Friday, July 15, 2016

Adding some accountability to your trading - helping a day trader to improve

A while back I was approached by a day trader who wanted some help in improving his performance. This took me back a bit - as readers of this blog may know, when I started trading back in 2003 it was as a day trader (and I initially struggled) before I got into trend following.

I've long believed that the essentials of good risk management and being able to avoid mental errors are applicable to ALL types and styles of trading. This would therefore be an interesting exercise - for both of us.

I met the trader and his wife to discuss his trading history and to get an idea of what he believed were his issues.

He thought that his main issue was overtrading – taking too many trades. And yes he was taking lots of trades. But we needed to look further into this to get a clear idea.

He had a simple method of attempting to catch intra-day moves on the German DAX. He would look at price on a longer-term timeframe, before his entries and exits were made on a shorter-term timeframe.

His problem was that he would have a run of successful days before he suffered a catastrophic drawdown, with a total erosion of those profits from the previous few days, where he seemingly took an endless number of trades in a very short period of time. 

This cycle had repeated itself a number of times. He felt that there was a glass ceiling in terms of increasing his account balance and improving his trading performance. Obviously the key would be to eliminate those major ‘down days’. But what caused them?

So, to begin we conducted a review of his trading. To do this, he provided a copy of his trading journal and some chart screenshots, together with providing copies of his daily trading statements from his broker.

The main points which came out of this review process were as follows:

  • While he had some clear ideas about how he was trading, there was no trading plan which clearly defined his rules for determining entries and exits. 
  • As a result of this, he was sometimes too impatient in waiting for an appropriate signals as he was taking some entries based on a feeling or a visual interpretation. 
  • If he was waiting for an entry signal when price would break out of a consolidation area, he was entering at the right level, but his stop was placed within the consolidation area. This meant that he could easily suffer the frustration of being stopped out repeatedly from price 'noise' or whipsawing. 
  • Most interestingly, the large runs of losing trades were on days where the market he was trading was a ‘trend day’ i.e. the market moved pretty much in one direction the whole session. What we found was that he had either a) missed the initial entry at the start of that trend, or b) he took his profits far too early in that trend, for fear of seeing price reverse and losing those profits. 
  • In both of these scenarios, he then started taking trades against the trend of the day simply on the basis that he felt price had moved too far, and was now looking for the reversal. In other words, he was attempting to try and pick the extreme of the move without getting a clear entry signal based on his rules.  
  • Occasionally, he would increase his position size on these counter-trend trades in revenge. 
  • He was being subconsciously ruled by a desire to make a minimum level of profit each day.
Going through this, we identified that the overtrading primarily came about from those repeated losses suffered when he was trading against the day’s trend. 

In effect, he was self-sabotaging himself as a punishment for either missing the earlier trend signal, or for bailing out of a winning position far too early.

So, the plan was clear. He needed to:

  • clearly define his entry and exit rules so there was no ambiguity - this would help him avoid taking trades against the current price trend.
  • stay ‘in the moment of now’ – if price was still going in the direction he was trading, he would keep the position open until the price move had finished; 
  • avoid taking profits too early for fear of losing them; 
  • keep his risk per trade constant, and with ensuring his initial stop was placed correctly. 
He made a further change - to help him try and avoid the price 'chop' during quieter periods, he switched from using specific intra-day timeframes to using tick charts. Again, he would use higher number tick charts to identify the price direction, and lower value tick chart to time his entries and exits.

All in all, there was plenty to think about, but now he clearly understood what his issues were, and he had a clear plan in place.

To help him follow his ‘new’ plan, he would track his trades and any errors made. We would use a couple of simple spreadsheets to record what was going on:

The first was to simply add an extra column into his trading journal, so that he could clearly mark whether he performed the trade in accordance with his entry/exit rules, and his position size and stop placement. He would put an “X” in the column when he made an error, and a “O” in the column when was able to follow his rules. The idea was to make the chain of “O”’s as long as possible, similar to a paper chain. We wanted to make that paper chain as long as possible.

The second spreadsheet would effectively ‘drill down’ on those trades where he had marked a “X”.

On this sheet, he listed all the various types of errors he typically made on the left hand side, and then he would record an “X” against the relevant error every time he made it. He would also note the amount of losses or lost profits (in R) that the error generated. He could make up to 5 errors of the same type. Once he made the same error for a 5th time, then he would be required to close his trading platform down for the day. If the same error was repeated a 6th time, he would have to stop trading for the rest of the week – and so on. It was agreed that, if he committed the same error 10 times, he would close the account.

To give him some accountability for this, he agreed to forward copies of his spreadsheets and his trading statements so I could see what was going on. In this way, he could not fudge the results.

The final, crucial, element was that his wife became more involved. In the past, she hadn't been particularly encouraging and wondered why he bothered trading as he wasn't making any money. She agreed to become more interested in his progress and generally more supportive. She was fully aware of the process we put in place. For her, it was a win-win situation. If he couldn't stop making those errors, then he would eventually have to close the account. If he could, then he would be making money for them both.

Setting this process up meant that he was now focused on trading correctly, rather than trying to make money - and certainly not trying to make a minimum profit each day.

If you have a basic method which has a positive expectancy, then the profits will follow - providing you can trade in accordance with those rules, control your risk and avoid those mental errors.

We have been going through this process for a month now. He is still trading. He hasn’t committed the any of his typical trading errors 5 times. His profitable days are still profitable. He still has losing trades (lots of them!) and losing days, but they are now controlled. As a result, he has now been able to avoid those disastrous days where he tried to go against the trend and suffered repeated losses - simply by being forced to trade correctly. This has dramatically helped the compounding effect on his account.

As a happy by-product, his relationship with his wife has significantly improved too!

Humans are creatures of habit. In this particular case, we had to replace the previous bad habits with new, better ones. So the above process was a glorified version of the feedback loop:

  • We conducted a thorough review, identified the areas that needed changing, and put a clear plan in place;
  • He got some emotional support and encouragement from his wife;
  • We updated his trading journal and included creating a 'paper chain' of O's - this gave him a visual key to try and stick to - the longer the paper chain, the better he was trading;
  • Where he did make errors, he was keeping track of what errors he was making, and quantifying the effect on his performance;
  • We put a circuit breaker in place on his trading, so that if he carried on making those same errors he trading activity would be curtailed;
  • We introduced some accountability by having his performance and adherence to the revised plan reviewed by a third party.
  • He was concentrating on following his trading process, not the monetary outcome.
He now knows what works for him, and can see that by being patient and disciplined, his account is growing. He accepts that disciplined trading can be boring and repetitive - and profitable. He accepts that some days he won't make money or get any trading opportunities. He also knows the importance of recording his trades and keeping track of his errors. The good habits are taking hold and starting to become second nature. He is on his way to becoming a consistently profitable trader.


  1. Really nice, productive and real world example in identifying the problems and just as important providing cogent solutions. This trader showed he knew he had problems and reached out to correct them ... a telling sign that this trader is serious about improvement. These corrective actions will greatly increase his probability of success in improving his "R," thereby improving his confidence. These new processes will also keep him in the game until these new tools will become second hand nature. These specific posts are very insightful to all us as they are show reality and don't incessantly dabble in the theoretical (you provide balanced posts, it's good to have both) ... again, Well Done!

    1. Thank you Raven for your kind words. Yes he had the desire to improve, and was willing to make the necessary changes. A lot of people do not get to that stage - often people simply think it comes down to entries and exits, and don;t bother to think about how their emotions can affect their trading.

      So it's all credit to him - he was prepared to make the necessary changes AND he followed through on them!