Bad Assed Trader: Sometimes when you're struggling with something in life you find that the message you need to hear is repeatedly thrown your way - as if fate is trying to tell you something.
In reality I suspect that when we're struggling with something we're more receptive to the message but so it has been for me this week. I keep hearing of instances where discipline and consistency have led to success.
The latest instance was from MoneyWeek magazine, of which I am a regular reader. An article by Tim Price, director of investments at PFP Wealth Management was so relevant and timely as to appear like a supernatural adviser urging me to continue with my trading strategy and giving me reassurance that it will succeed.
The article is about Jesse Livermore, born in 1877 whose fortunes peaked in 1929 with a net worth of $100m (equivalent to over $1bn today). He used his own money and his own system of trading and said "The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the man of inferior emotional balance, nor for the get-rich-quick adventurer. They will die poor."
As Tim Price says in his article "Consistently profitable trading - following Livermore's rules - is perfectly possible. The reason why it is not more widely achieved is simply because it requires significant mental discipline, and not much else. The prevailing human tendency today is to look for quick wins and to avoid hard graft or any form of psychological pain, or effort."
Livermore's approach requires no market forecasting, no analysis of fundamentals (such as economics and politics). He says you should never trust your own opinion or back your judgement "until the action of the market itself confirms your opinion" - it is purely technical analysis.
Livermore's strategy is based on trend following ("The trend is your friend" as traders like to say). It is also based on risk management which means always knowing how much of your overall capital you are prepared to risk on any given trade (like the 1% rule I always follow) and knowing precisely when you will get out. If you do not have an exit strategy, you do not have a strategy, full stop.
Livermore himself admitted that he lost money whenever he failed to follow his own rules (during his career he made and lost several fortunes). I was amazed to read how similar to my rules (I claim no credit for them - I was taught them) Livermore's rules were, such as:
I didn't understand what that last rule meant so I googled it to find out. It basically means don't add to a losing position - don't buy more of whatever you've bought that is losing value. Apparently people do that because by buying more it means the average value of their initial investment is decreased (buy 5 apples at £1 and the average cost is £1, if you then go on to buy 5 apples at 60p then the average cost of your 10 apples is 80p, which throws a better light on your overall investment: 10 apples at 80p each looks better than 5 apples at £1 each). I had never thought to do such a thing and so will have no problem sticking to that rule, I have never been tempted to add to a losing position - in my eyes that definitely looks like throwing good money after bad.
I reflect that some of his (and my) rules are easier for me to follow than others.
I have had no problem sticking with my 1% risk rule. I have had no problem cutting the losses, only once did I move my stop loss by 2 pips and cannot imagine doing such a daft thing again. But I understand from listening to other traders that this is a common failing.
I don't follow too many markets - at present I am only following the Euro and only trading the five minute time frame, so I can't be more discerning than that.
The rules which are most difficult to follow are the others. Not trading when there are no obvious opportunities. This is something which I think becomes easier with more experience as a trader. When you're a novice none of it seems to be really obvious and you have to do quite a bit of analysis to find the trade that meets your rules. So if nothing jumps out at you then a common mistake I've made is to think that you just haven't looked hard enough and you will see one if you keep looking.
Of course you then do find a trade because you make one. I am still working on this rule.
Letting the profit run is a rule I am able to follow to a degree, but I have come to learn that I need to set a target which is reasonable and technically justifiable and walk away because trying to manage a trade when you're in it is very tricky and your mind plays games with you. You ignore the warning signals that show price is moving against you because you want the trade to keep going your way - a symptom of greed. Or you believe that price is turning against you before the technical signs are apparent - a symptom of fear.
Fear and greed are the main drivers of emotional trading and both wreck your trading strategy, your trading record and your trading profits. Best to set the target at a time when you are objective (ideally before you place the trade) and stick to it. I find writing it down as part of my plan for that trade helps. But to be quite frank, I'm still struggling a bit with this rule.
