Seven Deadly Sins of Trading doc

Seven Deadly Sins of Trading by Harvey Walsh Copyright 2012 Beige Media Published by Beige Media at Smashwords Smashwords Edition, License Notes This ebook is licensed for your personal enjoyment only. This ebook may be not be resold or repackaged, but may be given away to other people provided it is not modified in any way. Contents Introduction Sin Number One: Switching Strategies Sin Number Two: Not Having a Trading Plan Sin_Number_Three_Not_Understanding_Money Sin Number Four: Not Testing Sin Number Five: Not Putting In The Necessary Effort Sin Number Six: Overcomplicating It Sin Number Seven: Not Taking Action More From The Author Introduction Between the private coaching I used to run, my original Day Trading Freedom course, and my best-selling book How To Day Trade Stocks For Profit along with my more recent forex book, I have taught traders from all over the world. Whilst many of my students have never traded before, there are many more who come to me having some experience, but who for one reason or another are not profitable in their trading. What is it that makes one person profitable while another person of similar background, intelligence, and motivation, is unable to make money from the markets? It's a question that I have spent a lot of time thinking about. By working with a great many unprofitable traders (as well as plenty of profitable ones) I have discovered the same basic errors cropping up time and again. In fact, so common were these mistakes, I started referring to them as the seven deadly sins of trading. In this ebooklet, I tackle each of those mistakes in turn, and I tell you how you can overcome them. Sin Number One: Switching Strategies "The Hunt For The Holy Grail" The holy grail of trading - we've all looked for it - the super system that never loses. We've searched forums, read books, been to seminars, and discussed in chat rooms, but the secret system that wins every time continues to elude us. Why do we waste so much time and effort searching for something that doesn't - cannot even - exist? Because it's far easier than facing up to the reality that trading isn't quite as simple as buying when a magic indicator says buy, selling when it says sell, and watching the endless profits roll in. Actually, it is almost a simple as that, but we'll come to that later on. For the moment, the important thing to recognise is that there is no holy-grail-always-wins trading system. Anyone who tells you otherwise is stringing you along. It's certainly easy to get caught up in hype and marketing talk about winning systems. It is in our nature to look for shortcuts, for the easy way out. Of course the reality is that if there was a trading system that won every time, everybody would start using it and the markets would become unbalanced and inefficient, which in turn would cause the system to stop working. Markets, by their nature, simply do not allow for any such system to exist. The grail hunt is a highly destructive behavioural pattern that affects almost every trader at some point in their career. Typically, the trader starts by learning a system or strategy, which they execute for a short period of time. The strategy may prove profitable almost immediately, or may incur an early loss. Either way, sooner or later a loss will happen, and equally inevitably, a run of losses will occur together. At this point the trader decides that this is not the system for them, and heads off in search of a new method. In jumping from system to system in this manner, the trader never gives a strategy time enough to prove itself over the long term. All systems involve some losing trades, that's the nature of the markets, but as long as a strategy has positive expectancy overall (that is to say, it will on average win more than it loses), then those losses are of no importance. Action As traders, we must accept that fact that losses are to be expected, and stick to our chosen system for long enough to prove or disprove its expected long-term outcome. In doing so, we break the grail hunt cycle and overcome one of the biggest obstacles to our success. As a final note on this subject, I want to add a word about forums and chat rooms. Whilst these are undoubtedly excellent sources of information and ideas, they can be very dangerous in fuelling the cycle of strategy jumping. The nature of these resources means that they continually offer new ideas, and to the trader that means new temptations. By all means test out or paper trade new ideas alongside a live strategy, but beware of becoming a forum-follower and re-entering that pattern of always jumping aboard the 'next big thing'. Sin Number Two: Not Having a Trading Plan "If you fail to plan, then you plan to fail" I don't know who first said that, but it's a very sound piece of advise indeed. Planning is something that is all too often overlooked by traders, and yet a well drafted trading plan is one of the most important tools for success and profit. In talking to struggling traders, I am constantly amazed at not only how many don't have a trading plan, but how many don't even know what such a plan is. In fact a trading plan is quite simple. It is a document that details every