All posts by Madan

Why do we exit prematurely from a trade

Impatience

I had the privilege of meeting so many traders last weekend in a trader’s conference in Lavasa, Pune. It was an excellent eye-opener for me with respect to the struggle a budding trader goes through. Different traders had different issues and wanted to talk about a common issue among traders in this post.

Many traders have the issue of closing trades too soon. Especially, as it gets closer to their intended target (or trail too close if they dont have targets). Once the stock/future reaches certain level, they seem to trail the stop much closer only to have the market take them out and then reverse to their target (or taking its original path). This seems to happen over and over (in varied intervals). They are afraid to give money back to the markets and have seen traders going for counselling for this behavior in western countries. We all understand this is a problem but a little background will help us see it more clearly.

Analysis of the problem:

This is a classic example of ‘prospect theory’ which states that people are willing to settle for a reasonable level of gains (even if they have a reasonable chance of earning more), and are willing to engage in risk-seeking behaviors where they can limit their losses. In other words, losses are weighted more heavily than an equivalent amount of gains. An employee thinks this way every time he/she looks at the paycheck and sees how much money has been deducted for taxes. He/she doesn’t want to work anymore, and earn more money, because he/she does not want to pay more taxes. Although the employee would benefit financially from the additional after-tax income, prospect theory suggests that the benefit (or utility gained) from the extra money is not enough to overcome the feelings of loss incurred by paying taxes.

Cleansing thought:

Many traders wonder why consistently being profitable in stock markets is always elusive. The above mentioned problem is one of the main reasons that inhibits consistent profitability in trading. ‘Learning what to do, and actually doing what we learned (under pressure) are two different things’. And once again,it goes back to one’s desire to maximize the chance of gain, not to maximize the gain itself.Getting out of winning trades prematurely, is an obvious manifestation of this phenomena. This is also why most of the traders inherently look for ‘high winning rate’ system.

All it serves to do however, is make one feel better at that moment in time. In reality, it is to the severe detriment of our long-term performance. One has to realize that trading is a big-picture endeavor, and what feels good in the short term, is most likely counter-productive in the long term. Quite simply, leaving a large amount of money on the table, or worse yet; missing a major winning trade, is just as bad, if not worse, than a losing trade. The market however, lulls us into complacency, and even reinforces this natural behavior, because it spends more time in ranges than in trends, where small profits quickly vanish. We then learn to instinctively cover trades before they return to our entry point, or turn into losers as we would have seen this behavior many times selectively.

What makes matters worse, is that that our exits command top priority in the trade decision hierarchy (for obvious reasons), followed by trade size, and entry point. Liquidations (exits) are far more important than initiations, and harder to get right. When we enter a trade, it is the most hopeful point in the trade cycle, but come exit time, a trader is bombarded with stress, cognitive load, emotions and bias and they all have reared their ugly heads, just in time to distort our expected value of the trade.

Having a predetermined target and sticking to it is not the answer, in my opinion. If we have specific target based exits and if it works for us, that’s great. In most cases, people are going to get out early anyway, and it is tantamount to trying to predict the market. It is more important to concentrate on projecting losses, risk management, and finding signals that produce trades that are well defined, have a proven edge, and are reproducible, rather than trying to out-guess the market.

Essentially, if price action or our expectation dictates the market should continue in our favor, why get out? And, why use a target that we’re not going to follow as our exit point? Exit the trade when price action/indicator signal tells us the trade is not good anymore.

Parting thought on this topic:

Imagine that trade management is like grilling a steak. If we like our steak well-done, we are not going to take it off the grill after 4 minutes, because we’re hungry and can’t wait for it to fully cook. And we’re not going to take it off the grill at some arbitrary time, because some cookbook said a well-done 2-inch steak should be cooked for 10 minutes. Instead, we are going to observe the steak, maybe poke it with our finger, or cut it open a little to see if it’s done. And only when it is cooked to perfection, do we take it off the grill. This applies to EVERY steak we cook. Same applies to every trade we take in the markets.

Thanks for reading and happy trading !!

Overcoming the fear of pulling the trigger

There’s a saying that’s been used in pool halls and poker rooms – if you gonna sweat it, then don’t bet it. Don’t get me wrong here. it’s good to be a little nervous because it keeps things exciting and in perspective but if we see our setups working again and again in a consistent manner and we don’t put on a trade – that’s like having the “the upper hand” in anything that involves winning and we are not betting. It’s like having the best batsmen in our team and no wicket-keeper behind us, it’s like spotting Tiger Woods a 10 stoke lead, and it’s like getting a Royal Flush (in poker) when the pot is maxed out.

