Key Lessons of 2019
Hey guys, I wanted to write another blog for a while. Unfortunately one that I completed was totally lost. I couldn’t recapture the tone and create a similarly impactful post, so I decided it’d be better to just start writing here without any expectations. If you want some more clarification just reach out at my twitter here: Brian Lee.
Disclaimer: All of the subject matter below is simply my opinion. I have a long way to go and do not claim to know any absolutes in trading. I’m always changing my ideas and beliefs but this is where I stand at this midpoint of 2019.
Please read blog#1 and blog#2 if you haven’t already, I’ll likely reference some aspects of those stories.
You cannot rush the process
I am 2 years into this trading journey and it’s very apparent to me that I have a long way to go. Nearly every time I had the best trading of my career, I’d get humbled by the market. The market taught me everything I didn’t know one setback at a time. Trading isn’t easy and if you aren’t passionate enough to push past the pain you will never make it, plain and simple. Pain is the only way forward. The truth is that we learn the most when we make mistakes. When you win there is no chip on your shoulder, you don’t push yourself past exhaustion to understand when and where you made an error and resolve to do better. Failure is by far the best teacher in this game, prepare to fail and give yourself room to do so. Do not risk more than 2% of your account, even less when you’re trading around PDT. Look up “risk of ruin” and determine if you’re going to be in this game when you inevitably make that string of mistakes. Yes, it is inevitable. I don’t care how hot you think you are or how much money you made, humans are flawed, you will slip up. Do not be blindsided by this fact and prepare for the worst.
A lot of what I focus on these days, and what you will find in this blog is that I’m hyper-aware of the downsides. You may scoff at it now, as I have, but when you are humbled then you’ll truly understand. Part of me thinks that every great trader NEEDS to experience massive failure to push to the next level. It’s synonymous with some of the world’s best market participants.
I know young traders see the market as full of opportunity and blind optimism, but I beg you guys to really acknowledge some of these lessons that I’ve learned. I know you will come face-to-face with them in the future, so just be aware and you may survive.
First Lesson: You cannot rush the process: Take it slow, prepare and give yourself room to make mistakes.
Risk/Reward
Risk and reward drives my entire operation. It’s not called reward risk for a reason. It is precisely the risk that drives the decision to move forward. You have to think in terms of risk first, after all, we are professional risk managers. Risk is determined by your ability to stomach the loss. What exactly can you trade flawlessly? Can you cut a loss without hesitation knowing that you’ve given $100, $200, $500, $1000 or more to the market? As soon as you put on that trade you should resolve that your money is gone! How many of those losses can you take before you are emotionally unstable? You could be comfortable trading a $500 position but if you’re only at $27000 on a trading account then you will be fearful of PDT in just 4 losses OR less. Why not take that dollar risk and give yourself 10 or 20 losses in a row to PDT? Lastly, is the risk worth taking the trade?
Reward is the optimal outcome of your trade. This is where you aim to take profits and have thus created a criteria for a plan. Your reward should far outweigh your risk such that you can recover any mistakes you make, unless you’re operating at an extremely high winrate. For this matter, I’ll avoid commenting on scalping. Your price target should reflect a culmination of your experience with your setup and have statistical data backing your assumption. If you cannot identify the reward aspect of the trade, you’ll never be able to back your expectancy statistically.
Okay, we know all of this. What is the lesson exactly? The key insight is that you, as a trader, are able to manipulate this relationship in POWERFUL ways. The simple answer is: add to winners.
Looking at the image above, it should be pretty clear. Why is this important? By adding to winners, you’re exponentially growing your reward while risking the same amount of capital. This changes things…
The most underrated aspect of this is the psychological aspect. In a perfect world, we never experience slippage and consistently keep our losses at or near our desired risk. However, in reality, this doesn’t play out as cleanly. Protecting ourselves really is predicated on being able to react to all types of dynamic risk situations. The best example I can give is when a parabolic candle shoots up and hits every stop in the book and produces a short squeeze. You may not be able to react to this price action in time, so you either slam out, try to hold through it or have a market stop in place. In most cases here you will experience slippage of some kind and you will never know until it happens to you, but there will be a dollar risk that you cannot accept for whatever reason. Price may have been way too far from your desired stop, you may push the market up temporarily with your size or you’re newly sized up and cannot necessarily accept the loss as it might be “a weeks worth of gains”. Even if you take the loss for a bit more than you expect, the dynamic already shifts to the downside. If you were risking 3:1 and take -1.25R then it’s not really 3:1 is it? You will be in the hole immediately and this brings me back to my original point. Increasing your risk/reward positively affects your psychology because now you can rationalize that ONE win will more than cover your loss and put you in the profit. This inherently makes it easier to acknowledge a bit of slippage is part of the game and NO BIG DEAL. This was precisely the key insight I got from increasing my RR from 3:1 to an average of 4.5:1. Losses dictate how successful we will all be in this game, never forget that.
