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Your questions -My answers

questionandanswerThe Cardinal Sin Of Trading

Q:  Do you believe in the rule of not letting a winning position turn into a loser? If you do, how do you handle a situation where a stop out at the ATR would cause you to take a loss on a position that was a winner at one time?

A:  This has been called the cardinal sin of trading – to let a profitable position turn into a loser. But, it happens. And, just because it does happen, doesn’t mean that it provides you with an excuse not to take your medicine and own the loss.

When we are wrong and we do have a good trade go against us, our top priority remains capital preservation. Therefore, if when painful, we cannot let a small loss grow into a larger one. The worst thing in the world is letting a bad trade turn into an investment and being held hostage by the break-even curve. That’s why stops are important and why sticking to them, even if it requires you to exit with a loss, is mandatory.

Buy The Dippers

Q:  You sometimes refer to the “buy the dippers” in a what seems to me to be a negative tone and yet you also describe part of your style as buying on pullbacks. How do you distinguish these two ideas?

A:  That’s funny you mention this and I appreciate it especially as you say I fall well within the “buy the dip” camp. I have no problem with the buy the dippers as long as they’re present and in charge of the tape, we’ll be just fine. But, the problem is, of course, that if every dip gets bought, at some point Mr. Market will figure out a way to roll back that trade and gain back some respect for his ability to cause the most amount of frustration to the majority. This will ultimately lay the foundation for a nasty bull trap scenario where everyone is long at the wrong time and then caught with their pants down in a sizable reversal. In my experience, when any trade becomes a routine money-maker, you have to expect the market to throw you a monkey wrench. There’s no room for complacency and whenever I have something that works like clockwork and others have figured out the same, I get nervous.

Step by step…

1. Create a clear, concise method that will serve you to find trading ideas. A method consist of simple to implement consecutive steps based on market anomalies. A method should be derived from your trading goals and it always incorporates in itself money management techniques for capital preservation.

2. Use those trading ideas to create a plan of action.

3. A plan of action usually consists of two or more scenarios. For example if X happens, I will go with trading idea A; if Y happens, I will go with trading idea B. We create different scenarious, because we can’t control the market. We forecast what might happen and plan how we will react if certain event or a process happens.

Having a clear method helps you to be consistent and disciplined in finding new trading ideas. Creating a plan helps you to profit from your trading ideas. It assist you to focus on your goals.

Money-Mind-Method

Mind: The key to winning is inside the Mind. As Master of your mind, you have to manage and understand your emotions very well. It is extremely important to understand not just the individual’s psychology, but also the crowd psychology of the markets. To become a successful trader, you must have sheer perseverance and discipline.

Method: There is no Holy Grail in the search for the perfect method to trade. Follow the wisdom of ‘Plan your Trade and Trade your Plan’. A good trading plan should cover your entry, exit and position sizing requirements. My method consists of discretionary trading techniques that combine both fundamental and technical analysis, in addition to my own proprietary automated trading system. Coming up with a good trading plan requires lots of market experience, as you modify, conquer and solidify your trading techniques. Don’t be duped by charming salesmen selling get-rich-quick-without-effort secret recipes. 

Money: Overall profit/loss depends on money management. The first goal of money management is capital preservation. If you lose 10% of your capital, you have to make 11% just to break even. If you lose 40%, you need to make 67%, and if you lose 50%, guess what? You have to make 100% just to recover! So before you think about making big money, first you got to think about not risking your capital unnecessarily. Money management is too important to be overlooked.

Trader Vic’s Principles of Trading

It’s a helpful book to return to when market conditions get tough. A great place to start is Vic’s “business philosophy,” as encapsulated in three rules:

1. Preservation of Capital

2. Consistent Profitability

3. Superior Returns

Below is Sperandeo in his own words:

Preservation of Capital

Preservation of capital is the cornerstone of my business philosophy. This means that, in considering any potential market involvement, risk is my prime concern. Before asking, “What personal profit can I realize?”, I first ask, “What potential loss can I suffer?” (more…)

Cut Losses Short

Cut losses short is the sister rule to the let profit run, and is usually just as difficult to implement. In the same way that profitability comes from a few large winning trades, capital preservation comes from avoiding the few large losers that the market will toss your way each year. Setting a maximum loss point before you enter the trade so you know before-hand approximately how much you are risking on this particular position is relatively straightforward. You simply need to have a exit price that says to you this trade is a loser and I will exit before it gets any bigger. Due to gaps at the open, or limit moves in futures we can never be 100%
certain that we can get out with our maximum loss, but simply having the rules, and always sticking to it will save us from the nasty trades that just keep on going and going against our position until we have lost more than many winning trades can make back.

If you have a losing position that is at you maximum loss point, just get out. Do not hope that it will turn around. Given that trades are either winners or losers, and this one is shouting Loser at you, the chances that it will turn around and become a large winner is tiny. Why risk any more money on this losing trade, when you could simply close it out (accept the loss) and move on. This will leave you in a much better place financially and mentally, than holding the position and hoping it will go back your way. Even if it did do this, the mental energy and negative feelings from holding the losing position are not worth it. Always stick to your rules and exit a position if it hits your stop point.