Bottomline – we just got to do it. But, as we know already, it is easier said than done unless we know and address the root causes. This is commonly called as ‘fear of pulling the trigger’ in trading arena.

Before doling out solutions, we need to understand the psychological aspects behind this fear.

Reasons behind this psychological fear

1. Fear of loss – We can break this fear down into two distinct psychological characteristics:

A. Lack of confidence – encompasses all things associated with a trade (the whole nine yards) Starting from analysis, methodology for trade selection (mechanics) execution and a plan to handle exogenous events.

B. Lack of discipline – includes all of the above but with direct focus on self, and our ability to react, either in accordance with a specific set of “rules”, or to unexpected, unanticipated scenarios.

2. Fear of winning – this fear may sound funny but this is very much true as any other fear involved in trading. This fear can be broken down into a plethora of psychological characteristics, all of which can be clumped into a single fear – fear of change.

Fear of change involves all aspects of our life at this moment –

a. Winning will make us more desirable financially and-or personally (aspect of relationships),

b. We believe we are not entitled to win (aspect of self-image),

c. A successful career means more responsibility (aspect of personal growth).

The possibilities of why we would fear change are nearly endless. However, the reasons are completely unique to us. There is no trading specific material for this. Self-help books and reading material might help a bit.

3. Urge to make money faster – this urge can make us not want to lose in any trade. As losing equates to lesser capital than where we started. This urge can also stem from the fact that our livelihood depends on the money we make from trading

4. Mechanical vs Discretionary system – If we are a discretionary trader, we’re probably suffering from a condition that golfers suffer from time to time: the yipps. The yipps is a putting condition where one get so anxious over where the ball is going to go that we get janked up before we hit it. It’s typically a fear of blowing it past the hole. In other words, fretting about the result even before we hit the ball. Usually a golf instructor would say – swing smoothly and keep your head down. A discretionary trader goes through ‘yipps’ more than a mechanical trader. Mechanical traders face some other demon – second-guessing the system. If our system is mechanical, yipps will not exist that much.

Possible solutions to these conditions

1. Back testing would obviously give us confidence to pull the trigger but what would help us when we face a losing streak? That’s where reduced leverage (to start with) would help us. Start out with 1 lot, follow the system to the dot. It is really important because it creates that ‘discipline’ brain muscle in us. And, slowly and gradually move up in size. Remember, we are all in this profession for the long haul – no hurry. But, if a trader is in pressure to make money right away (and big), market will show us the road to adversity.

2. Trading for monthly expenses – Most of the newbie traders have the strong urge to make money (who doesn’t) but this can act very counter-productive to our efforts. Do not trade for monthly expenses – we can start withdrawing money for our expenses in the later stage but not when we have issues in pulling the trigger. So, having backup money (to cover expenses for 3-4 years) while trading initially is imperative.

3. Little tuning to our mindset will also go a long way in our favor. Whenever we have a setup, the first thing we can start telling to ourselves is that “this is going to be a losing trade and I am going to get stopped out on this” . We EXPECT to lose on this trade but we don’t HOPE to. There is a difference between expecting and hoping. We HOPE to win on this trade but we don’t expect to. When we lose, we are ok as we expect and prepare for it. When we do win, we give a pat on our shoulder since we expected to lose. Tomorrow we will start all over again – again expect to lose but hope to win.

Good luck and happy trading !!

Finding the right trading mentor

Along with filling my tires with air and the tank with petrol, I always wash my car before embarking on a road trip. Not only is a clean machine more pleasing to the eyes, but a clean windshield is more transparent to the eyes. This pristine condition however, is about as ephemeral as that freshly filled tank of petrol. Between the smoke and dirt, to pollution and oil, it is amazing how quickly, dirt and gunk can collect on a clear windshield and morph it into an opaque sheet of glass. Even after, I generously apply my windshield washer fluid, I cannot attain the level of transparency I had achieved at the car wash.

Just like car windows, we go through life, and as we progress, we all collect some level of gunk on our souls and subconscious minds. This gunk consists of misinformation, prejudices, conflict, trauma, and myriad other experiences that form negative layers on our psyches. These layers form an opaque film that prevents us from seeing the world in the way it truly exists. And being unable to see reality clearly, will severely limit one from fulfilling their true potential.

