Trading: Myths and Facts – Part 3

In trading, perfectionism is an extremely harmful mindset. No trader on earth can avoid losses. Whenever you open a position, either your stop or target is hit, or either you close it in a negative zone or a positive zone. There is no way around these. You need to resolve to stop feeling sorry for yourself and dwelling on negative thoughts whenever a trade goes negative. So, you have a loss in the market. A loss is a loss. You only suffer when you believe that it should not be that way.

Arguing with reality causes all manner of suffering. Until you understand this, you will not understand life and trading. As a beginner and often being deceived, loss trades would test your commitment to trading success and forever change the way you view the markets. However, they also give us the opportunity to develop valuable qualities befitting a great trader.

Myth #4: Without Having Reasons for Entering Trades, You Would Always Lose

Fact: How good and pleasant would it be if the markets were able to move in our favour simply because we have reasons for taking trades. Apart from certain no-rule traders, the majority of traders are rule-based market players. Yet a majority of traders lose. For example, a price action might be pushing up the upper band of the Bollinger Bands, when the RSI is overbought, when the Stochastic reading is in the overbought region, when a candlestick reversal pattern has formed, and many analysts are saying they are expecting a reversal based on a certain fundamental event. You might still take that trade and lose.

Making the best trading decision in the world is no guarantee that a trade will not move against you, neither would the market respect you just because you know what is happening to the Loonie or the Kiwi. Your survival on the markets requires something more than mere reasons for taking trades. Most trading reasons come from strategies (and strategies are the least important factor in trading success while the most important factor is psychology, followed by effective position sizing methods).

I am not saying it is bad to have reasons for taking a trade – for having no reason is even worse. A good trader must have reasons for taking any long term and/or short term trade, but their survival secret lies in using very small position sizing, cutting losses and running profits. There are easy ways to capitalise on market unpredictability and meet your objective through sound position sizing and by sticking to winning exit criteria.

Myth #5: It Is Better to Abandon Even a Good Trading System If It Loses

Fact: You need patience to use any trading strategy successfully. The value of patience will forever be emphasised. Losing trades happen quickly; winning trades take time to develop.

Trading legends are not those who always double their accounts, but those who make presentably consistent profits over a long period of time. These traders have good years and bad years, good months and bad months, and good weeks and bad weeks. The most important thing during a losing period is for a trader to suffer as little drawdown as possible. If your drawdown is very small, then recovery will be very easy when the market condition becomes favourable. If you happen to examine the live account history (not back-tested or curve-fitted results) of any successful trader, you would see losses and profits, plus how the trader has moved ahead irrespective of those losses.

The lesson is straightforward: A good trading system will intermittently experience drawdowns, but will recover ultimately. It also means that part of the accumulated profit would sometimes be given away. For example, one trading system uses the initial stop of five per cent, has a maximum drawdown of -20.01%, annualised gain of 29.63%, net profit of 373.86% over several years, and average winning trades of 49.47%. This is still a good result which recovered irrespective of drawdowns.

Trading rookies and impatient traders may conclude that a trading system is bad during a period of drawdown or a losing month or year. A trading system that worked well in the past would soon survive any present losing streak. You should not abandon your great trading idea because of a losing streak: Just as you should not abandon a loving, caring, faithful, honest and humble spouse because of a mistake on their part. Someone who treated you well in the past might continue doing so in the future in spite of occasional shortcomings on their part.

If you abandon your good system for another, you would soon experience drawdowns with your newly-found system; just like someone who experiences the same problem with a new mate after divorcing the former good mate. A professional trader may go through consecutive losing months, but he can recover at last and move ahead. He knows the most important thing in trend following is to keep losses very small and ride winners. He does not abandon his strategy simply because of transient losing streaks.

Myth #6: The Best Traders Are the Ones Who Win Organised Trading Competitions

Fact: You need not be an institutional speculator or a trading champion before you can become a great trader. Please answer this question: Who is really a trading expert, someone who accumulates hundreds of percentage points in a short period of time, or someone who has been surviving on the markets for many years?

In a trading competition, those who make the highest returns are chosen as winners, especially when they make the most money. Most of these competitions are usually short in duration (whereas a short period of time is not enough to determine the validity of a trading strategy). A winner of a trading competition is thought to be a champion on the battleground of the financial markets, whereas risk management is given little thought. Honest-hearted traders and funds managers that cherish the value of patience, risk control and capital preservation do not seek that kind of recognition.

I am personally interested in demonstrating how I survive on the markets on a long-term basis instead of showing how I make huge profits over a short period of time. A scalping system which works well in a ranging market may fail in a trending market: A trend-following strategy that works well in a trending market may fail in a sideways market. When such a system is used in a period that is only favourable to it, it may make the user appear like a guru. One trading system was used successfully in one trading championship – with flying colours.

The amazing results from the championship were displayed and people rushed madly to buy the system. Majority of them later crashed and kept their mouths shut. The odds of long-term survival with high-risk trading (like 20% or 40% per trade) are astronomical.

One popular trading journalist (who is now a successful trader), won a decisive stock trading competition and thought that he knew what he was doing. He was celebrated and rewarded for his supposed ingenuity. Little did he know that his victory was out of sheer luck. He invested $20,000 which belonged to his granny and lost almost all the money. Then it dawned on him that he was a real novice. He later learned what it really takes to be a successful trader and his life was transformed.

There was one trading challenge some years ago, in which the top winner made over 1200% in one month. Other winners also made hundreds of percentage points within the month. There were aggressively crazy advertisements about those top winners and the trading styles they used. Even people who did not know anything about trading acquired those strategies, only to resell them to other novices like them. Nobody cared about the highly risky position sizing that the so-called winners used. But some time later these same people had gone mute about these ‘magical systems’.

People often make a mistake by thinking that they can always trade with 100% accuracy. I heard of someone who promised a profit of 175% to his investor on a monthly basis, but no returns ever came. He had run away! It became clear that his mindset was shaped by those incurably tricky marketeers who show [doctored] gargantuan profits. Many a trading strategy has been bought because of very high returns in a short run only later to experience a huge drawdown with it. Almost anyone can make money in a given period – but long-term consistency is what is most difficult to achieve.

I know how much sly marketeers contributed to my harsh experiences during my novice years. I always believed them because I lacked the knowledge about trading truth. If you are to accept the words of sly marketers as fact, you must be prepared to face the possibility of 20% drawdown per trade if you target 20% profit per trade. You must believe that it is possible to avoid losses in trading, despite contrary time-tested evidence shown by reality.

You must believe that a trading system or a piece of software is a holy grail, despite what those who had been trading before I was born were saying, that the holy grail is risk management. Which course do you want to take? When your mind is in sync with the truth about trading, you will have taken a giant leap forward in your personal evolution as a trader.

Conclusion

To perform well in any field, a person must master the information and skills specific to that field. Both professional and novice traders face losses. The only difference is that professionals know how to deal with the losses and eventually move ahead, whereas novices do not or they are not willing to do that.

Great lessons can be learned from great traders. These lessons contain both an appeal and a warning. The existence of trading principles that work leaves you with a choice: Accept them or reject them. The choice you make will eventually reflect on your trading results. You are ultimately responsible for your success or failure. The next article in this series will look at some unethical trading attitudes.

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Author: Mustapha Azeez
Originally published: November, 2011.

Reproduced with kind permission of: TRADERS’ media GmbH