Hard Stops (Market)
There is so much misinformation regarding stops and it was built into my psyche as an aspiring trader. I was told that mental stops were superior and hard stops were like a handicap for the undisciplined. First of all, if someone tells you that you need to be extremely passionate, devoted and hard-working and they just don’t know if you have it in you, then you’re more likely to try to overcome that feeling of invalidation and prove them wrong (marketing technique)! It felt sort of similar in this case: I can be disciplined!
The topic was thoroughly discussed on twitter and @keekztradez did a great job writing up his thoughts here. I won’t go into the pros and cons of mental stops vs hard stops.
I traded mental stops for the majority of my trading career and I’ll tell you now that it works 95% of the time but the 5% of the time it doesn’t, you’re in for emotional turmoil. You may freeze and watch your position go negative and become a short-term bag-holder if any variable throws you off of your expectations. This sets you back a fair bit, not only that, but more importantly your mental capital is spent and you may lose confidence. It will have an adverse effect on your trading unless you’re really poised.
I’ve had days where I’m extremely green and in the money. I’m minding my own business and then that MASSIVE candle comes out of nowhere and catches me a bit by surprise. I have a choice there and most of the time I’ll get out on the follow-through, but in some cases I’ve taken a much larger loss than I anticipated by waiting it out irrationally.
When I look back, the worst periods in my trading journey have been a result of disrespecting my planned stop across the board and NOT due to a lack of opportunities. I think many traders will find it true for themselves as well. Our primary job is to manage risk, if there are no plays then take the losses and walk!
What I used to do is have my level 2 window loaded and ready to cover at my price. I would just observe the market until it was time to execute and press enter. I also had a hotkey that would cover above the ask by 3 cents, guaranteeing I could at least get out on some slippage. However, this method can fail pretty easily if the stocks price movements out-range your current expectations. Like I said before, it works most times but when it doesn’t man it sucks. As a result, I operate with discretionary hard stops. Let me explain:
The more experiences we gain as traders the more we kind of get a feel for the order flow and potential red flags. I know that in many cases I was able to tell that the stock was holding up and trapping shorts. I’m sure we all develop that spidey-sense where our setup looks to be failing. The few moments before an explosive move where you can sense the risk, that’s when I set my hard stop. Usually this is when the stock is in my favor and I’ve already made a significant paper gain, but sets up for a violent reversal. Before I could sense it but was only ready to press my button, now with the stop I’m able to guarantee I don’t get caught in some huge bid and, in the worst cases, a volatility halt! I am literally so thankful now instead of disgusted when I see that minor slippage because I know the “what if” scenario is SO SO much worse. When that fill comes through I take the gut punch but it gets easier the more you take it. The beauty is you can adjust your stop to fit your expectations. You could set it for breakeven and I’m sure that feels amazing! For me, I set it generally at my intended stop or just below and try to ride it out, sometimes I beat the failed attempts and keep my position and why would I put on the trade if I wasn’t ready to take the loss anyways. I’m actually a little too good at taking consecutive losses… a lot of the time I’m taking -2,3R before even making a penny and that is just my confidence in risk/reward giving me a psychological edge. Combining high risk/reward setups, accepting losses, and hard stops I’m able to alleviate a ton of pressure.
Discipline
Okay, what the fuck is discipline? I’ve spent so much time and energy researching the psychology and the practices involved by the so-called experts. I read a ton of books, watched videos and practiced what I “learned” until they were habits. What I realized is that I’m a flawed human being… and in trading, ONE mistake can do you in.
I wake up everyday at 3:50 A.M. whether I feel good or absolutely awful because I want it that bad. I got 4 other people to practice 10 hours a day starting at 5 A.M. to play against Europeans on a massive ping differential for 1 entire year without pay because I wanted it that bad. I’ve done things in my professional gaming career that can be described as extremely disciplined, yet I had no clue what it meant in the context of trading… This is a completely different type of discipline. This is the discipline of the mind and unfortunately our minds and hearts are connected, not to mention that trading is one of the most difficult things you can attempt. It is full of paradoxes, baits and switches. It’s often doing the opposite of what we think or feel that is the correct choice.