Sticking with the trend. Well I like to think I follow that rule but when I review my trades after the event I sometimes find that this has not been the case - so clearly I do unconsciously break that rule. It was a mistake I made more as a complete beginner, particularly trading the Forex when you have four different time frames and may think you are trading with the trend but, if you look at a higher time frame it is apparent that you are not. Price can be going up on the hourly and five minute charts but down on the four hourly and daily charts - it's all part of the inevitable cyclicity of price action. Learning to trade the Fx is all about getting the time frames aligned so you are going with the trend in all four of them - and my trading strategy is based on spotting the moment where price on the five minute chart is just turning back to follow the same trend as the other three time frames.
One of my trading tutors, Chris, explained it brilliantly. He said you have to imagine that the four time frames are like a family going out for a walk in the park. The daily chart is the grandfather, he determines the direction of the walk (or trend). The four hourly trend is the father and he also strongly influences the direction (of the walk/trend). The hourly chart is the big brother who you want to see walking alongside his father and grandfather. The five minute chart is the little, rather wayward, brother. He's only 2 or 3 years old and he keeps letting go of his big brother's hand and dashing off in a different direction to the other three. He's only allowed to do that for a short while before they grab him and pull him back into line.
So my strategy is about spotting when that little boy has dashed off and then, most importantly, the moment when his family tug him back into line. When they do he swings back into their direction and of course being a keen and energetic little thing he starts to lead the way, sometimes with quite a head start. This is reflected in the price going from a sharp or gentle movement against the trend to a sudden whiplash back into the trend and a hearty price movement in your favour - if you catch it.
And then I come to the last and most difficult of Livermore's (and my) rules - Wait for the market to confirm your opinion before trading. Traders always say "Trade what you see, not what you think" and this is what they mean by it. And it's so hard!
When you've done a bit of analysis and you can see that the trend is up on the daily, four hourly and hourly time frames and it's down on the five minute time frame then you believe it's only a matter of time before price turns back up and you're watching every movement on the chart expecting to see confirmation of this change. And because you're expecting it you read into it, you start to think rather than just see.
Successful trading is about not thinking but just seeing and accepting that.
Tim Price, in his article, strongly recommends the value of following the trend. He says "you would be surprised to discover how many professional investors have no interest in Livermore or in following these few essential rules". I am surprised to hear that as it seems pretty basic but then I guess someone has to set the trend and if not the professional investors then who?
In the meantime, I agree with Tim and Livermore, and would only say in my own Bad Assed Trader way, that the most difficult part of trading seems to me to be waiting for the market to confirm one's opinion. If you can get that right then I reckon you have it made.
In reality I suspect that when we're struggling with something we're more receptive to the message but so it has been for me this week. I keep hearing of instances where discipline and consistency have led to success.
The latest instance was from MoneyWeek magazine, of which I am a regular reader. An article by Tim Price, director of investments at PFP Wealth Management was so relevant and timely as to appear like a supernatural adviser urging me to continue with my trading strategy and giving me reassurance that it will succeed.
The article is about Jesse Livermore, born in 1877 whose fortunes peaked in 1929 with a net worth of $100m (equivalent to over $1bn today). He used his own money and his own system of trading and said "The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the man of inferior emotional balance, nor for the get-rich-quick adventurer. They will die poor."
As Tim Price says in his article "Consistently profitable trading - following Livermore's rules - is perfectly possible. The reason why it is not more widely achieved is simply because it requires significant mental discipline, and not much else. The prevailing human tendency today is to look for quick wins and to avoid hard graft or any form of psychological pain, or effort."
Livermore's approach requires no market forecasting, no analysis of fundamentals (such as economics and politics). He says you should never trust your own opinion or back your judgement "until the action of the market itself confirms your opinion" - it is purely technical analysis.
Livermore's strategy is based on trend following ("The trend is your friend" as traders like to say). It is also based on risk management which means always knowing how much of your overall capital you are prepared to risk on any given trade (like the 1% rule I always follow) and knowing precisely when you will get out. If you do not have an exit strategy, you do not have a strategy, full stop.