Lessons from the Wizards

3994One of the first books I read in this business oh-so many years ago was Stock Market Wizards. It had a profound impact on my thinking about trading, psychology, risk, capital preservation, etc.

  1. All successful traders use methods that suit their personality; You are neither Waren Buffett nor George Soros nor Jesse Livermore; Don’t assume you can trade like them.  
  2. What the market does is beyond your control; Your reaction to the market, however, is not beyond your control. Indeed, its the ONLY thing you can control.

    To be a winner, you have to be willing to take a loss

  3.  HOPE is not a word in the winning Trader’s vocabulary;

  4.  When you are on a losing streak — and you will eventually find yourself on one — reduce your position size;

  5.  Don’t underestimate the time it takes to succeed as a trader — it takes 10 years to become very good at anything

  6.  Trading is a vocation — not a hobby (more…)

Three Trading Wisdom

Preservation of Capital

Preservation of capital is the cornerstone of my business philosophy. This means that, in considering any potential market involvement, risk is my prime concern. Before asking, “What personal profit can I realize?”, I first ask, “What potential loss can I suffer?”
…There is one, and only one, valid question for an investor to ask: “Have I made money?” The best insurance that the answer will always be “Yes!” is to consistently speculate or invest only when the odds are decidedly in your favor, which means keeping risk at a minimum.

Consistent Profitability

Obviously, the markets aren’t always at or near tops or bottoms. Generally speaking, a good speculator or investor should be able to capture between 60 and 80% of the long-term price trend (whether up or down) between bull market tops and bear market bottoms in any market. This is the period when the focus should be on making consistent profits with low risk.
…Anyone who enters the financial markets expecting to be right on most of their trades is in for a rude awakening. If you think about it, it’s a lot like hitting a baseball — the best players only get hits 30 to 40% of the time. But a good player knows that the hits usually help a lot more than the strikeouts hurt. The reward is greater than the risk.

Pursuit of Superior Returns

As profits accrue, I apply the same reasoning but take the process a step further to the pursuit of superior returns. If, and only if, a level of profits exists to justify aggressive risk, then I will take on a higher risk to produce greater percentage returns on capital. This does not mean that I change my risk/reward criteria; it means that I increase the size of my positions.

Step by step…

1. Create a clear, concise method that will serve you to find trading ideas. A method consist of simple to implement consecutive steps based on market anomalies. A method should be derived from your trading goals and it always incorporates in itself money management techniques for capital preservation.

2. Use those trading ideas to create a plan of action.

3. A plan of action usually consists of two or more scenarios. For example if X happens, I will go with trading idea A; if Y happens, I will go with trading idea B. We create different scenarious, because we can’t control the market. We forecast what might happen and plan how we will react if certain event or a process happens.

Having a clear method helps you to be consistent and disciplined in finding new trading ideas. Creating a plan helps you to profit from your trading ideas. It assist you to focus on your goals.

Lessons From The Wizards

One of the first books I read in this business oh-so many years ago was Stock Market Wizards. It had a profound impact on my thinking about trading, psychology, risk, capital preservation, etc.

Sometime ago, I came across a good discussion of the lessons from the book at Simply Options Trading. What follows is my edited adaptation of those rules he derived from Stock Market Wizards:

  1. All successful traders use methods that suit their personality; You are neither Waren Buffett nor George Soros nor Jesse Livermore; Don’t assume you can trade like them.

 What the market does is beyond your control; Your reaction to the market, however, is not beyond your control. Indeed, its the ONLY thing you can control.

 To be a winner, you have to be willing to take a loss; (The Stop-Loss Breakdown)

 HOPE is not a word in the winning Trader’s vocabulary;

 When you are on a losing streak — and you will eventually find yourself on one — reduce your position size;

 Don’t underestimate the time it takes to succeed as a trader — it takes 10 years to become very good at anything; (There Are No Shortcuts)

 Trading is a vocation — not a hobby (more…)

Courage

Not all traders have the courage to stand up to their actions. It takes a lot of courage to deal with the fears a trader must overcome in his career. The first is the fear of success that is so common and is the most prevalent. We want success and are afraid of it at the same time too. As our account grows so does the fear of handling those amounts of money. Could you trade risking a bigger amount as the account grows? Sometimes we sabotage our own success as it puts us out of our comfort zone. Another aspect of the fear of success is the subconscious fear of not being able to sustain that success. Our ego is questioning our ability to avoid messing up and losing that prized status of a hero. Same holds true for a windfall success. We know we might be able to do it again but our ego says we will look bad if we cannot do it again. Professional Traders have developed the ability to methodically achieve success and the confidence to repeat it while reducing the odds of sabotaging themselves via their egos. Professional Traders know that trading is boring and is not full of fun and excitement. That is why they have the courage to give up the fun and excitement in exchange for trading capital preservation. They also have the courage to not become addicted to winning big all the time. They know there will be singles, doubles and losers along the way too. They have the courage to stay on the sidelines at times and miss trading opportunities. They also know when to get out of a trade bravely and have the courage to ask for help when needed. They have the courage to stick to their strategy, ask dumb questions, admit it when they are wrong and finally have the courage to trade for profit and not for pure excitement.

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