Wednesday, July 7, 2010

Staying Single : How to Avoid Falling in Love with Trades

When we embark ourselves in the incredible adventure that is trading, we quickly find that the worst obstacle to achieve our goals is nothing but ourselves. In all the years I have been trading I could tell you that most of the problems I have had have been caused by my own actions which have been a consequence of my - sometimes - irrational thinking. One of the worst ways in which I affected my own trading in the beginning was what I would call my "love affairs" with trades. When we start to trade we tend to make every position we enter too important because in the beginning we all generally lack focus and perspective regarding trading as a business. On today's post I will talk about this great problem I had when I started trading and I will share with you some of the things I did to "stay single" and avoid this disastrous experiences with my trades.

It was a sunny afternoon several years ago when I decided that everything was set. The stars had aligned, my setup had come true and I finally had a perfect EUR/JPY trade ready for entry. I entered the trade, entered my stop loss and take profit levels and waited for a few hundred dollars to go into my account. However, the market decided that the odds were against me and I was facing a position very close to my stoploss in a few hours. Then I remember that the EUR/JPY had done this to me before and I exit my trade only to find out I would have hit my TP after a few hours. My decision -based on this irrational thinking - was to give my trade "more room", I moved my stoploss to allow the trade to continue. Then it moved even MORE against me and it wiped my trade. I ended up losing almost 4 times what I had initially planed to lose and the position never bounced back to the level I had set as a TP.
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This is only one of the several examples of times in which I fell in love with a trade and refused to let it go. The consequence was not only a significant financial loss in my account but a feeling made up of frustration and anger that had a snow ball effect that made me revenge trade the market and end up at an even worse point. When you trade like this you are operating your business like a 5 year old, good things - profitable trades - make you very happy and euphoric while bad things - losing trades - make you absolutely frustrated and angry. It certainly took me a few months but I finally realized that this was a recipe for total disaster.

To change this is no easy thing because the present - the trade on your screen - has an inevitable effect on you psychologically. It is extremely difficult to stay calm and trade your system like you were meant to trade it, to avoid intervention and to avoid feeling like a winner or loser based on some limited trading results. This was the most difficult thing I had to do to become a profitable trader to remove these emotions and become immune to the short term emotional effects trades had on me.

How did I do it (and continue to do it!) ? What worked for me was simply to change my perspective from a short term look to a long term look. I realized that trading wasn't working for me because I was too focused on short term results (turning a profitable trade today) rather than on long term results (obtaining a good average yearly return). My strategies and trading didn't have any long term focus and this was the reason why I wasn't getting anywhere. I decided that if this was going to work for me I needed to have long term targets and I needed to know exactly how my systems would perform in the long term. How long and deep their draw down periods were, how many losing trades I could be expecting, etc.

The change here was from night to day. When I started to have a long term outlook on trading as a business and I had a clear perspective on the way my systems worked, understanding why they were going to be most likely successful in the long term and when exactly I needed to stop trading them if they weren't was a blessing to my trading career. Losing trades just became a characteristic of my systems and intervention became a clear thing to avoid since it was obviously detrimental to my systems' results. I became a very cold-minded trader and I have successfully managed to avoid "falling in love" with my trades.

To me a trade right now is simply a very small part of what constitutes my long term goals and therefore it simply makes no sense to get happy or sad about the outcome of any single one of them. Certainly if you are a new trader my advice for you is simple, write down a plan that is extremely clear and that has all the detailed characteristics of your trading system laid out (draw down periods, expected loses, expected profits, etc). Know exactly what you are getting into and gain a LONG term perspective into your trading. Treat your trading like a business with long term goals and you will gain an amazing level of control and discipline that will put you on your way to become a profitable trader.

If you would like to learn more about automated trading and how you can use automated trading systems to improve your trading abilities please consider buying my ebook on automated trading or joining Asirikuy to receive all ebook purchase benefits, weekly updates, check the live accounts I am running with several expert advisors and get in the road towards long term success in the forex market using automated trading systems. I hope you enjoyed the article !

2 comments:

C. Smith said...

Daniel-

Here's a thought regarding evaluating trading systems. This comment belongs more with yesterday's post, so sorry for being a day late.

Anyway, for each trading system (based on the 10-year backtest), calculate the "pain index" which the amount of drawdown times the number of days endured.

You can calculate it based on starting equity and only consider drawdowns from initial equity, or any drawdown from an equity high in the account.

The idea is that a system with a large drawdown for a lengthy period would have a larger pain index than a system with small, infrequent drawdowns.

Up to now, I have just been looking at the % drawdown or drawdown to profit ratio which doesn't tell the whole story.

Looking at the backtests on Asirikuy, it would seem that WA3 trading GBP/USD for example, would have a higher pain index then Teyacanani trading the same pair.

I think its another dimension to consider in addition to the other criteria you used in yesterday's post.

Let us know your thoughts and keep up the fine work!

Chris

Daniel said...

Hello Chris,

Thank you very much for your comment ! :o)

Indeed, your concept of a "pain index" is interesting and it could lead to better evaluation over the psychological aspects of trading a given system.

Systems that have high "pain index" values may indeed be psychologically harder to trade due to the overall draw down aspects of the systems. I will give it some thought and do some calculations and I'll write a post about the idea :o)

Regarding the draw down evaluation, you should use the backtesting analysis tool developed by Gabor which allows us to measure draw down characteristics of trading systems like draw down period number, depth, length, monthly profitability, etc.

Thank you very much again for your comment Chris ! I hope you are enjoying Asirikuy and the blog a lot :o)

Best Regards,

Daniel

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