Livermore himself admitted that he lost money whenever he failed to follow his own rules (during his career he made and lost several fortunes). I was amazed to read how similar to my rules (I claim no credit for them - I was taught them) Livermore's rules were, such as:
- Stick with the trend
- Don't trade when there are no obvious opportunities
- Wait for the market to confirm your opinion before trading
- Cut your losses but let your winning positions run
- Don't follow too many markets
- Never average down into a losing position
I didn't understand what that last rule meant so I googled it to find out. It basically means don't add to a losing position - don't buy more of whatever you've bought that is losing value. Apparently people do that because by buying more it means the average value of their initial investment is decreased (buy 5 apples at £1 and the average cost is £1, if you then go on to buy 5 apples at 60p then the average cost of your 10 apples is 80p, which throws a better light on your overall investment: 10 apples at 80p each looks better than 5 apples at £1 each). I had never thought to do such a thing and so will have no problem sticking to that rule, I have never been tempted to add to a losing position - in my eyes that definitely looks like throwing good money after bad.
I reflect that some of his (and my) rules are easier for me to follow than others.
I have had no problem sticking with my 1% risk rule. I have had no problem cutting the losses, only once did I move my stop loss by 2 pips and cannot imagine doing such a daft thing again. But I understand from listening to other traders that this is a common failing.
I don't follow too many markets - at present I am only following the Euro and only trading the five minute time frame, so I can't be more discerning than that.
The rules which are most difficult to follow are the others. Not trading when there are no obvious opportunities. This is something which I think becomes easier with more experience as a trader. When you're a novice none of it seems to be really obvious and you have to do quite a bit of analysis to find the trade that meets your rules. So if nothing jumps out at you then a common mistake I've made is to think that you just haven't looked hard enough and you will see one if you keep looking.
Of course you then do find a trade because you make one. I am still working on this rule.
Letting the profit run is a rule I am able to follow to a degree, but I have come to learn that I need to set a target which is reasonable and technically justifiable and walk away because trying to manage a trade when you're in it is very tricky and your mind plays games with you. You ignore the warning signals that show price is moving against you because you want the trade to keep going your way - a symptom of greed. Or you believe that price is turning against you before the technical signs are apparent - a symptom of fear.
Fear and greed are the main drivers of emotional trading and both wreck your trading strategy, your trading record and your trading profits. Best to set the target at a time when you are objective (ideally before you place the trade) and stick to it. I find writing it down as part of my plan for that trade helps. But to be quite frank, I'm still struggling a bit with this rule.
Sticking with the trend. Well I like to think I follow that rule but when I review my trades after the event I sometimes find that this has not been the case - so clearly I do unconsciously break that rule. It was a mistake I made more as a complete beginner, particularly trading the Forex when you have four different time frames and may think you are trading with the trend but, if you look at a higher time frame it is apparent that you are not. Price can be going up on the hourly and five minute charts but down on the four hourly and daily charts - it's all part of the inevitable cyclicity of price action. Learning to trade the Fx is all about getting the time frames aligned so you are going with the trend in all four of them - and my trading strategy is based on spotting the moment where price on the five minute chart is just turning back to follow the same trend as the other three time frames.
One of my trading tutors, Chris, explained it brilliantly. He said you have to imagine that the four time frames are like a family going out for a walk in the park. The daily chart is the grandfather, he determines the direction of the walk (or trend). The four hourly trend is the father and he also strongly influences the direction (of the walk/trend). The hourly chart is the big brother who you want to see walking alongside his father and grandfather. The five minute chart is the little, rather wayward, brother. He's only 2 or 3 years old and he keeps letting go of his big brother's hand and dashing off in a different direction to the other three. He's only allowed to do that for a short while before they grab him and pull him back into line.
