(Harun I., June 19, 2008. a US perspective)
Trading principles correlate to everyday life. The odd thing is that 80-90% of traders fail. Trading draws primarily intellectuals (doctors, lawyers, engineers, etc.) who are usually successful in their field of expertise. They think the same set of tools that made them successful in their professional life is all that is needed but, ego dashed to a million pieces, they come, they see, and they fail.
Trading principles are easy to understand but difficult to implement because our mind, the great trickster, betrays us. But those who are successful are usually successful in all parts of their lives because they have embraced these principles as a way of life and by doing so avoid a multitude of troubles.
So what are some of these principles and how can they help us? I have outlined my thoughts below. While nothing is perfect, they have worked for me in all aspects of my life.
Trade with an edge.
"Know the enemy and know yourself
In a hundred battles you will never be in peril.
When you are ignorant of the enemy but know yourself
Your chances of winning and losing are equal.
If ignorant both of your enemy and of yourself
You are certain in every battle to be in peril." -- "Art of War" Sun Tzu
In trading an "edge" is nothing more than an advantage or what we like to call a "positive expectation." Most people think that this means that their methodology must produce more winning trades than losers, this is not the case. The edge should produce a scenario in which the average winning trade is greater than the average loser. This is how a trading system that wins only 30-40% of the time can be profitable.
All successful endeavors have been so because an advantage has been exploited. Knowing your strengths and weakness as well as those of the enemy put the odds in your favor. While a potential client or employer are not "enemies" they may been seen as an adversary who must be won over. Understanding their global needs and psychology is tantamount to being successful.
Every surviving species has an edge which has allowed it to survive. Man’s edge is his ability to think and change his environment in order to survive. The ability to understand universal principles and change our environment is what separates us from all other creatures on the earth. But with this unique ability comes the stewardship of the earth. Long on greed while short on wisdom and humility we (industrialized, first world countries) have disregarded this all-important responsibility. Driven by greed and high on hubris, we have burned through nature’s gift’s. Resource depletion has left us vulnerable to the inevitable perfect storm -- and now it is brewing.
Failure to understand the enemy and ourselves is where we blundered in Vietnam, and in Afghanistan and Iraq. Arguably, when we launched the WOT (War on Terror) we knew not ourselves or the "enemy" and therefore, 5 years later, the free world's best trained, most technologically sophisticated military is still embroiled in a conflict that appears to have no end with what one would think is a seriously disadvantaged foe.
Sun Tzu never went to a war college or had a Mac computer but he was much more brilliant than our military and civilian leaders today in that he understood the principles and statistics of winning.
Plan your trades, trade your plan:
Alan Lakein said: "Failure to plan is planning to fail. Planning is bringing the future into the present so that you can do something about it now."
"No battle plan ever survives contact with the enemy." — Field Marshall Helmuth Carl Bernard von Moltke
Someone who has been in the markets long enough and is successful knows that the worst time to make an unplanned decision is when the market is open. The majority of off the cuff decisions made while the market is open are the wrong decision.
Successful traders have a plan that has all the elements of winning: mind, method, and money management. Their plan has contingencies because they understand what the good Field Marshall laid out in the above quote.
Getting into a trade is easy, 80% of traders get in on the right side of the market. Where they toss it up is at the exit. Most traders have no exit strategy and therefore they lose.
What is our exit strategy for the petrochemical cycle? We have had over 150 years and we are in panic mode. What is our exit strategy for the end of credit expansion? Meltdown it seems. What is our exit strategy for Afghanistan and Iraq? Can’t think of one? That’s why we are losing.
Cut losses and let winners run:
Losing traders, business leaders and governments do the exact opposite. They cave to the "sunk cost" cognitive bias and don’t realize or seem to forget that by cutting losses they can live to win another day.
I hear this as the excuse to stay in failed relationships, failed government policies and programs, failed businesses, and war. "Too many have died to quit now" goes the refrain.
But losses should be planned for and shouldn’t be let to run. I can’t think of any successful trader who answers a margin call. They realize they are wrong, take the loss and reverse the position if it is within their methodology to do so. There is no use sending good money after bad. There is no use making SUV’s as crude oil prices skyrocket. There is no use in staying in an abusive relationship. 4000 dead soldiers does not justify, for the sake of it, the sacrifice of another 50,000.
These few principles are simple enough but difficult to implement. Like I have said, I can’t say that these principles would make for a perfect world. There are times when I lose my way, which are followed by instructive losses, and I have to get back on track. But each moment is perfect and all things are relative. Principles for trading successfully are not specific to trading but are universal to life. Because they are mostly ignored is why we have what we have.
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