This obscuration and its destructive effects, are often exposed and magnified when trading. Negative habits and emotions cause more trading losses, than misreading a chart or misinterpreting market fundamentals. It is often said that the eyes are the window to the soul, but anyone who has ever traded, knows that trading can expose one’s weaknesses, and open up a Pandora’s Box of vulnerabilities, that are there for all to see and quantify.

The only way traders are able to shed this fabric of filth is through self-discovery. You can read as many books on trading as you desire, and create new indicators and ways of looking at, and analyzing the market, but if you don’t look at, and analyze yourself first, it will be difficult to find success.

The road to self-discovery inevitably leads to the path to success, but you must first be able to chip away at the layer that obscures you vision and clouds your view of the road. By determining and eliminating your weaknesses, negative habits, and negative emotions, you will then be able to trade with a clear head and clear vision. But, this is easier said than done. To ease out this ‘chipping away rough edges’ process, we tend to look out for a much more experienced/able person to teach/coach/mentor us. This is exactly where the process of mentoring can be extremely helpful (if not inevitable) in our trading profession.

This blog post has not been confabulated much in the trading books/seminars and articles but nevertheless, a very cardinal topic. As trading is a performance endeavor, it’s natural to think that a mentor can enhance a trader’s performance. Lot of folks actually say that they ‘mentor’ traders but it is actually just trader’s education. The fatal shortcoming of most efforts in trader education is that they provide teaching but not mentoring.

Difference between a mentor and coach

First of all, as we see trading as a performance endeavor, we need to understand the difference between a mentor and coach. In trading perspective, Coaches are people who help traders with the mental/emotional/psychological aspects of trading, including techniques for improving self-control and trading consistency. On the other hand, Mentors are people who help traders with the actual mechanics of trading – the ‘how-to’ aspects of defining setups, setting stops and price targets, position sizing and risk management and sometimes, play a role of a coach as well. So, a mentor can be a coach but a coach can never be a mentor.

Benefits of mentorship/coaching

1. As mentors are dedicated to our success, it is an assumption that we can see him trade live. When we see an experienced person do it live in front of us, one automatically picks up clues on intangible things. Like a child learning from his parents or a observing a mechanic at work when his listens to an engine running. Mentor can shorten that learning curve dramatically but no mentor can completely replace live experience of seeing things unfold for ourselves. Having said this point, it is pragmatically very difficult for the mentor to show him trade live as his timeframe might be different than yours.

2. It’s almost guaranteed that the nuances that a mentor has picked up over the years while looking endlessly at price action and patterns can never be observed/learned by a trainee reading a book or trying out himself until it’s too late.

3. The reason we see mentoring as a key ingredient in success across disciplines is that the right teaching guides learning trials toward optimal development. Great athletes don’t just exercise daily – they perform the right exercises. That is equally true for developing traders.

4. Think about this scenario – we can spend a lifetime browsing trading forums, online articles and reading thousands of threads, books. If you are lucky you stumble upon the right material, recognize its value and stick with it. But a mentor/coach can build a solid base of knowledge and reasonable expectations. They can also give that gentle push if one is lethargic, minute course correction when we go off-course and much more.

Many a times, people wander from one moving average crossover system after another, buy one useless indicator after another or spend years deciphering the code left behind by W.D. Gann (no disrespect to Gann followers), figuring out the influence of Neptune, Uranus and Jupiter on the Nifty and blow up account after account to end up with debt, job loss, a divorce and drinking problems.

5. This game is just too difficult and too challenging that if we are not tenacious, it will be only a matter of time before the market chews you up, swallows you up whole, and spits you right out again (like that scene from Anaconda where that big snake spit out people after swallowing). The only way we’re going to achieve great things in the markets, is to be tenacious to overcome these challenges. When times get tough, how will we gather our senses and get up? A right mentor can do that with ease. Think of a personal trainer in a gym. They will correct the exercises we are doing and introduce new ones. They will help us sustain effort when we lose momentum. Over the course of our gym workouts, we don’t just improve our exercising skills. We also become a stronger person, someone more fit, and someone who feels better about themselves.

Problems faced by mentees while choosing a mentor

1. Mentee can never be sure about the success of a prospective mentor (especially, in an online world full of posers) before submitting himself fully into the relationship. And even if they are successful, they probably trade in a very different style and we would have to either relearn or get very aggravated and it would ultimately be a setback. In that sense, a coach is much easier to find than a mentor. But that is aggravating too because most of us just want someone to tell us when and how to trade.