aspect of your trading strategy. It is literally a blue-print for your trading methodology. What should be in this document? Here are the most important areas it should cover: Mission Statement - A defined objective for your trading. If you don't know what it is you are trying to achieve, how will you know when you have achieved it? Having a well defined goal is essential to success in any venture. Pre-market preparation - Actions required before the market opens, setting up for the trading session, reviewing economic calendars, and so on. Trade entry rules - When to open a new trade, and just as importantly, when to stay out and remain on the sidelines. Trade exit rules - When to close (fully or partially) a trade. Money management rules - How to size your trades and manage risk in a way that will ensure you stay in the game. Post market actions - Trade logging and analysis. As anyone who has traded in a live market knows, we must often overcome our natural emotional responses in order to execute our trades correctly. Cutting losses and letting winners run can be easier said than done. By defining, as precisely as possible, our criteria for entering and exiting trades, we have a reference that we can use to help us overcome these responses. The trading plan should be kept at hand throughout the market session. When we see a possible entry coming up, by referring back to our strict written entry criteria we can objectively look at the chart and make a informed decision about whether to enter or pass. The same applies to exiting, whether the trade is winning or losing. Over time, trading becomes almost mechanical and stress-free. Action We must have a written plan that defines all aspects of our trading, and we must commit to following it to the letter. Only by rigidly sticking to our strategy can we honestly determine if any problems in our trading lie within the system itself or within our execution of that system. Sin Number Three: Not Understanding Money Management You might well be thinking that money management is a really boring subject, but before you decide to skip to the next section, let me say that this isn't just about making sure you survive long enough to turn a profit. It can also open up whole new trading opportunities to you. There are two distinct sides to this subject, and for some unknown reason, most people only ever talk about one of those – survival – or what I call classic money management. It is hugely important though, so let's cover that right now. The idea is simple; firstly, we have a pot of money to trade with. Secondly, as we have established, losses are a part of trading and so there will be times when the cash in that pot decreases instead of increasing. So it stands to reason that if we don't manage that cash correctly, it is entirely possible that we lose it all and can no longer trade. The concept behind classic money management then, is to trade in such a way that our losses do not affect our ability to trade. An example will make this clearer. Let's assume we have a starting balance of $5000. We want to ensure that we can survive in this trading game for at least six months – easily long enough to prove our strategy and ability, and to turn a profit. At its simplest, we could say therefore that the maximum we would allow ourselves to lose each day is $40. If we hit that limit, we would stop trading for the day. This would keep us in the game for our six months assuming the worst case scenario of losing every day - which would be quite some feat in itself! We could expand this money management strategy to say that if we lost our maximum limit of $40 a day four days in a row, we wouldn't trade on the fifth day of the week. Furthermore, if we lost three weeks in a row, we wouldn't trade the last week of the month, and so forth. If we were losing as badly as that, clearly something would be wrong either with the strategy or our ability to execute it and so these enforced breaks would offer a chance to step back and analyse where we were going wrong. Assuming a $40 a day maximum loss, it stands to reason that we could not enter any trade where the possibility for loss was greater than $40 – to do so would be to expose our account to a greater loss than is permissible. So our daily limit gives us a starting point for calculating risk and reward ratios for actual trading setups. Not only does classic money management ensure we have a decent shot at getting profitable, it gives us a psychological advantage too. Knowing beforehand the maximum we can lose in any one day or on any one trade removes a huge amount of pressure. We can enter a trade and assume that our money is already lost. By cutting it free at the trade entry in this way, we feel less stressed about the trade and can manage our position based on what actually happens in the market rather than what we want to happen. There is as I mentioned, another side to money management – position sizing. Many traders will trade fixed position sizes based on the availability of funds. This is perfectly valid, but it means that when looking at possible trades, they are inherently limited in what they can enter. Dynamically adjusting the size of the position a trader is willing to