Sunday, December 24, 2017

From theory to practice - marching to your own beat

Yesterday I was asked an interesting question by an aspiring trader based in India who I have corresponded with for several months. I know he has eagerly been collating a lot of knowledge and information from a number of traders and resources over this period of time. Now he was basically asking me:

"How can I put all my trading knowledge into practice?"

The answer to this is a simple step-by-step process, which can be used by anyone in a similar position:

Whether they were formulated before you started asking questions of others, or were influenced by the answers and information obtained, you will have developed your own basic beliefs or ideas about how you can make money in the markets. 

These may relate to the basic concept (trend following, support and resistance, price action etc.), your preferred timeframe based on your own work and family commitments, and the level of capital you have available to trade.

This may ultimately mean that the majority of information you may have collated can be dispensed with as it could be irrelevant to your chosen path. For example, someone who tries to identify turning points in the markets would use different elements or philosophies compared to a pure trend follower.

From there, you formulate a plan designed around those beliefs, and a series of rules to 'formulate' your approach. These will include how you will determine your level of risk, what markets to trade, how you will get in and out of positions, as well as determining any portfolio heat thresholds.

Then comes the step of taking this from theory into practice, and actually interacting with the markets using your approach over a meaningful sample of trades. This will where the psychological elements of trading will kick in, and start to directly affect actual performance achieved, giving a comparison to theoretical performance (this is what I refer to as 'the expectancy gap').

It is also critical that in this phase you do not make any changes until the sample is complete, and hopefully the sample will cover different market phases or states - trending or non-trending, stable or volatile. Ideally you want your chosen approach to be as robust as possible, or at a absolute minimum you need to be able to identify those market states where conditions are not favourable towards your own method.

From there, it is a question of reviewing the results which should be maintained in a trading diary or log, not just in terms of the performance achieved and the relevant metrics, but also how well he was able to follow your rules, and the emotional ups and downs you have experienced.

That will give you the information needed to identify what areas need work, and you can formulate a plan of necessary improvements.

You then go all the above steps again, and again...

It is my belief that this is type of feedback loop is one that all traders should adopt and use. You are always evolving as a person and a trader, and the markets frequently go through changes in state. You are always learning. 

And as you progress through the months and years, you may find that your core beliefs may change too, which will mean further revisions are required.

The end result we all strive for is a method that generates a positive expectancy, and can be followed without question and with discipline. 

Crucially, by following this process you will also end up with a method tailored to you, your beliefs, your strengths and weaknesses, and your personality.

And this should have the happy by-product that you do not need to rely on the opinions, predictions, market calls  or signals of others. You will march to your own beat with confidence.

Now, the above process itself takes discipline and work. And, for some, it will be too much. They would rather take the easy route, and look to follow someone else and their signals - partly so that if they lose money, they can blame someone else. But if you can do the above, the potential rewards are massive.

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