2. If we are successful in identifying someone who is capable of mentoring and/or coaching, it would still be difficult to convince him/her to mentor/coach us. He might be able to do it for his friends/family but not for complete strangers online or someone we met in a coffee shop.

3. Finding a mentor in a trading forum/social media is like finding a needle in a haystack. All of the information that a new trader needs to be successful is out there for the taking. But there is a thousand times as much useless and misleading hogwash than there is actionable/logical information.

5. Having a mentor will not guarantee success. It still comes down to the individual sitting in that chair, clicking that order into the market and keeping their cool no matter what happens and doing this day in and day out. So, no guaranteed success can lead to discouragement in searching for the mentor/coach

Eight essential qualities of a good coach/mentor

1. He cannot be a teacher only. His primary occupation must be trading (albeit a consistently successful trader – how to figure that out? No idea)

2. He does not have to give it away for free (if you ask me personally, it’s just pie-in-the-sky).

3. It is not important to me whether he shows me his trading statement (no one will do that). I want to see immediate value in his analysis of my trading shortcomings.

4. Pro traders often share similar traits, they are humble to the market yet enormously confident of their ability to stick to a stop and target/TSL. They never ask others about their entry/exit or never post their charts to flaunt their prowess in market reading.

5. He should never get into useless egoistic arguments as successful traders never indulge in petty ego fights.

6. They have very little opinion on ANYTHING under the sun.

7. He must be able to identify trends, pull-backs and all price action with logical reason. If he can’t, he must not commit any risk to the market. And he must wait as long as it takes. All day, all week if necessary. Basically, he should exhibit enormous patience

8. He should be willing to dedicate a specific amount of time looking at my weekly/monthly progress.

Looking at the list, one might think it’s inconceivable to find a mentor/coach. Such people do exist, they are not chimeras. It takes time and effort to uncover gems. Why should stuff reveal itself to us unless we are willing to sweat blood for it?

Final thoughts on ‘mentoring’ – points to ponder

1. No a mentor (or a coach) is not mandatory to be successful. The key word is ‘mandatory’. It should be rephrased as “A mentor is not mandatory for everyone to be successful”. However, since 95% of traders are not successful might be a clue that something else is necessary?

2. If you have children – let me simplify this – would we let them out on their own, let them pick up knowledge on an unstructured basis? We wouldn’t. Skill is only developed through prodigious practice and there is no use of talent with unstructured practice. We all are not Mozart, and based on statistics neither is 99% of society. Of course, the best way to learn is to learn by doing, but there is such a thing as ‘deliberate practice’. Geoff Colvin (author of the book ‘Talent is overrated’) will give a thousand scientific and real examples on why this approach works.

3. We do not have the leisure of learning at our own pace or structure (even though that is the best option available). Trading is a ridiculously competitive dog eat dog world. Any endeavor worth undertaking is worth doing well, especially when it has unlimited potential like trading.

4. Trading is the last bastion of true capitalism. So for us to compete at our own level of possibility, we want the best tools and the best environment that we can get. Then it is up to our ability to use those tools, think on those terms and eventually expand beyond to get bigger, faster and stronger.

5. If someone is charging heftily to mentor you (reasonable charge is fine as the mentee might not take the mentor seriously if mentorship is done for free), time to take that ‘proverbial’ run in the opposite direction. Typically, good mentors don’t advertise. Human nature what it is – once you have made a substantial amount and understand how to protect it (unlike Livermore, who despite being the greatest ever, was never able to protect himself), then trading by itself is boring. Inevitably some pros start teaching, finding those pros – that have made it, been able to keep it are the ones to search for. Not easy, not supposed to be.

6. As I’ve said before, many come into trading with no formal training or background in this field and expect to make leaps and bounds in a relatively short period of time which is completely fatuous. Working with a “mentor” whose full time job is trading would be very beneficial for many traders. What people don’t understand is a mentor can’t instantly make someone profitable. Any that lay that claim should be avoided. A mentor should serve as a person that helps the trader develop a solid foundation to their trading and provide feedback as the trader continues to develop. He should also assist with developing a realistic trading strategy and attainable/measurable goals. So many get lost just in this area alone and begin the futile search for the perfect trading method.

7. If your only refuge is some online forum and/or social media, reach out to those people you admire/get inspiration from. Don’t ‘worship’ them. EGO has no place for real traders and the fact that one trader wants to worship another makes no sense. They are just people who are wrong 60 to 70% of the time anyways. Build some rapport with them over time and they will begin to trust you and ask them to help you a little here and there. Again, don’t WORSHIP them.

