Seven trading lessons from the school of hard knocks

#1. Always use a stop

Trading is timing. Just like sports. When you are wrong footed in tennis you don’t stand in your corner hoping that the ball will somehow come back so you can hit another volley. Same when you miss a kick in soccer,  a throw in football or a hit in baseball or cricket. You take the loss and move on. 

If you want to stay in the game,  in trading you need to follow the exact same ironclad rules as you do in sports. For example if I trade on MetaTrader my execution scripts  have stops and targets built-in. If I trade on TradingView I use custom made AutoHotKey scripts to do the same thing. If I trade equities I always use diagonal option spreads to express my view because that way the stops are embedded into the strategy. And if I am trading from my phone, I always set the stop right after I enter the trade  then worry about setting exits next.

#2 Always have a plan

Sports are well defined games with a specific set of rules and you know in any sport what you are going to do next once you miss. In trading many people are lost when they are stopped out because they have no plan for what to do next. 

I was only able to consistently respect stops once I figured out what I will do next in case of a stop out. Only then did my action become nearly automatic.

Instead of hoping that your trade is a winner, assume it will be a loser and ask yourself - what will I do then? Will I look for the same setup again? Will I move the setup to a different time frame? Will I use a different size? Will I widen my targets and stops? Regardless of what yo do always, always have a plan and then execute that plan. This way you won’t be wallowing in self pity of "woudda-coudda-shoudda"  but will be looking forward to what comes next.

#3 Have confidence in the setup and let the details evolve

It doesn’t matter if you trade trend or fade trend. You need to have confidence in your broad setup and stop obsessively tweaking the strategy  before trading it. K is a continuation trader and has been trading Zip for years. Her entry criteria are pretty much set in stone, but she is merciless on any trade that moves even a few pips against her. Therefore her stops and targets are very fluid. I trade reversals all day long with Bounce but I am ironclad in my attitude towards exits. I always wait for the stop and target to hit. Even if the trade comes within a 1/10th of a pip of the target and then reverses and stops me out I will reenter on the next setup and do the exact same thing because that is the only way that the math of my set up works.

Why do K and I  trade so differently? Real market experience. We both have the ultimate confidence in our entry signals but have learned through countless hours of trial and error what exits work best for each of us. That information cannot be determined a priori. That’s why all backtests fail. You have to let the details evolve.

#4 Only ultra-low or ultra high Leverage

If you are actively speculating on margin then I don’t think there is any middle ground. You either trade like an insurance company and start with ultra low margin size so that you are able to absorb large losses and achieve a very high win/loss ratio (lots of small wins and one or two large losses) or you trade like the lottery taking highly leveraged bets hoping that you will get lucky and hit a long winning streak. (Side note - every single  trading contest winner employs the lottery strategy - that is why you never see any of them repeat the feat more than one or two times in row).

Regardless of how you trade you need to know the rules before you start. Want to triple your account in a couple of months? Then trade high leverage and be prepared to lose all your money at least once or twice.  Want to eke out profits almost every day? Then trade with ultra low leverage and aim for a few basis points per trade.

Those are your only two choices. Everything in the middle will just drain your money without any results. (Note - the operative word here is ACTIVE TRADING. If you are doing 3 or 4 trades per month, I am not talking to you)

#5 Be a traveler not a tourist

The great Anthony Bourdain who made so many wonderful travel documentaries, used to always say, “Be a traveler not a tourist”. What he meant was - get dirty. Don’t just follow the well worn paths of the guidebooks. Wander off on your own, explore the land, try out the food, talk to the locals. Make the journey your own.

Trading is very much the same way. We are all taught the same well known trading strategies. Never follow them blindly.  The most successful traders in our room always modify both K’s and my ideas to make them their own. Every strategy is just a recipe. You need to adapt to your taste to truly enjoy it for life.

#6 Measure your performance at least one period forward

If you are day trading, never ask yourself - how did I do today? Rather, evaluate your weekly results. If you are swing trading, look at your quarterly results, not your monthly P/L. If you are investing - measure yourself in 3 year blocks of time. 

My day trading became markedly better when I started to set weekly targets rather than daily goals which helped me to take the daily losses in stride. The more you move away from your immediate time frame the more you’ll be able to escape the recency bias ameliorating the manic/depressive cycle that affects us all.

The game is not about today, or tomorrow or even next year. The game is about succeeding in trading for life.

#7 One pip makes a big difference

If you are an active trader it’s amazing to realize the power of just one pip. If you do at least ten trades a day that’s about 2500 trades per year. If you can extend your profit target just by one pip more you’ve now made 25% extra on your account on an unlevered basis. Of course that’s utterly unrealistic because the example assumes that every trade is a winner, but the bigger point still stands. Tiny improvements can yield massive performance differences if they are compounded over time. $100,000 at 10% compounds to about $250,000 in 10 years, but manage to squeeze just one pip more and add 5% per annum to that return and now your end result is $400,000. That’s no chump change from just a teeny, wheeny, tiny improvement in execution.