Through my reflections about how I made the turn from unprofitable to profitable trader I have been able to locate some of the specific changes in my train of thought that caused this to happen. I have realized that the way in which I approached trading changed slowly but surely into a way which allowed me to profit from the market on the longer term. What were these fundamental changes in my approach to algorithmic trading? On today’s article I will tell you the five things I needed to realize before I became a profitable trader which I think every trader needs to realize at some point to reach the same stage. We will talk about each one in detail and why it is so important to reach the status of being a profitable trader who can systematically exploit inefficiencies in the longer term.
Probably you’ve been struggling a lot and you don’t know what you need to do to achieve profit in trading. I was there and it is – at least it was for me – a slow and painful journey to learn the things that need to be learned and to get all the necessary experience that is required to profit from the market. The road towards market profitability is paved with traps and sadly most people need to walk into all of them, stand up , dust themselves off and continue before reaching the final success goal. But what are these very hard things you have to learn before you can become profitable? Is there a way to “speed up” the process? I am now going to tell you the five things I think everyone should realize before they become profitable traders.
1. Decades are important, days are not. In trading one of the hardest things to do is to realize that short term results have no meaning. In the market ANY short term result has an inherent component of randomness which makes the distinction between a true profitable edge and a streak of luck impossible. If you take 15 trades and you won 10 does this mean you have an edge? No, there is a strong chance that just by pure luck you achieved a small temporal advantage over break-even. Many trades over many years are necessary to get an edge which is measurable (which you can be certain you have) and therefore EVERYTHING you do in trading must be aimed at decades and not at days. Your profit targets, expected draw down depths, lengths and other statistical characteristics should be derived from thinking across decades, you should put your targets in decades and NOT in days or months, analyze systems across 10-20 years. The big boys think long term, can you?
2. There is a real probability that any scenario will happen. In trading absolutely all scenarios will eventually happen and realizing that this is a reality is something that will allow you to evolve and get closer to being a profitable trader. Trading a system or strategy with the hope that X or Y scenario will never happen is a big NONO. You’re thinking you are safe because your strategy didn’t wipe an account trading a martingale on a 10 year backtest ? Think again! All possible scenarios will eventually happen, X consecutive losses, a 100% move on a pair above or below historical highs. All of this has a probability to happen and therefore it eventually will. Since this causes all systems to eventually fail the only protection we have is having a worst case scenario that does NOT involve a wipe out, derive worst case scenarios from formal statistical criteria – like Monte Carlo simulations – which can get you out before it’s too late. Trade any system assuming something will not happen and it will happen and you’ll get wiped out.
3. Simulations have limitations. A very important thing every algorithmic trader must know before becoming profitable is that simulations have their own limitations. Testing systems with the idea that everything you code and test gives reliable results is a death-trap since you will get deluded by your own extremely profitable and yet unreliable simulations. When you realize that simulations have limitations and you KNOW what these limitations are you will be able to get into the act of coding and evaluating systems that give results that closely match what would have been truly obtained in real previous trading. When you code with restrictions aimed at addressing the limitations of your simulations you’re a step closer to being profitable.
4. It’s not about psychology. Many traders believe that the reason why they aren’t profitable is because of some psychological factor. For example you’re too greedy and risk too much or you cancel your trades or stop your systems too soon because you fear your account will get wiped. One of the biggest realizations I have had as a trader is the fact that psychological problems are NOT a cause of your failure but they are a symptom of the TRUE reason why you fail which is lack of understanding. Once you realize that your problem is a problem related to your lack of knowledge and understanding about the market, trading and algorithmic system development (if you’re trading systematically) then you will have a fighting chance because you will be able to attack the ROOT cause of your problems.
5. It’s better to be profitable than to be right. A huge reason why failure is so predominant amongst aspiring algorithmic traders is the huge marriage many traders get into with their own systems. When you develop a mechanical system you should think about it as a tool and not as your child, the system has to be stress tested and “beat up” like there was no tomorrow in order to know if it can stand up to the test of live trading. Did the final out-of-sample test didn’t work? Did the system fail a spread widening test? Did it fail dramatically under a Monte Carl distribution perturbation test? Any failure of a stress test is accompanied by a “bye bye system”. It is MUCH better to go back to the drawing board and work until a robust system is generated. Only trade a system if after carrying out any possible stress test it still survives, the more you test them “by fire” the better they will be. Better profitable than right!
The above items I have pointed out are what I believe to be important key aspects of the profitable trader mindset. All profitable algorithmic traders I know have them and I would imagine that it would be extremely hard to achieve long term success without realizing the importance of all the above mentioned ideas. Can you just believe them? No, most traders will need to learn them by experience and by the “beating up” of the market each time one of the above is neglected. Some people will need to wipe 10 accounts using Martingale systems, some will need to wipe accounts using systems that do not have reliable simulations and some will need to get immensely frustrated with the chasing of short term profitability (that will come and go). Those who make it across will have a chance.
I hope you enjoyed this article ! :o)