take in relation to the cost of the underlying instrument can open up whole new trading possibilities. Let's look at that in a little more detail. Many stock traders start by trading very small sizes, perhaps 100 shares per trade, and then work upwards from there as they gain experience and funds. The same applies to futures traders, although to a lesser extent because most futures contracts are worth more per contract per tick than 100 shares (which equate to $1 per tick); in other words stock traders have the opportunity to start smaller. As stock traders increase their size, there is usually a tendency to remain with fixed sizes per trade. For example, I know many traders always take positions of 1000 shares at a time, making every 1 cent move in a stock price worth $10. Traders who work in this fixed way are missing out on an opportunity to increase the number of trades available to them. Why? When a trader looks at a chart setting up, one of the aspects of any potential trade s/he will be considering is the reward to risk ratio and how it sits with their own money and risk management profile. For example, let us assume we have an account balance of $30k, and a maximum risk per trade of 1% of account size, a common enough scenario. This gives a maximum risk of $300 per trade. Dealing exclusively in 1000 shares at a time, this means we are willing to take a maximum loss of 30 cents per share on any one trade. Certainly we have every chance of finding good trades every day where a 30 cent stop is sensible, but what about the hot-stocks of the day that are showing great volatility and range? A fairly recent example (at time of writing) of such a stock is AAPL, which has put in some stunning intraday moves – runs of many dollars at a time. With our 1000 share trades, most of these moves on AAPL will have been out of bounds simply because it has not been possible to trade them with a 30 cent stop – indeed the spread has been 25 cents or more for some of the time. If however, we were to reduce our size, we could increase our stop without increasing the maximum risk to capital. If we wanted to trade AAPL with a stop of 90 cents, trading 330 shares would expose us to a maximum loss of $297, which is within our risk reward parameters. The bigger expected return from the trade would make up for the smaller profit per cent gained, and very often the moves on such stocks are proportionally greater than the required reduction in trade size. We can see then that by considering size in each trade, it becomes possible to actually shift the reward to risk ratio in our favour, and open up a whole range of trading opportunities that we may otherwise have to pass by. Action In order to give ourselves the best chance of survival in the market, we must define clear money management rules for our trading, based on our available capital. Doing so will give us the added benefits of relieving the psychological pressure involved in taking losses, and opening up new trading possibilities that may previously have been thought too risky. Sin Number Four: Not Testing Trading is a great business. It offers potential levels of income and freedom that most people can only dream of. So it's quite natural that having got the groundwork out of the way, the novice trader is eager to get clicking those buy and sell buttons and see the profits roll in. But hang on – the preparation isn't over yet! Imagine for a moment that you decided you wanted to become an airliner captain. You spent time and effort researching the type of aircraft you were going to pilot, you read some books on how to fly, and then one day you found yourself sitting in the cockpit, lined up at the end of the runway. Clearly, without having actually taken some time to learn how to fly this machine full of passengers, trying to take off would be a disaster! So why is it so many traders believe they can read a book about trading and then leap into the market without first getting some experience? If you were going for the pilot's job, you'd take a training programme which would undoubtedly see you getting some no-risk experience in a flight simulator. This would give you the opportunity to make all of your early mistakes without crashing a few seriously expensive 'planes in the process. As traders, we are very fortunate in that we, like airline pilots, can practise and hone our skills in a risk-free environment. Indeed we have the added benefit that we can simulate our activity with high degrees of realism at little or no financial cost at all. I am of course talking about paper trading. In the most basic sense of the term, paper trading means that we follow our trading plan exactly as if we were going to put real money into the market, but at the point where we would actually buy or sell, we simply make a note of the current price instead of opening a live trade. We would continue to manage the trade exactly as if we had real money in the market, and would exit accordingly, again, writing down the exit price. Going a step further from pen and paper, today's internet-generation trader can take advantage clever software simulators which imitate a live trading platform. These programs, often free, have the advantage of making the paper trading experience much more realistic. They also cannot be cheated in the same way as a note on a piece of paper, which is to say we cannot conveniently decide to erase a trade we later decide was a mistake! There are some who believe that paper trading is not worthwhile as it can never reproduce the emotional stresses that are involved in live trading. Whilst that is true to a certain extent, I would argue that if you are not sufficiently proficient at executing your trading plan in a simulator, why would you be able to do so with real money? Paper trading gives us a great opportunity to put into practise what we have learnt, test new strategies, and tune our skills with no risk. Once a trader can consistently show a profit on a simulator, they are ready to take the next step – live trading. Again, this is not something to be rushed, and again, like airline pilots we can work our way up to this. [...]... "It was a great day! I made a $1175.50 profit." "Per 1 January I started day trading full time." "I am already making my job salary in trading. " "I ended my first day of live trading with a net profit of $279.53." Now in its third major edition, How To Day Trade Stocks For Profit has helped countless people go from novice to full time day trader Expand your trading skills and learn to trade the multi-trillion... the wonder of the internet, we can trade them all That means that when you have some spare time, there is a market open somewhere There's no need to give up the day job to try out trading Time: "I don't have time to sit in front of a computer all day learning this stuff" Half an hour a day is enough time to learn the basics of trading inside a couple of weeks After that, half an hour a day of practicing... real If trading equities (stocks), we can buy and sell very small amounts at almost negligible cost If trading futures, we can usually start with "mini" contracts which are valued at a fraction of the price of a full size version Whilst this limits our profit potential as we take our first steps in the live market, it very importantly also limits our potential losses With the huge array of software... the expense of existing obligations In other words, a novice trader can learn the markets and practise their trading whilst continuing in their day-job, and without significant outlay Indeed I would advise any would-be trader to have a steady source of income when they start out The absolute need to generate a profit can have a hugely detrimental effect on trading decisions A problem a lot of student... but if we take a step back for a moment, trading really need not be complicated at all Finding a strategy to work with can take as long or short a time as you like There are plenty available off the shelf (including within my own books, naturally!) Formalising that strategy into a written personal trading plan is something that requires only a couple of hours of time up front, after which it can be... price chart! I'm not saying that modifying and testing of new systems and ideas isn't valid, but when it's done at the expense of trading an already profitable system, the trader ends up chasing their own tail, and loses out in the long run Remember that every strategy will have losing trades When those losses are within the normal expectations of the system, there is no need to start fiddling Stick... to the field of online trading; people believe that they can read a book, open an brokerage account, and start making huge amounts of cash just like that I used the analogy of an airline pilot in the previous section, so let's continue with that theme here Not many people would expect to decide on Monday that they wanted to fly long-haul airliners, buy and read a book on the principles of flight on... take the next step to becoming a profitable trader It's a sad fact that many who read this will never take their trading dream further But those few that do will be well on their way to success, profit, and trading freedom More From The Author Learn how to trade the US Stock Market, the world's largest and most liquid equity market In How To Day Trade Stocks For Profit, Harvey Walsh uncovers the techniques... setups used by professional NASDAQ day traders The book is a complete course designed to get you quickly making money from the stock market No previous trading experience is necessary Easy to read and jargonfree, it starts right from the very basics, and builds to a remarkably simple but very powerful profit generating strategy Readers of this book make real money Here's what just a few of them had to... us, along with discount brokers offering cheap trading instruments, there is no need for any trader to get seriously burned on their first outing into the market Action We must commit to testing and practising our trading in a risk-free environment before putting our capital into the live market Only when we can show consistent profit on a simulator, should we move on to trading real money, and then only . mistakes, I started referring to them as the seven deadly sins of trading. In this ebooklet, I tackle each of those mistakes in turn, and I tell you how. Seven Deadly Sins of Trading by Harvey Walsh Copyright 2012 Beige Media Published by Beige