Good luck with your search for mentors/coaches and happy trading!!

Handling trading losses effectively

I have been hearing some stories of traders/investors who have lost quite a sum of money in the last few days. Worrisome part is that some folks have borrowed money for trading and have lost it as well. Few other folks who are managing other’s money (PMS) have also lost substantial amount too.

These kind of losses happen in trading profession (especially for the uninitiated) and all is not lost here. So, thought of writing this post to see how to take this losses in a positive stride.

1. Taking ownership of losses –  No one is responsible for our losses except us. Not the market, not the system, not the people who gave us the money to trade. We have to realize that we were wrong, we had taken too much risk, and we were employing trading methods that did not work. Period. No point in blaming outside manipulators of markets or bad luck. We, as traders, need to accept that we have completely and utterly made a hash of things (really no choice here and this is not a luxury we can afford). In a job scenario, we can blame others and get away with it but not in trading.

2. Stop trading right away –  a  trader might not like to hear it but this is absolutely necessary.

Take the time to process what had happened, figure out what was done wrong, and make radical changes in the approach to markets. Jumping from one system to another will not cut it. Most of us try to tweak our system after a heavy hit. Optimizing the system based on last 6 month of market performance would not cut it. Just a small time-based break would soothe off the mind a bit. Most of the times, this should be enough to come back as a different trader.

3. Refocus and relearn –   Use the time away from trading to work on other aspects of your life and career. Create alternate streams of income so that one doesn’t depend on trading income alone. ‘Depending on trading income’ in the initial stages of trading is probably the biggest sin in trading.

Trader should try to focus on building the self-image with other aspects of life not just with trading. In doing that activity, he can remain opportunity-focused and not regret-focused. Please stay focused on what you could control, not on what you could not.

4. See the setback as an opportunity to bounce back –  I am sure the loss was very painful. Make sure that you would never go through such an episode again. Try to create a new balance between trading and the rest of your life so that you would never be dependent upon trading results for your happiness and fulfillment.

5. Handling depression –  a trader need to figure out how to handle depression. More so, a losing trader. It is better to handle it heads on than brushing the episode aside and continuing to lose money in a state of denial.

Depressed feelings are a normal response to loss: the loss of money, the loss of dreams. Sometimes you have to go through that loss before you can come out the other side as a different person, one who has learned from the experience. So, please stay positive.

6. Get out of need to make money mindset – If a trader gets attached to the need to trade and make money–and once his perfectionistic voice of “I should have bought there” and “I should have sold here” in hindsight kicks in –he is no longer grounded in markets. It’s when those frustrations build over time, becoming self-reinforcing, that traders lose discipline and focus and eventually perish. Mental rehearsals would help in these cases.

By staying physically relaxed in one’s breathing and posture and by mentally rehearsing a mindset in which it is OK to miss moves–there will always be future opportunity–traders can prevent many of these train wrecks.

7. Trading too large for our account size –    Swing in the equity curve almost always is proportional to the negative effect on trader’s psyche. Higher the swing, higher the negative effect on pysche and the vice-versa.

When we trade size that is too large for our account size, we subject ourselves to drastic swings in P/L, and that subjects us to drastic swings in mood. In turn, we then make trading mistakes that bring a negative expectancy to each trade, and the size eventually blows us up.

As they say, in trading, if we create drama in your returns, we’ll create trauma–and that’s how trading career end.

8. Understand failure –  Knowing the worst-case outcome if this trade happens to fail can reduce the fear inflicted by a previous failure from an unseen event. Black swan events aren’t common, so it’s not reasonable to fear them every time you approach a setup. Weigh the potential for loss, and if it’s outweighed by the potential for gain, the probabilities are favorable enough to participate.

9. Psychologically, it’s healthy to experience defeat and then overcome it – It strengthens you to battle back and win. If you lose the wrong way–by taking so much risk that you can’t come back for the day, week, month, or year–you rob yourself of the victory that could be yours by going from red to green.

10. Make a choice to move forward –  All of us have the ability to choose, whether it’s our career or our spouse or our attitude. Maybe your fear somehow gives you comfort right now, because it’s been a habit you’ve allowed. That won’t cut it though, so it’s time to change. Eventually, you either decide to get back on the right path, or you’re completely done trading. Make your choice and get on with it—and don’t look back.