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Trading as a Business:
The Art of Strategy Design - In Theory
By Charlie Wright
I have refined a standard procedure that I use to work
my way through the process of creating a strategy. We
will start with the big picture and make increasingly
more detailed decisions about the strategy. We will
begin with the major assessment of what type market
action we want to trade and what kind of trader we want
to be. We will end up with making decisions on exits,
and how far away to put our money management stops.
Pick the Market Type
Again, the first decision you must face is what type of market action you want to trade. Although on the surface this may look like an easy decision, in fact, it is a difficult judgment. The reason it is difficult is because most new traders only consider one aspect, profits. They simply try to pick the strategy that makes the most money. Unfortunately, focusing on the money will probably lead you to make the wrong decision. It is the psychological aspect of trading each of the market types that is the most important consideration. Keep in mind that it does not make any sense to create a very profitable strategy that you are unable to trade psychologically.
Researchers have found that 95% of all traders lose
money. If we accept this to be true, then almost all
of those millions of decisions will ultimately be wrong.
As these decisions move the market, the market reflects
human nature, and if 95% of the traders are losing money,
it is clear that to make money you cannot trade like
everyone else. If everyone else is trading as human
nature demands they must, to be successful you have
to trade against human nature, your human nature.
The most profitable trades I make usually feel like losers when I put them on. Taking these trades always goes against my human nature. For instance, many years ago I used to day-trade the S&P futures. On one particular day I had suffered a string of six losing trades in a row and had experienced a drawdown in excess of $11,000. This was an extremely difficult day and I was ready to quit when with 45 minutes to go in the day I got another signal. What I really wanted to do was to throw my computer out the window and go home. There was no reason to put on another losing trade. Why throw more money after bad? I was not a masochist! The market was choppy all day and I surely was not going to make any money on another useless trade.
At this point however, I decided that if I did nothing else for the day, at least I would take all of the trades my strategy gave me. If the strategy lost money, then I would have to change the strategy, but I never wanted to say that I did not have enough discipline and stamina to implement the strategy I had developed, even though my instincts told me this next trade would be financially stupid.
So I took the trade, and vowed to take every subsequent
trade until the market closed. I was not going to follow
my inclination and quit. I would assess the strategy
after the markets closed, not during market hours. During
market hours, my only job was to implement the trades.
Well, the market exploded into one of those end-of-the-day
moves that lasted until the closing bell. Not only did
I made back all of the days losses, I ended up
with an $8,000 profit for the day!
Many people were trading the trend this particular
day. Trend traders had built up large losses in a very
choppy market and most of us simply gave up. Just when
we were ready to give up, the market moved. Those who
gave up missed the big move. The human thing to do,
the financially conservative thing to do was to quit
and preserve money for another day. The people that
made money traded against their human nature and stuck
it out. It was a very difficult thing to do, but I learned
a great lesson on that day.
I learned that to trade the trend effectively you must
be able to make the hard trades. The market will push
you to your psychological limit before it gives you
the profit. It will make sure that all the weak players
are gone before it gives those that remain the big move.
You need to make sure that you are not one of the weak
The other lesson is, dont try to trade a market type that is impossible for you to implement. If you cant see yourself trading through a situation I just described, or you have been in one or several just like it and had trouble or quit, then trend trading probably is not for you. It is better to recognize early what type of markets you are capable of trading and accept it rather than to lose a lot of money finding out.