In Continuation with previous 2 article
Risk Below 5% of Equity Per Trade
- I intend to risk below 5% on a trade, allowing for poor executions. Occasionally I have taken losses
above that amount when major news caused a thin market to jump through my stops.
- Risk no more than you can afford to lose, and also risk enough so that a win is meaningful. If there is no such amount, don’t play.
- Speculate with less than 10% of your liquid net worth. Risk less than 1% of your speculative account on a trade. This tends to keep the fluctuations in the trading account small, relative to net worth. This is essential as large fluctuations can engage Fred and lead to feeling-justifying drama.
- Betting more boldly produces more volatility. Good traders are familiar with both and keep their trading well within their tolerances.
- I use a rule of thumb that you place less than 10% of your liquid net worth at risk and that you stop your losses at 50% of that – so you have net exposure of 5% of your liquid net worth. If you have a net worth of 1.5 million, you might have liquid net worth (cash, stocks, bonds, etc) of, say, about 500,000 (a wild guess). Then you might place $50,000 of that at risk and cut your loss if you lose $25,000.
- The idea is to keep the venture below your threshold of financial importance, so nominal ups and downs do not trigger your emotional uncle point and motivate you to abandon the venture during drawdowns.
What Trend Trading Is (Ignore Fundamentals)
- Reliance on Fundamentals indicates lack of faith in trend following.
- For Trend Traders, understanding the markets is typically optional, often counter-productive.
- When an up-trend happens, the price is moving up.
- Trend Traders get a signal and pull the trigger without regard to the result of any individual trade.
- Playing for comfort and searching for meanings are both counterproductive to Trend Following.
- Trend Following systems do not speak about entry and exit prices.
- Trend systems do not intend to pick tops or bottoms. They ride sides.
- I don’t implement momentum; I notice it and align my trading with it.
- There is no such thing as THE trend. Some of the shorter indicators are down while some of the longer ones are still up.
You Don’t Need to Get Caught Up in Intraday Market Movements / Do Not Day Trade
- Having a quote machine is like having a slot machine on your desk— you end up feeding it all day long. I get my price data after the close each day.
- Day Trading is an exercise in limiting profits while continuing to pay normal transaction costs. Day trading may provide a way to cover up deep feelings that the trader does not wish to face.
- Short Term Trading is one good way to realize your intention of reducing account equity.
- Intraday trading is tough since the moves are not as big as for long-term trading and there is no comparable reduction in transaction cost. In general, short-term trading systems succumb to transaction costs and execution friction. You might simulate your system over historical data and notice how sensitive it is to assumptions about where you get your fills.
- The shorter the term, the smaller the move. So profit potential decreases with trading frequency. Meanwhile, transaction costs stay the same. To compensate for profit roll-off, short-term traders have to be very good guessers. To improve guessing skills, you can practice dealing cards from a standard deck, one at a time. When you become very good at it you might be able to make money with short term trading.
Prudent Money Management is the Key to Longevity
- The key to long-term survival and prosperity has a lot to do with the money management techniques
incorporated into the technical system. There are old traders and there are bold traders, but there are very few old, bold traders.
- The manager has to decide how much risk to accept, which markets to play, and how aggressively to increase and decrease the trading base as a function of equity change. These decisions are quite important—often more important than trade timing.
- I have incorporated some logic into my computer programs, such as modulating the trading activity
depending on market behavior. Still, important decisions need to be made outside the mechanical system boundaries, such as how to maintain diversification for a growing account when some positions are at position limit or when markets are too thin.
- I tend to alter my activity depending on performance. I tend to be more aggressive after I have been winning, and less so after losses.
Longevity is the Key to Success
- The profitability of trading systems seems to move in cycles. Periods during which trend-following systems are highly successful will lead to their increased popularity. As the number of system users increases, and the markets shift from trending to directionless price action, these systems become unprofitable, and undercapitalized and inexperienced traders will get shaken out. Longevity is the key to success.
Do Not Pyramid Aggressively
- Aggressive pyramiding, and other forms of accumulating monster positions are good ways to lose big money, even in a bull market.
The Trader and the Trading System Must Meet
- Systems don’t need to be changed. The trick is for a trader to develop a system with which he is compatible.
- My original system was very simple with hard-and-fast rules that didn’t allow for any deviations. I found it
difficult to stay with the system while disregarding my own feelings. I kept jumping on and off—often at just the wrong time. I thought I knew better than the system.
- Also, it seemed a waste of my intellect and MIT education to just sit there and not try to figure out the markets.
- Eventually, as I became more confident of trading with the trend, and more able to ignore the news, I became more comfortable with the approach. Also, as I continued to incorporate more “expert trader rules,” my system became more compatible with my trading style.
- As I keep trading and learning, my system (that is the mechanical computer version of what I do) keeps evolving.
- Over time, I have become more mechanical, since (1) I have become more trusting of trend trading, and (2)
my mechanical programs have factored in more and more “tricks of the trade.” I still go through periods of thinking I can outperform my own system, but such excursions are often self-correcting through the process of losing money.
- I don’t think traders can follow rules for very long unless they reflect their own trading style. Eventually, a breaking point is reached and the trader has to quit or change, or find a new set of rules he can follow. This seems to be part of the process of evolution and growth of a trader.
- A trading system is an agreement you make between yourself and the markets.