaneously being stopped out of several positions, that may be as a result of the general markets trying to change direction itself. Again, something else you cannot control. 

If you don't want to risk losing on several positions in one go, then you should consider limiting the number of positions you have open at any one time, or only open new positions when your stops on existing trades have been moved up to reduce or eliminate open risk on those trades.

Once again, this is all part of taking responsibility for your own actions, as these factors are fully within your control.

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