So my strategy is about spotting when that little boy has dashed off and then, most importantly, the moment when his family tug him back into line. When they do he swings back into their direction and of course being a keen and energetic little thing he starts to lead the way, sometimes with quite a head start. This is reflected in the price going from a sharp or gentle movement against the trend to a sudden whiplash back into the trend and a hearty price movement in your favour - if you catch it.
And then I come to the last and most difficult of Livermore's (and my) rules - Wait for the market to confirm your opinion before trading. Traders always say "Trade what you see, not what you think" and this is what they mean by it. And it's so hard!
When you've done a bit of analysis and you can see that the trend is up on the daily, four hourly and hourly time frames and it's down on the five minute time frame then you believe it's only a matter of time before price turns back up and you're watching every movement on the chart expecting to see confirmation of this change. And because you're expecting it you read into it, you start to think rather than just see.
Successful trading is about not thinking but just seeing and accepting that.
Tim Price, in his article, strongly recommends the value of following the trend. He says "you would be surprised to discover how many professional investors have no interest in Livermore or in following these few essential rules". I am surprised to hear that as it seems pretty basic but then I guess someone has to set the trend and if not the professional investors then who?
In the meantime, I agree with Tim and Livermore, and would only say in my own Bad Assed Trader way, that the most difficult part of trading seems to me to be waiting for the market to confirm one's opinion. If you can get that right then I reckon you have it made.
You should read Reminiscences of a Stock Operator; it's a veiled biography of Jesse Livermore (with his approval) - basically all that's changed in the book is Jesse's name. It's very well written and builds upon what was discussed in MoneyWeek. There's also How to Trade in Stocks written by Jesse himself, but it's rather dry and probably not as informative.
ReplyDeleteI don't know if Tim Price mentioned anything else about Jesse, but he is both a shining example and a dire warning to all traders. He showed that with the right strategy even if you lose it all you can get back up again even better than before; but on the flip-side he proved money isn't everything. He had a pretty messed up personal life which ended up with Jesse putting a pistol in his mouth.
Hi Nelly and thanks for adding that useful information and recommendation. I did read that Jesse shot himself which is a very sad ending for someone who was clearly so talented. Like you say, money isn't everything and one of the most interesting aspects of trading for me is how important it is to develop one's understanding of oneself and the personal growth that is needed to become an effective trader. I'm using it as an opportunity to gain a more positive attitude to everything in life (not that I've ever been very negative...)
ReplyDeleteThis was a really helpful post for me, the book I've just read on Forex gives a bit of background, and the how, and risk management, but nothing really about sensible strategies and absolutely nothing about timeframes. Other than the one trade I did last week on the cable I haven't done anything else because I was getting confused with the different trends in the different hourly charts. Now I can look at them with a fresh perspective! :) xxx
ReplyDeleteThanks for the feedback Scarlett. I've watched 5 Fx DVDs and sat through over a dozen training days and I still get confused with the different trends in the different hourly charts so don't be hard on yourself for not getting it straight away!
ReplyDeleteIt's one of the reasons I would urge new traders to only trade with a demo account until you are consistently showing profits (for longer than a few weeks). Then start with a few pence a pip whilst you get used to the money aspect.
Professional traders say it usually takes at least 6 - 12 months before traders really start to develop the discipline and consistency they need to be able to make it. They say you have to serve your apprenticeship. 80-90% of Forex traders never make it - they quit - because it's not easy!
I don't know what your book says about trends but we tend to be told not to trade a currency pair long unless price action is above the moving average on all time frames above the one you are trading in and either is or is about to be in the one you're trading. For my sniper strategy I'm not allowed to trade it long unless price action is above the 50MA the evening before (at about 8pm)and in the morning on the daily, four hourly and hourly. So even though the Euro is apparently having an upday today I couldn't have traded it because price was under the 50MA on the four hourly and hourly last night.
It's all about having plenty of strong confirmation in your favour regarding the likely trend of the day and then buying a dip in it. xx