Today marks the 3rd anniversary when I left a full time job and started trading. I have penned this article as a mini celebration.
Someone theorized if we reverse a terrible trading system (eg. one with a 20% winning probability) and buy when it signals to sell, we should have a very solid trading edge with an 80% win rate …… sorry to burst your bubble ….. no bacon here.
- Because the market is varied, an edge may work in one market condition but fail in others. The terrible system in question may actually run an impressive win rate under the appropriate market conditions.
- Generally I categorize market conditions into 2 groups - 1) whether the price is in trend, range or indeterminate, and 2) how price behaves inside the trend /range eg. wild price swings, normal tempered price movements with nice swing highs and swing lows, or fast paced momentum.
- So the first pre-requisite to good trading – the trader must match the correct edge to the correct market condition. (The internet has trading strategies galore – many are good strategies and can be profitable when relevantly applied to the right market environment.)
- Second – money management is critical – Ralph Vince and others proved clearly that without good money management, one can still lose money even with a strong edge. (Refer to previous blog post No money management = Gambling.)
- Third , trade management is equally important. The market often swings a trader out before running to the trader’s original intent. How can a trader avoid or minimize the damage from such whimsical moves? That is a crucial part of trade management. When to add to a position, when to reduce a position (eg .take profit , take a loss), how to enter a trade (graduated multiple entries/exits, when to use a single lumped entry/exit), how far or near to put a stop, when to use a dynamic stop, when to use a hard stop, how to take profits at what levels. How much can one bear? What is the reward risk ratio? Is it advantageous to scalp a pair given a certain spread and trading costs? Trade management is really multiple scenario management after a trade is executed. It is closely tied to the edge and tells the trader how good it is if various scenarios arise – and must be done before entering the trade.
These are 3 pivotal points of how I trade. Of course, there are other factors (eg. psychology), and the internet is full of similar advice. But look again, if you have clear, defined rules in these 3 areas, your trading would be much calmer, more rewarding, and hopefully enjoyable.