My little brother was an overweight child. He used to drink at least 4 sodas a day and thought nothing of it. One day I sat with him and explained why sugar is bad for him and that he should lay off on the soda. He agreed and decided that it’s what he wanted as well. What happened during the next few days? He slowed down. However, he eventually he started drinking them again though. Why? Our refrigerator was constantly stocked up with sodas. It was simply too easy for him to relapse into his old habits. I talked with my parents and had them stop loading up his soda of choice and put water in it’s place. Long story short, during the next few months my brother lost a significant amount of weight and looked like a totally different kid.
I tell you this to quickly illustrate the fact that knowledge doesn’t equate to positive action. We KNOW a lot of things, knowing more things doesn’t make a difference in a lot of cases. What does make a difference is attacking the problems by making that which we feel is a problem more difficult than the opposite action. In some cases, we can even make impossible to fuck up.
Humans crave the path of least resistance. If it’s easy we’ll tend to do it. By making things difficult or impossible we systematically design our lives. When we consider choices that we’d like to make and come to a conclusion, shouldn’t that be the end of it? We’ve thought it through, now it’s time to create the perfect storm to actualize it.
I’ve beaten this dead horse a million times and I’ll do it again. What are ways that we can discipline ourselves as traders using this new perspective? Max loss, position max loss, shutting down everything.
The only new thing here is shutting everything down, the others are talked about, at length, in blog#2. One of my problems is FOMO. I’ve nailed massive moves and given all my gains back despite making the decision to cash in my chips by waiting around and looking for opportunities that are low-odds throughout the day. So, I said “okay, next time I will just walk!”. Some talk that was, I left up my scanner and saw, for ONE moment, the new price of a stock on my watchlist. I saw some buddies talking about it on discord, I read a pop-up notification on TweetDeck. I loaded that bad boy up, platform and all, and entered the trade. Sure enough, it was a terrible choice. I had already decided earlier that the trade was lower-odds and less likely to satisfy my trading criteria, it was better to walk. I take the trade, take a loss. Get back in, take a loss. Now I’m pissed. That’s the kind of situation that leads to emotional mistakes.
It’s always been hard to follow through when the market is literally designed to tempt you in. If you think you’re educating yourself by sitting through the market and watching prices move… I’d disagree. It’s a FOMO machine. I’ve been trading a decent amount of time now and I can really tell when a day is going to be low-odds or completely dead. Knowing this, isn’t the best option to wait for greener pastures and take the day off? Why do we feel like we need to trade everyday? It’s the way most of society operates and we feel like we’re not working when we’re not making money everyday. This is the wrong attitude because the market simply doesn’t give a damn about what we need or want. My solution is to make the decision, shut everything down including my friends (lol). I just exit every single FOMO-inducing item on my desktop and go to bed or play some games. I come back, review my watch and come to conclusions. Either way it’s market education, you may have misread the situation OR you’ve avoided total disaster and can see what produced that outcome. It’s not a race… there will always be another opportunity, focus on the process and remember that no ONE trade will make your career.
The more and more I find myself letting automation take the place of my in-the-moment decision making, the more consistent I get. We’re able to use technology and resources to stave off our worst selves and I believe that is an absolute must in trading.
Strengths/Weaknesses
“The goal for the trader is to develop a system with which he is compatible” — that is, a harmony between a trader’s emotional constitution and trading technique. In this case, a system is a set of rules for trading: what to buy, how much of it to own, when to get in, and when to get out, either to take a loss or to collect profits. These rules are intellectual in nature — at least, that’s how they look from the outside.
Lurking below the surface are the emotional buttons they push when the trader employs them. The intellectual aspect of trading rules are what most aspiring traders reach for while learning the craft because they’ve had that approach ingrained in them since kindergarten. Unfortunately, most aspiring traders find out far too late that the act of trading is 20% intellectual and 80% psychological.” — Ed Seykota, Market Wizards
Time and time again, I find myself coming back to this quote. I first stumbled upon it when reading Michael Martin’s, The Inner Voice of Trading. Do you actually believe those words? I imagine if you’re new it sounds like a bunch of bologna, but it hits home for me at least.
Martin goes on to expand on Seykota’s words:
“Incompatibility between trader and system is the single greatest reason most traders don’t succeed, regardless of trading style. They have no emotional connection to their trading rules and methodology. They know trading rules from a technical and intellectual standpoint, but not from a psychological or self-awareness one…In unfortunate cases, the trader is not self-aware but continues to seek the answers. Ironically, these answers to successful trading are found within the trader’s own mind.”
