The lesson here is straightforward. Trade less frequently and trade smaller than you think you should.
Of these two, trading smaller size is easier to grasp and much more intuitive. If you are risking less, then your P&L won’t swing as wildly, allowing you to stay more level-headed and to make better decisions without getting scared or euphoric. You also are unlikely to lose as much during a bad run, allowing you to sidestep potential catastrophic losses and to stay in the game, both financial and psychologically. Ultimately, it’s steep drawdowns that end careers. If you can avoid big declines In your equity and be in the right place psychologically to bounce back, then you will have a long and successful career.
But trading less frequently is equally important. By making it a priority to trade less frequently, you are making sure that you think harder and deliberate before entering and exiting a position. This allows you to focus on executing your methodology, rather just impulsively leaping into and out of positions. That should boost the quality of each trade and in turn, your overall success.
You are also making sure that you are picking your spots, thereby boosting the percentage of your trades that are winners. Even a small increase in your win rate, e.g. from 40% to 43%, would mean a measurable improvement in profitability. Having more winners, and having those extra winners generate bigger gains on average than the losers, can mean the difference between a so-so year and a great year.
The reason I bring this up was to share with you two reactions I got when describing these recent trades and cash holdings. I had two separate conversations in July — one with a well known Trader, the other with a Fund Manager (known in the industry, but not a household name) — about our posture prior to yesterday’s drop.
This is a good one and something we can all learn from both when making good and bad trades. If you can delay your emotional celebrations or harsh criticisms after the trading day (or trading week) is over, that’s to your own advantage. Far too often traders fall trap to what I call “trading on tilt” where they try to wreak revenge on the market by making more bad trades after the first bad one to get back to even. In addition, if you’re doing really well and making great trades, put your guard up. It is true that the times we are most vulnerable to catastrophic losses usually follow the times we’ve experienced a very hot hand and have convinced ourselves that everything we touch turns to gold.
Understand the various scenarios that the market may present you and then plan your actions for each of them. That is preparation, not prediction. Prediction tends to bind you to one point of view because when that doesn’t come true, you don’t know what to do.