Observation is the fundamental building block of learning. It’s almost impossible to work on your performance without having an eye to distinguish good mechanics from the poor ones. Much like before one is able to utilize any equipment in the gym, it’s important to figure out what you are working on, and how you are working on them.
Let us look at a “newbie” trader named K. K was a trader that didn’t know what to work on. Being new to the market, he was trading one to three contracts following a period of paper trading like most new traders would. There was this once where E-Mini S&P Futures (/ES) was range-bounded during an unusually slow midday period. To most developed traders, the market is going nowhere.
/ES had been oscillating in a narrow range for quite a few minutes and without any discernable trend. As soon as /ES moved a tick higher, K jumped in and purchased 3 contracts of /ES. When asked what was the rationale behind the trade, he replied with as much conviction as he could muster, “We can’t seem to go any lower.”
The trade sat there for a few minutes before the market returned to its earlier level, leaving K’s /ES trade 2 ticks in the red. Visibly uncomfortable, he persisted in the trade and hung in there. As /ES down-ticked one more time, K exited the trade altogether. While he was beaming with pride in exercising his discipline in cutting losses, K was oblivious to the fact that he had poor command in trading mechanics.
Let us review his shortcomings…
- K had no real trade idea.
“We can’t seem to go any lower.” Is definitely not a firm foundation for a rational wagering of one’s trading funds. There is a huge difference between the reality of “market heading nowhere” and the perceived view of “cannot go any lower”. As long as the volumes are only limited to few dozens contracts per minute on average, the market is not going anywhere. Without a valid trade idea, K lost his edge in the competitive business of trading.
- K gave up his edge needlessly.
In a slow market, there should be no urgency to getting a trade in. As the saying goes, trade only when there is a trade, not when you want to trade. If K had a valid reason to enter the market, he could have simply held out a bid instead of taking the offer. By doing so, he lost a tick. He could have gained $37.50 ($12.50 x 3) by being patient. Worst of all, K chased the price unnecessarily. He hit the offer after price ticked up away from him. This left him exposed to other traders preying on working bids and could now take their scalping profits.
- K wagered impulsively.
A good trending market will give multiple opportunities for entry, making scaling into trades an easily attainable task even if one is “chasing after” the price action. By entering with his maximum 3 contracts lot size, K was exposed to maximum risk before he had an opportunity to see if the trade moves his way.
- K exited emotionally.
Instead of exiting when the trade didn’t go his way, K exited the trade when it went against him. In other words, he took it personally. If his trade was entirely based on catching the breakout move, it should have gone his way immediately. A good exit would be one that took out the position when this scenario didn’t happen. Instead, K waited till the trade reached his pain threshold before exiting.
- K did not process information effectively.
There was no time during K’s trade that there was evidence of bidders entering the order book or lifting offers in size. Instead, K missed out seeing bidders cancelling their orders prior to the market moving against him. Therefore K couldn’t exit quickly.
K was a “newbie” trader, and lack of understanding of his trading mechanics is certainly understandable. Interestingly, there are many “seasoned” traders out there that still showed the same lack of understanding of the trading mechanics. Many of these flaws are due to emotional factors.
For example, a professional trader might be pressing too hard to make money at the end of a tough month and have been putting on trades impulsively. By impulsive, I meant entering a trade without clearly looking for a trading edge or waiting for a good fill. In other words, trading when there is nothing to trade.
Other times, the flawed mechanics represent bad habits cultivated over time. For example, traders tend to place a pre-defined stop several ticks away from their entry price without reference to the current market volatility. Placing a X ticks stop might be ideal during extended hours but using the same X ticks stop will be too tight during live hours. Even though the fundamental trade idea was not wrong, failure to exercise discretion in trading mechanics led to a bad trade.
One way traders can avoid this pitfall is to enable them to be keen observers of their own trading mechanics. This means placing emphasis on trade executions as much as overall profitability. Too often than not, traders tend to place profitability on their radar and discard the rest of the mechanics that leads to a good trade. Emphasis has to be placed on management of trades, from position sizing through exits.
Majority of traders think about trades as things; as events that only have 2 outcomes – Profit or Loss. A better approach to trading performance views trades as processes. That is, it’s not just what you do, but how you do it that matters. Profitability is simply a function of good trading, not the other way round.
Many developing traders face the hurdle of K. As such, without formal coaching, many traders leave the business after concluding that “trading is not for them”. In the business of trading, there is no black and white; there is only grey. Theories learnt in school served no function except as a pre-requisite for a vague understanding of how the economy and the market work. Mastering the theories doesn’t escalate you to the level of “PhD of Trading”.
How many of you went through similar experience as K? I strongly urge you to educate yourself and work with an established trade mentor. What sets the retailers and professionals apart is the quality of their training they received. Attending a weekend seminar doesn’t make one a professional trader. If only it can be so easy……
