The four pillars for trading success
We all wish trading came naturally to us; after all that would’ve meant saving countless hours, (a lot of) money, friendships that were broken after having a shitty day in the market
Oh and these reflect my personal views and experiences, I am sure you could argue for something different
What are those four pillars?
(Wish their was like a way to drop a curtain or something)
- Risk Management
- Trading Edge
Let’s break these four pillars into a section each:
Trading is difficult. Like any other skill it will take time to master, the only way to through the deep water is to preserver, if you haven’t given up you haven’t failed.
As long as you get back up after being pushed back down there is still hope.
That being said, having fallen off (many) horses it does take persistence to get back up on the horse, the same goes with trading, there will be losses, there will be mistakes, but there is a need to continually get back up and get ready for another try.
There is also an undeniable need to spend countless hours in front of charts in order to develop and test an edge and persist until we feel comfortable with our own strategy
Trading is all about survival, protecting the assets we have, making them grow, without getting killed. Keep that in mind.
This point is rather straight forward so there’s no real value spending too much time dealing with it, we are left with
- Risk Management
- Trading Edge
Risk management is probably the first subject new trades should look into, we can break it down into two topics: protecting the initial capital and an understanding of probabilities.
Protecting the initial capital
One of the best ways to screw up your psychology and give up is by taking huge losses that will destroy the size of the trading account
In order to protect the initial capital, it is key for traders to understand how to size their positions and (ideally) maintain a constant risk profile.
Why is it so important to avoid large losses?
If a single trade isn’t properly sized, it is possible for a trading account to be blown – by that I do mean, it is possible with one trade to lose all the money (and potentially more) you have in the trading account…
Let’s dive into “smaller losses”:
A 10% loss requires you to make 11% back in order to get back to the starting point, which when we think about it, isn’t that bad, it could be worse… However, if you take a 50% loss then you will need to double your account in order to bring it back up to the starting size…
Yep…. Here’s the example:
10,000+10,000*(-0.5) = 5,000
(Mainly wanted to show the benefits of getting a university degree, I can do maths now 😊)
The key lesson here is:
MAKE SURE YOU DON’T SCREW UP THE POSITION SIZE
The likelihood of you preserving and not screwing up your mental game after such a loss is extremely low so… If you want to have a career in trading, make sure you size your positions correctly.
Now this one may seem a bit more obvious, but over many discussions I’ve realized it may not be the case
There will be winning trades, but there will also be losing trades, this is a given, anyone that promises you a 100% strike rate is either into high frequency trading (and works at a huge fund) or is trying to get your money, and the likelihood of the second far outweighs the first…
Now it’s let’s dig into why I think it is key to understand your trading edge and your numbers (more on that afterwards)
If you are a trader you may have a 45% strike rate (it is possible to be profitable with a lower strike rate, as it is possible to be a consistently bankrupt trader with a higher strike rate)
As you can see on the following image, you have a 72% likelihood of taking 6 losses in a row over 50 trades taken, yep a 72% likelihood, that’s freaking surprising eh
The likelihood of taking 7 losses in a row is at a “more acceptable” probability of 49% (which is still super high!?)
Knowing the probability of taking 7 losses in a row is close to 50%, no better than flipping a coin, how much should you risk?
If you risk 5% per trade, you shall be down 30.2% (assuming you adjust your $ risk after each trade) that means you’ll have to make back 43% to get to the level you were before this losing strike… A rather big number if you ask me – however if you only risk 1% then you’re only down 6.8%
Let’s say you’re trading a 100,000$ account, I would highly prefer being down 6,800$ instead of 30,200$… Can you imagine the impact on your psychology? I would be devasted with a 30.2% loss
Don’t forget, trading is a survival game, and you can only survive if you protect your initial capital and risk the right amount… Don’t show off… Now onto
Probably the less fun part of trading for most of us (I’ll admit, I actually love it!) but you’ve probably heard it from many people psychology is key for traders, it may even represent 80% of the work you need to do to become a profitable trader
Now what are common traps we can fall into
- Sticking to our bias
- Trying to prove we know better
- I can’t lose so risking more
- I just need to get even
- I’m just one trade away from being profitable this month
I always used to get told off for doing more than five bullet points but there’s so many other examples!
So how can we have a profitable psychology?
- Focus on the process – they do not care about being right or wrong
- Understanding the numbers linked to your trading strategy
- Having strong opinions weekly held and being willing to flip sides
The most important part of trading is understanding that the market doesn’t care about you, and you shouldn’t really care about it. Instead focus on the process, be willing to jump ship and understand nothing is guaranteed in the market.
Instead, focus on yourself, spend time off the charts, recharge, meditate, empty your mind, and execute your trading plan
The worst enemy you have is yourself – and sadly you’ll never really get to beat him to the ground, even the famous Greek philosophers sometimes had urges (some were also doing the exact opposite from what they preached…)
Truly believe I can’t make a better point than Yvan:
Confidence is not “I will profit on this trade.” Confidence is “I will be fine if I don’t profit from this trade.”Yvan Byeajee, The essence of trading psychology in one skill
Try calming your mind, ideally empty your mind from all greed hesitation and passion, instead remain neutral and in control. The best way to do that is to meditate, and if you refuse to do that, go for a thirty minutes walk without your phone, just paying attentions to your thoughts, it should help you drop all those negative charges.
Tihbo puts it beautifully
Now I could spend an entire day ranting about the importance of psychology but I believe this is a journey you alone can take since it is deep inside you and no matter how many quotes I put in front of you the decision to let go and become present is yours.
Having a trading edge
Yep, this is the last point… Not necessarily because I believe it’s the less important, but you can make money with so many different markets and in so many different ways, you can skin the cat yourself.
However, it is extremely important to have identified your trading edge and be able to prove it exist in the historical market without having to adjust it, that’s one of the main problems quants are faced with, they adjust their strategy so it provides great returns in the past but does not work when the market conditions change
So what do you have to do?
Back test your strategy over several years and several pairs, forecast possible moves, use your trading plan with a reduced risk for the first few months in order to make sure the edge is there
Understand that even a profitable strategy will have losses
Here’s an example of my go-to set-ups after having backtested it over a few pairs for 2019
I have come to realize, that two of my favorite set-ups are not very profitable for me (the 3rd rejection and the hover) therefore I will have to adapt, another key point is understanding that my strike rate (without including BE) is of 34% however as you can see the returns are profitable, because my average win is a lot bigger than average loss.
Keep on working, keep on testing your strategy and never become over confident, because that will be your end.
The end 😊
Before I ask you to like this post and share, I would like to thank both Tiho Brkan and Yvan Byeajee I most of the data I used came from their tweets!
What do you think are the key pillars for success in the FX market?
Hope you enjoyed this article!