What is the difference between these two scenarios?
Feeling completely comfortable and in-control of your trade.
Feeling stressed out while in a position, feeling the significance of each tick for OR against you?
Emotions.
In scenario one, you’ve likely made this trade before. You have a plan, you know your entries, your risk and your price target. You’ve seen this pattern play out and have back-tested your results. You’ve sized in properly, not risking too little or too much. You can accept that you may be wrong and could lose a certain amount of money.
In scenario two, It could be that you’ve succumb to a number of trading sins such as revenge trading, over-trading, averaging down, FOMO/chasing, not cutting losses where you planned, incorrect position sizing or entering the state-of-mind called “risklessness”. Perhaps you are prepared and have a plan but aren’t able to execute when it comes down to it because you can’t accept the risk. It could also be that your system doesn’t benefit your strengths. The list goes on and on. Every dedicated trader is aware of the potential harm and will experience these feelings throughout their journey.
Why do these things happen and how can we curb our tendencies to make these trading errors?
In my opinion, it comes down to — Knowing Yourself
Considering you have a viable strategy where you’ve performed backtests, statistical analysis and studied your pattern, all you need to do is execute. Here is where it gets interesting, there are dozens of variables that go into each individual trader’s psychology. Your task is to sort out all of these variables and find your own particular style.
When it came down to myself, I was really focused on my strengths and weaknesses. I wanted to empower myself where I was strong and find ways to circumvent mistakes.
How do we do this? The first answer is review. Everyday you should have a detailed log of your trades and a little bit of context for each. Go through what you did well and what mistakes you made. Then you should ask, “how can I improve this?”
By asking yourself this question, you start looking for the causes and look for solutions. One way I found was to combine scripts and indicators (please don’t ask me what I use) as guides that work in tandem with my beliefs. Yes, I believe there are indicators out there that are not “noise”. Again, this is something where I think there is a lot of misinformation for the sake of marketing to newbie traders. When I was fielding the market initially, I was overwhelmed by different strategies and gravitated to those who said “simple is best”. Now, simplicity is definitely the highest form of sophistication, however to ignore the availability of resources available may be harmful to your trading.
When it comes to market participants, there are a lot of people out there with differing ideologies. By being dynamic and open to seeing what they say, we’re able to capitalize on their beliefs. VWAP is the perfect example. So many traders say they couldn’t be bothered by it, yet they throw it up on the chart because so many others do. So why would that not be the case for many others? @Team3dstocks often wrote about institutions picking certain trends and identifying which one they were using. He may have several lines drawn on his chart but once he notices one conform, that’s where we’d presumably be able to identify patterns. I can tell you for certain that my trading was significantly boosted by modifying different scripts and indicators to fit my view as well as using popular ones as a guide.
So how does this play into knowing yourself? Well, you may have a host of issues and, don’t get me wrong, many of them probably won’t be solved by tools. But considering you’re profitable or have a tested edge, you should really just need to tighten up your execution.
Let’s say you have trouble timing the market, then look for ways to create signals for yourself where you’d ideally attack. You could script in TOS signals that automate some of your ideas. This can be used as a tool to take a low-risk entry with a wide-stop and get your feet wet instead of freezing and letting the trade go in your favor without you. Again, ADF @Team3dStocks says that some of the most powerful indicators are so OBVIOUS. Why do we have to overwhelm the market with our intellect? There are some averages, for example, that people really respond to. You don’t need a bollinger band with an offset of -3.2 with an ichimoku thunderstorm cloud to identify the top of a bounce. THIS is where we keep it simple.
On the flip-side, you can now use these tools to your advantage. Let’s say you’ve got a great adding system down and you want to increase your risk/reward by lowering your risk. Sometimes you can identify trends with the lines and use those to maximize your winners. Get creative, I didn’t write this part to coerce anyone into using indicators or scripts. I just wanted to open your mind a little bit and consider how these applications can be used to boost your performance. Always take each item with extreme caution and properly back-test your results. If you need help scripting contact @leandrosalama on Twitter. He is an absolutely amazing TOS coder who can help visualize your ideas so that you can be a bit more efficient in your process.
Final Thoughts
I really just wanted to get this out there and it went on for a LOT longer than I initially thought. I did start to fatigue a little and usually prefer to one-shot blogs so there might be some mistakes. I’ll make edits as I see fit and for any questions please message me on Twitter. Again, do not do not ask me about any of the scripts or indicators I use. These things are highly subjective and personal to the trader, let your observations of self define what YOU need.
