Survival Tips
Before I go into the particular markets, I would like to start off with a few things people who are just starting to trade (or getting your feet wet) should get into first.
1. Discipline
This sounds like something your headmaster/ drill sergeant would say. However so, I believe this is necessary for survival in anyplace. Without it, the best plans will be meaningless as impulse and reaction take over in the heat of the situation.
It is true that a vast majority of Day/ Retail traders will end off under the line (studies show anything from 70-80%). Shocking isn't it? (That is the basis for some trading signals that utilise information on where most of the market is positioned through the COT report and trade against that.)
The underlying issue isn't for the lack of a risk management plan but the trader's inability to follow that plan. Read on for an example I think we all can identify with at some point in our investment journey.
(Case Study)
A trader goes long in Security A at a level that sees pretty good support over the last 52 weeks or 3 months (Depending on the volatility and nature of the market) someone says; does something the market does not like, or some nutter decides to sell off a position the depth of the market isn't able to digest causing a steep nose-dive.
The initial thing that goes through most trader's minds would be one of the 2 or a variation of either. It will not detract from the gist of either.
a) Markets bounce; the support is good; the position will come good. I'll hang on to it and lower my stop.
b) This is just intra-day volatility and the market should correct itself. I believe this is a buying opportunity so I'm going to average down my entry price.
One of the 2 scenarios can happen.
Scenario 1:
The market does in fact go through mean reversion and recovers. Trader a) goes on to make money ; Trader b) makes a lot more from the averaged down entry point and vastly larger exposure. Both traders have just been rewarded for doing well in the gambit.
Scenario 2:
What was said alters some fundamental points that was used in forming the expected value of the security; the large sell off was executed by someone who has seen something the rest of the market had missed (i.e. buying into a price bubble with unrealistic valuations derived from faulty fundamental assumptions built into the expected price.) Both traders would have been adversely affected. The first trader would have lost more than had he allowed the stop to trigger. The second trader would have lost a lot more given the larger (averaged down) position and may even have gotten his trades pulled by his brokerage for having failed to meet the margin call in a timely fashion.
The point here is, by the time typical traders really know what is happening, the market has moved against them. Most are either unwilling to crystallise what they think is a paper loss and try to weather the storm hoping for scenario 1 or they just fold by letting the brokerage pull that position. The result for both is that they lose a large chunk of their account with that one gamble. If they had followed their risk management regimen, they would have taken that loss that will not disable them ensuring that they still have a viable account to re-enter the market when it turns in their favour.
2. Risk Management
Traders hate getting their stops triggered (Some traders use stops to initiate a position so... this does not refer to those guys) due to the effect that has on their P&L. Yes. It can be a painful experience.
Point is, Stop orders aren't the ONLY tool in the tool box you can use to manage your risk.
Before I get deeper into this, lets identify what this risk is and what it does to a trader's psyche.
An old saying "Scared money won't make money" - Translated, If you are losing sleep over the exposure you have on the market, the tendency for the trader is to take profits early and losses late. Such a trader can be right 90% of the time but if he's taking just 10-20 points in profit but taking 40-100 points in losses, he won't have an account to trade with before long.
The exposure is a trader's risk. What makes a trader sweat isn't the fact that they have a position but it is the potential dent in their account if they are wrong given the size of the position they have got running.
Eliminating risk isn't the point of risk management. It is the control over the size of the P&L event when things do go wrong that exemplifies the effect of good risk management. One is expected to implement the regime through control over the size of a position and the pip cost of a stop getting triggered for a position.This minimises the scariness of losing a position and hence not feel the pressure to "get out of it while the going is good". Such traders are more inclined to let the gains run and stop losses when they need to.
Trade sizing is something I recommend you use in addition to the application of stop levels.What made The Turtles Trading Rules a success was not their suite of indicators but their trade sizing. It is the lynch pin to how the Turtles became such a success.
The typical rule of thumb is not to risk more than 2% of your trading account. There are a number of calculators out there you can use. All the calculators does is identify the size of your trade you should be making considering the given pip cost, the number of points you would like to put the stop from your entry point for the security in question. You can choose a different percentage to match your risk appetite on these calculators.
I hope the above will help you in your trading if you are just starting out and looking to understand how some people simply shrug losing trades off.
Feel free to direct your queries and concerns to me via E-mail if you have them and if you feel how these tips do not apply to your market, I will like to hear from you.
Charles JD Lim, CAIA
1. Discipline
This sounds like something your headmaster/ drill sergeant would say. However so, I believe this is necessary for survival in anyplace. Without it, the best plans will be meaningless as impulse and reaction take over in the heat of the situation.
It is true that a vast majority of Day/ Retail traders will end off under the line (studies show anything from 70-80%). Shocking isn't it? (That is the basis for some trading signals that utilise information on where most of the market is positioned through the COT report and trade against that.)
The underlying issue isn't for the lack of a risk management plan but the trader's inability to follow that plan. Read on for an example I think we all can identify with at some point in our investment journey.
(Case Study)
A trader goes long in Security A at a level that sees pretty good support over the last 52 weeks or 3 months (Depending on the volatility and nature of the market) someone says; does something the market does not like, or some nutter decides to sell off a position the depth of the market isn't able to digest causing a steep nose-dive.
The initial thing that goes through most trader's minds would be one of the 2 or a variation of either. It will not detract from the gist of either.
a) Markets bounce; the support is good; the position will come good. I'll hang on to it and lower my stop.
b) This is just intra-day volatility and the market should correct itself. I believe this is a buying opportunity so I'm going to average down my entry price.
One of the 2 scenarios can happen.
Scenario 1:
The market does in fact go through mean reversion and recovers. Trader a) goes on to make money ; Trader b) makes a lot more from the averaged down entry point and vastly larger exposure. Both traders have just been rewarded for doing well in the gambit.
Scenario 2:
What was said alters some fundamental points that was used in forming the expected value of the security; the large sell off was executed by someone who has seen something the rest of the market had missed (i.e. buying into a price bubble with unrealistic valuations derived from faulty fundamental assumptions built into the expected price.) Both traders would have been adversely affected. The first trader would have lost more than had he allowed the stop to trigger. The second trader would have lost a lot more given the larger (averaged down) position and may even have gotten his trades pulled by his brokerage for having failed to meet the margin call in a timely fashion.
The point here is, by the time typical traders really know what is happening, the market has moved against them. Most are either unwilling to crystallise what they think is a paper loss and try to weather the storm hoping for scenario 1 or they just fold by letting the brokerage pull that position. The result for both is that they lose a large chunk of their account with that one gamble. If they had followed their risk management regimen, they would have taken that loss that will not disable them ensuring that they still have a viable account to re-enter the market when it turns in their favour.
2. Risk Management
Traders hate getting their stops triggered (Some traders use stops to initiate a position so... this does not refer to those guys) due to the effect that has on their P&L. Yes. It can be a painful experience.
Point is, Stop orders aren't the ONLY tool in the tool box you can use to manage your risk.
Before I get deeper into this, lets identify what this risk is and what it does to a trader's psyche.
An old saying "Scared money won't make money" - Translated, If you are losing sleep over the exposure you have on the market, the tendency for the trader is to take profits early and losses late. Such a trader can be right 90% of the time but if he's taking just 10-20 points in profit but taking 40-100 points in losses, he won't have an account to trade with before long.
The exposure is a trader's risk. What makes a trader sweat isn't the fact that they have a position but it is the potential dent in their account if they are wrong given the size of the position they have got running.
Eliminating risk isn't the point of risk management. It is the control over the size of the P&L event when things do go wrong that exemplifies the effect of good risk management. One is expected to implement the regime through control over the size of a position and the pip cost of a stop getting triggered for a position.This minimises the scariness of losing a position and hence not feel the pressure to "get out of it while the going is good". Such traders are more inclined to let the gains run and stop losses when they need to.
Trade sizing is something I recommend you use in addition to the application of stop levels.What made The Turtles Trading Rules a success was not their suite of indicators but their trade sizing. It is the lynch pin to how the Turtles became such a success.
The typical rule of thumb is not to risk more than 2% of your trading account. There are a number of calculators out there you can use. All the calculators does is identify the size of your trade you should be making considering the given pip cost, the number of points you would like to put the stop from your entry point for the security in question. You can choose a different percentage to match your risk appetite on these calculators.
I hope the above will help you in your trading if you are just starting out and looking to understand how some people simply shrug losing trades off.
Feel free to direct your queries and concerns to me via E-mail if you have them and if you feel how these tips do not apply to your market, I will like to hear from you.
Charles JD Lim, CAIA
