The expectancy gap and performance leaks

When trading, you are free to construct your own methodology and set of rules to use - what markets to trade, triggers for entries and exits, how much equity to risk etc. That's the easy part.
 
For the majority of us, the difficult bit is ensuring you keep operating within that framework.

Building your own approach to the markets and the decisions and actions you take are entirely within your own control. But you have no control over what the markets do. Ideally, you want to react to the market's price movements, and trade within the confines of your carefully constructed framework.

Do you have what it takes?

Last month I had the pleasure of catching up with a trader I have known for a few years now, and mentored for a while. We talked for a couple of hours about trading in general, as well as how he has continued to develop himself as a trader. He is now trading full-time and has developed his own method (more of a swing-based style) which he is trading profitably.

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:

Creating good trading habits

Being successful as a trader over the long-term involves being consistent in your approach. This means creating a pattern of good habits that you can repeat.

Losing traders may be using an approach that has a positive expectancy, but they are not getting the results that they should - this can be down to poor execution, poor preparation, or making emotional, irrational decisions, as well as other factors.

What you can learn from Seve Ballesteros

Ballesteros on the 12th tee, Augusta 1980

In 1980 Severiano Ballesteros won his first US Masters by 4 shots. At one point in the final round he was a mammoth 10 strokes clear of the field. If some people thought his win in the Open Championship the previous year was a fluke, this announced his arrival as a world star.

In his book Natural Golf, Ballesteros talked about the aftermath of that success and how it actually had a detrimental effect on his game for a time:

Trend following, unrealistic expectations and a look into a fund's performance

Some people have unrealistic expectations when it comes to trend following - and trading in general, for that matter. 

I remember a trader contacted me once about some mentoring and essentially was looking for some assurance that, if he adopted a trend following approach, he would be able to make a +100% return over the next year.

Trading in the Zone - and some recent setups

While away for a recent holiday my reading material consisted of two classics by Mark Douglas - The Disciplined Trader and Trading in the Zone. For many Trading in the Zone this is the book that brought trading psychology to the masses.

Trading and the One Minute Manager

I've talked in the past about how I read books not necessarily related to trading, which can help you - one such example was Dale Carnegie's How to Stop Worrying and Start Living, which I wrote about here.

Another such book is The One Minute Manager. Originally published in the early 1980's, it became a business classic with over 15 million copies sold. Updated last year, can the The New One Minute Manager help your trading?

Lets look at the three 'secrets' discussed in the book:

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.

Spinning your wheel(s)

A few weeks back, I spoke to a trend follower who had been experiencing a frustrating period in the market. This particular individual previously worked in the City of London and has a strong regard for good risk control.

Working on yourself

In my previous post, I talked about ensuring you take action, after having a clear plan in place. 

But, for many, this is where any psychological issues start to rear their head, as you start to implement your plan with real money at risk in the market.

Most people solely focus on trying to develop a method that can generate profits from the markets. But, how many market participants do you know who spend just as much time (if not more) working on themselves?

2015 review - and an interesting question

Having now brought all my trading records up to date, and with no positions currently open, returns for 2015 total +36.82%. This equates to just over +16R. The full results are shown here, with the associated charts and graphs here.

In summary, the win rate has dropped a bit, but the profit factor (expressed in terms of R) has continued to increase, so that currently the average size of my winning trades is more than 5.2 times bigger than the average size of my losing trades.

An example of a failed setup

I recently posted a potential long setup which appeared on the Dow (see here for more). With last week's price action, this setup has now been invalidated.

As we can see, price has started moving in the opposite direction to that I was looking to trade, coupled with a sharp jump in the 2ATR volatility measurement.

This type of setup failure has also occurred on a large number of long setups on individual stocks. While the setups originally identified may appeal and meet all my criteria, a lot of them never trigger an entry.

One year on - have the changes worked?

"The great thing about being a trader is that you can always do a much better job. No matter how successful you are, you know how many times you screw up. Most people, in most careers, are busy trying to cover up their mistakes. As a trader, you are forced to confront your mistakes because the numbers don't lie." - Marty Schwartz

It is about a year since I start making some changes to my own trading approach. This followed a poor run of losing trades over several months which eroded most of the gains I had made in the first part of 2014. So, did those changes work?

The mathematical side of trading

When most people talk about how they approach the market, they refer solely to their style of trading.

In my own case, I follow price trends - I wait for a potential new trend to be signalled, and I will then 'hop on' for the ride.

However, there is another important factor you should consider, which is all to do with the mathematical side of trading.

Three year performance review

The end of June marks the completion of the third year since I changed my stop rules back in the summer of 2012. The results achieved I think speak for themselves - despite getting into winning trades only a third of a time, and enduring a horrible run of losing trades last year the annualised return over the three years equates to just under 80%.

Make your goals process related

A lot of traders talk about having written goals they work towards, and in the main this is good advice. One thing I would avoid however is making these goals financially based, or to give them a specific time limit.

One thing traders have to accept is that you cannot force the market into anything. If you are utilising a trading approach that has a positive expectancy, then you can only take what the markets are prepared to give. There will be periods where your approach works better than others. You have to accept that.

The Pareto Principle

In the early 1900's, Italian economist Vilfredo Pareto created a mathematical formula to describe the unequal distribution of wealth in his country, observing that twenty percent of the people owned eighty percent of the wealth. Since then, this basic principle has been applied to many aspects of life, business, management etc.

I even unknowingly referred to this principle in my e-book, in which I stated the belief that 80% of all trades taken would cancel each other out - small losses and small losses. It was the remaining 20% of the trades that generated the overall profit.

Turtle talk - Howard Seidler

Howard Seidler was one of the famed 'Turtle Traders' taught by Richard Dennis and William Eckhardt in the 1980's. Today, Seidler runs Saxon Investment Corporation, and has been consistently successful in the markets for over 20 years.

Below are some nuggets from his interview with Jack Schwager in the New Market Wizards: