Take A Punch March 19, 2010

Brett Steenbarger:

“Everyone has a plan ’til they get punched in the mouth.”

That’s one of the central challenges of trading. We set out with plans, then we get punched in the mouth with adverse movement.

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One way to think of risk management is as a framework that allows you to be aggressive enough to occasionally get hit in the mouth, but not so wild that you’ll get knocked out. Learning how to take a punch is key to boxing success, and it’s also an important trading skill.

Experience March 14, 2010

There’s no substitute:

From the folks at Elliott Wave International:

3. Experience. Some people advocate “paper trading” as a learning tool. Paper trading is useful for the testing of methodology, but it is of no value in learning about trading. In fact, it can be detrimental, by imbuing the novice with a false sense of security in “knowing” that he has successfully paper traded the past six months, thus believing that the next six months with real money will be no different. In fact, nothing could be further from the truth. Why?

Because the markets are not merely an intellectual exercise. They are an emotional (and in extreme cases, even physical) one as well. If you buy a computer baseball game and become a hitting expert with the joystick while sitting quietly alone on the floor of your living room, you may conclude that you are one talented baseball player. Now let the Mean Green Giant reach in, pick you up, and place you in the batter’s box at the bottom of the ninth inning in the final game of the World Series with your team behind by one run, the third base coach flashing signals one after another, a fastball heading toward your face at 90 m.p.h., and sixty beer soaked fans in the front row screaming, “Yer a bum! Yer a bum!” Guess what? You feel different!

To put it mildly, you will find it impossible to approach your task with the same cool detachment you displayed in your living room. This new situation is real, it matters, it is physical, it is dangerous, other people are watching, and you are being bombarded with stimuli. This is what your life is like when you are actually speculating. You know it is real, you know it matters, you must physically place orders, you perform under the scrutiny of your broker or clients, your spouse and business acquaintances, and you must operate while thousands of conflicting messages are thrown at you from the financial media, the brokerage industry, analysts, and the market itself.

In short, you must conquer a host of problems, most of them related to battling powerful human emotions, in order to trade real money successfully. The School of Hard Knocks is the only school that will teach it to you, and the tuition is expensive.

Or, as Dave Landry would put it:

- Trading is all about making decisions.
- Making good decisions comes with experience.
- Experience comes from making bad decisions.

I often wish I was through gaining ‘experience’.

The Beast Must Be Fed March 7, 2010

Barry offers some advice to a young trader. Excerpts don’t really do it justice, so I highly recommend you go read the whole thing:

Yes, there is an insanity to the markets that can make you mad if you let it. Instead, learn to see the delightful absurdity of it all. Revel in the stupidity, learn to read when the ‘wisdom of the crowd’ turns into an angry mob. Find some Zen in the foolishness of others.

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Time is always on the side of the patient. Study, learn, absorb all you can. You are waiting for the next opportunity to make your bones, your fortune, your reputation. It will come along eventually — if you wait for it and are in a position to take advantage when the moment arrives. As Pasteur said, “Chance favors the prepared mind.”

You must become a philosopher, a historian, a statistician, a trial lawyer, and a psychologist when looking at Mr. Market. Simply reading the data and trying to trade/invest off of it is a sucker’s game. The noise so totally outweighs the signal that it is easy to caught up in distractions.

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You must learn patience, young grasshopper. You must have faith that EVENTUALLY, the sorta kinda, almost efficient market will figure it out. That is when money returns to its rightful owners. There will be long periods of time when the blowhards, the jackasses, the arrogant, the ignorant will be eating better than you. During the dot com bubble, the dumber you were, the more money you made. Many of those who understood how silly things were missed out on the boom.

But this state of affairs is temporary. Eventually, the knaves starve to death under the oppressive force of their own ignorance. Be patient. The day of reckoning is often surprisingly late in its arrival, but it will not be denied. The beast must be fed.

Great stuff, Barry. Thanks for sharing it!!

Risk Management March 2, 2010

…prevents you from blowing out your account with just a few losing trades.

Deron Wagner goes over it in today’s free edition of The Wagner Daily:

…most professionals advise risking no more than 1 to 2% of account value for any given trade, depending on one’s personal risk tolerance. In the model portfolio of The Wagner Daily, we typically size each trade for a maximum loss of 1% (about $500 for the $50,000 model account). Furthermore, we always take overall market conditions into account, which sometimes causes us to reduce risk even further, such as by taking “half” positions in indecisive or choppy environments.

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Excepting the occasional adjustment for unusual market conditions, we size all positions to take approximately the same risk of 1% per trade. We don’t play favorites and take greater risk on one trade than another just because we think “this is the play of the century.” Quite frequently, the trades we have the lowest expectations for at the time of entry go on to be the biggest winners. Conversely, trade setups that look “perfect” at the time of entry often become nothing more than duds. As such, we learned a long time ago that picking and choosing the amount of capital risk per trade is not a winning strategy for our methodology. Rather, we take the same risk for every trade, and just let the law of averages work in our favor year after year.

Risk management and capital preservation. Learn what they mean, and how to implement them. They’ll keep you in the game.