Thursday, August 14, 2014

A critical element of achieving trading success

One of the key aspects of my approach is to control my risk at all times. This means I try to  'scale in' to new market moves, slowly increasing my exposure. I have set position limits on both how many trades I can open each day, plus how many I can hold open at any time. This, combined with my own stop methodology, means I try and keep my open risk or portfolio heat as low as possible.

If a move in the general market is to be a sustained one, then it will give you more than enough time to build up a portfolio of positions.

It is for this reason that my drawdowns have been kept as small as they have (refer to both the equity and R curves shown here), despite the number of losses incurred.

The biggest problem I have come across with new traders, as I have mentioned many times, is that of overtrading - taking on too many positions, too quickly. You may be able to get away with this during a raging bull market, but when market conditions get difficult, then all you will do is chop up your equity, or end up with significant drawdowns. It is at those times when you need to exhibit patience and discipline to wait for conditions to improve.

However this is where inexperienced traders tend to struggle. They have a fear of missing out of a decent move in the indices, so they jump into a whole bunch of new positions too quickly. They want the rewards but don't want to incur the risk. In the end, they conclude that the method doesn't work.

Similar to my rules on position limits, the Turtles had their rules on how many 'units' they could take at any time. Again, this was all concerned with controlling risk. Curtis Faith referred to this in Way of the Turtle:

"I have often seen people claim to have tested the historical performance of the Turtle system and state that those methods did not work or were not profitable. They would make statements such as "I implemented every rule except the unit limits". The unit limits were an integral part of of our system." 

In their situation, they were only allowed to take a certain number of unit in a particular sector, such as interest rate futures, but the principle is exactly the same. Faith also refers to the 1987 overnight price shock - had those limits not been in place, then losses incurred would have been (in his words) 'staggering'.

I was discussing my own trading with another trend follower the other night, and he commented on just how disciplined and patient I am, both in waiting for new opportunities to come along and holding open those trades that do develop into winning ones. This has not come easy, but can be learned - if I can do it, then you can too!

Everyone makes mistakes trading - the trick is to ensure that they are not damaging to your account, and that you learn from them. Good risk control helps keep the tuition fee as small as possible. Developing the correct mindset, and implementing changes to ensure that you do not keep repeating the same mistakes helps you develop as a trader.

The bottom line is this: you can take a winning system, and implement pretty much all the rules, but through poor overall risk control, you can turn it into a losing one. Controlling your market exposure is a crucial element of achieving success.

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