In my recent presentation, at the London Trader Show, I talked about the Five Indicators of Trading Success. Tools and skills which can support traders on their journey.
One of these tools was the “Route Map to Trading Success”.
A 5-step program designed to allow a trader to create a trading strategy, to apply that strategy consistently, review the outcome of each trade, to learn from those outcomes, and then use those lessons to feedback into, and optimise their trading process.
To visualise what I was talking about I created this slide, which shows a simple feedback or reinforcement loop, that if followed correctly should empower traders to achieve bigger and better things.
Let’s look at each of these stages individually:
- Process:
This forms the nuts and bolts of a traders day to day activity. Having a trading process allows us to act systematically not emotionally.
To act and trade rationally we need to follow a series of pre-determined rules that quantify the specific trading opportunities we are looking for.
The way, in which we will trade those opportunities when we find them.
And perhaps most importantly of all our attitude and approach towards risk and money management.
Removing emotions from the decision-making process is one of the key skills a successful trader needs to master.
Trading emotionally, by for example, instinctively jumping back into a trade after a loss, or a series of losses, can wreak havoc with your trading account.
Good sense can quickly go out of the window, and what starts out as an effort to get yourself out of a hole, only puts you deeper into it.
Create a set of up 10 trading rules that cover the type of trades that you will look for and in what markets, what your minimum risk reward ratio will be for a trade, how many trades you will have open at any given time etc.
Also, consider what exposure you will allow yourself to benchmarks like the US Dollar or the S&P 500.
Holding a portfolio of correlated positions can have unforeseen consequences for your P&L.
In my experience, the laws of unintended consequences rarely work in a trader's favour.
- Application
Creating a trading process is the first step, however, it’s no use having a well-defined trading process if we don't apply it in a disciplined and orderly fashion.
To do that we need to operate on a first-principles basis:
You can start doing this by finding your trading opportunities, for example, I like to screen for moving average crossovers. I also watch for RSI 14 oversold and overbought situations. so that’s readings that are <30 or >70.
As well as, reversal signals in candlestick charts, such as hammers and shooting stars. Candle patterns that often appear at the beginning or end of a trend.
Ideally, I will find several opportunities across these categories every day and sometimes one or two that overlap. That helps to create a short list of ideas that I can drill down into, to find the most actionable trades.
Doing this daily is a great way to build up your trading discipline and it also allows you to quickly get familiar with the universe of instruments you are monitoring. And you will soon start to learn key levels and recognise patterns in the price action within these markets.
Having identified our trading opportunities we then need to apply our risk and money management rules to them.
So for example, what’s the risk-reward ratio on the potential trade? does it meet our expectations which might be set at 3:1 or higher? If we can only make the case for an RR of 2:1 on a trade, then that idea will need to be excluded completely, or at least sidelined until its risk-reward profile improves.
- Outcome
Having become adept at seeking out trading opportunities and screening out those that don’t stake up from a risk and money management point of view, we are now ready to trade the opportunities that do.
And having actioned those trades in the market, we are now in a position to judge the outcome.
For each trade we make, we should have an entry-level or call to action, a stop loss level, at which we close the trade if it moves against us. And a target or take profit level that we are aiming to achieve.
We may have more than one target level we are aiming for. It’s not uncommon for traders to have up to three potential target levels, which could be reached depending on the momentum within the trade.
Once we have closed a trade we are then in a position to judge the outcome.
That might sound simple, however, it’s not as straightforward as, did we make a profit or a loss?
Important as that is, it’s just as important to judge how we got to that point as the end result itself.
Beware of outcome bias: A profitable trade that came close to blowing up your account is not a positive result. Whereas, a losing trade, in which your risk and money management rules did their job and limited your loss, is a positive outcome.
Remember success in trading is all about longevity.
That’s achieved by taking calculated and known risks and exposing yourself to as many viable trading opportunities, as possible, duing your time in the markets.
- Feedback
Taking what we discovered by examining the outcome of each trade or group of trades, thats things that were successful and worked well, and the things that didnt go as planned, means that we can work out what needs improvement and what doesn’t.
For example if our screen of the markets is generating lots of trading opportunities, but in practise we have few real winners, we need to decide whether its the selection processthat’s flawed or our application that’s at fault.
For example, are we making the classic mistake of snatching at profits and letting our losing trades run for longer than they should? Something that’s known as loss aversion.
If you go through this process on a regularly you should start to notice patterns forming in your trading behaviour. You might even spot traits in metrics like the time of day you trade the day of the week or the markets you trade.
To the extent that you could find that trades made on Wednesday afternoon, in US equities, are your most profitable. But, that FX pairs traded late at night are your least successful venture into the markets.
- Adjustment
Taking that knowledge and feeding it back into our trading process can help to improve our performance. In the example above we would look to focus on our Wednesday afternoon trading in US stocks, but at the same time cut out trading FX pairs late at night.
That simple action alone should have a positive effect on our PnL. And if we can work out what we are doing differently, or better on a Wednesday, than we are on the other days of the week, then we can try to apply that technique to those other 4 days as well.
By following these steps we should be able to create a positive reinforcement loop for our trading and that should help to keep us in the game for the longest possible time. Which in the end is what successful trading is all about.
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