2 Years of Trading - Lessons Learned (Part 1 of 3)

It has been about 2 years and well over 4,000 trades since I started trading full time in Q2 2011.  Over the past 20+ years, I've been involved with the markets on and off in one way or another.  But when I decided to return full time, I tried my best to be as humble and open with myself to start with a blank slate, just like a rookie or a freshman. 

Even though I wanted to restart as if I didn't know anything, when I first started learning about trading long ago, I could have told you nearly each of the lessons learned in these posts very confidently. 

I was like a teenager who "knows it all" only to realize decades later that the older you get, you really didn't know.  Experience has a way of doing that.  It's one thing to know, but it's another thing to truly understand and believe the words.

You will find nothing groundbreaking here in these mostly well known trading aphorisms, just views from yet another developing trader who has come to the realization that there are no secrets to trading -- except for passion, desire, hard work, and some luck. 

For readability, this post has been broken into 3 parts.

LESSONS LEARNED (Part 1 OF 3): TRADING FUNDAMENTALS

The concept of trading is simple

Trading is simple, just like golf.  Hit the ball with a golf club into the hole with the least number of strokes.  Conceptually easy, but as we all know who have tried, there's a lot of complexity involved with the details and execution.

Trading is similar.  However, there are many people trying to sell you a system or algo or model or "holy grail" with many bells and whistles, full of "proprietary" indicators, based on impressive statistical and mathematical formulas that can only be interpreted by ivory tower PhD's. 

But to goal for trading is to simply this:  Buy low and sell high.  Sell high and buy low.  Easy!  Right?

The entry method for most retail traders is based on 1) choosing a timeframe, 2) go with trend or counter trend, and 3) enter on a breakout or on a pullback.  Once you're on board, your trading plan should give you an idea of where you decide to take profit, or when to get out when you're wrong according to your risk and trade management parameters. 

For the most part, all systems are essentially a variation of the criteria above.  Learning the basics of trading is relatively easy.  There is no "holy grail" trading system, although I'm confident through my own analysis that there are certain trading setups that have enough edge for retail traders to make a very good living.  And when finding setups with edge, the point K.I.S.S. (keep it simple stupid) is also applicable.  This K.I.S.S. point is also something that makes more and more sense as time goes on.

However, I've realized that once you do achieve a basic nuts and bolts level of trading, the deciding factor between success and failure shifts drastically to your biggest trading obstacle -- your mind.

There is no right or best way of trading
When you follow or read many of the "trading gurus", many express the notion that their way is the best and only way.  That is completely, unequivocally false.  There are trading strategies and timeframes that work best for you.  We're all different.  I believe Dr. Brett Steenbarger's books explained it best.

Whether you're a macro / Fibonacci / chartist / volume profile / Market profile / volatility breakout / Elliot wave / DeMark / trend follower / channel trader / scalper / swing trader / or whatever type of model / system / indicator / methodology you prefer, successful traders have a certain setup that resonates for them (i.e. aligns with their strengths).  

I've found that the successful traders tend to have a way to "tell a story" about the market based on the construct that works best for them.  And more importantly, they have the discipline to execute their methodology consistently over the long term.

Finding your "style" is key, it's only a matter of time and/or luck
As rare as it is, some are fortunate to meet and marry their high school sweetheart and live happily together for the rest of their lives.  Some will be unfortunate to never find their better half.  Many think they found their soulmate, only to eventually get divorced.  I found this analogy similar to trading success stories.  The Market Wizards book series gives great examples of how successful traders all took different paths and approaches to become successful traders.

There are a very lucky few who find a trading method that suits them from nearly the beginning of their careers, and end up as successful traders for the rest of their lives.  Most do not (or can not) continue to put in the enormous effort hitting brick wall after brick wall, trying to find that trading strategy which ultimately suits their personality.  They end up as part of the 90+%, quitting before they find what works for them, with enormous psychological and/or financial deficits.

I've been there, chasing success by looking for one trading method after another, seeking a shortcut to a hot streak of winning trades that will finally help me get out of the psychological and financial hole, to vindicate me as not just another loser, but that as a fleeting winner.  This gambling mentality is not the best approach to long term success. 

However, this experience of chasing methods has exposed me to many trading systems and methodologies.  And this has helped me to learn what works for me and what doesn't, as well as gaining more knowledge about trading.  On a good note, it has considerably reduced my "upgrade-itis" desires to look for that brand new and shiny trading system.  Every time I look into something "new", it's like I've been there, done that.  I've become somewhat jaded of systems, which is good.

I've always known that the "holy grail" system of trading doesn't exist.  But after overturning so many rocks, I finally believe that it doesn't exist in the form we all seek.  There's a big difference between knowing and believing.

So the ability to pace yourself, so that you don't lose all your money or your psychological capital before finding your style, is critical to success.  However, how quickly you find "your system" that fits "your style" and personality can involve some luck.

Managing and exiting a trade is arguably more important than entry setups
Most new (and experienced) traders find it much more exciting to hear about a great system / model / indicator / methodology / holy grail that gets you long at the lows and short at the highs.  So how exciting is it to learn about where to put your stop losses, or how to scale out?  When you're starting off, you don't really think of how much you can lose, only how much you can win.  And scaling out?  Doesn't that mean you don't make as much money when you are right? 

Well, FuturesTrader71 promotes a coin toss SIM exercise where you enter long or short trade based on a coin toss, and then manage your trade according to predefined stop loss and profit scale outs.  He makes the point that the focus on entry setups are overrated.

As you adjust the stop and profit targets over various iterations of your experiment, you will become enlightened to the powers of what trade management can do to your bottom line results vs. an all-in all-out type management, even if the entries are based on a random coin toss. 

If you're not yet a consistently profitable trader, don't be surprised if you find that the coin toss experiment generates better results vs. your current trading.  Sad but true (don't as me how I learned, haha). 

You'll also see that trade management of your stops and profit targets are just as important (or more so) vs. your entry signals.

Risk management is key
For the beginning trader, discussing risk management is a BUZZ KILL.  The last thing you want to do when you're starting to trade is to limit your risk, because that will get in the way your huge profits!  But as time goes on, we all learn that this is mindset is the wrong approach for long term success.

If you don't have an edge, like gambling at a casino, they the best strategy is to bet all you have for just one play.  Then quit, because the more you play, the odds will eventually work against you.

But if you have a trading strategy with an edge, risk smaller per trade so that you can stick around around for the long haul.  Because even high probability strategies can have several losses in a row.  Therefore, if your per trade risk as % of portfolio is too high, you could eventually suffer a business ending drawdown, even with a solid high accuracy trading system.

The next post in this series is:  LESSONS LEARNED (Part 2 of 3): THE LEARNING PROCESS

Does your trading have an edge? Here's how to find out.

How do you know if your trading system has an edge or whether it's just random luck?

One way I learned was from Adam Grimes' book, "The Art and Science of Technical Analysis."  As I mentioned in the prior post, I consider his book a must have for traders.

In Chapter 12, there's a section called "Statistical Analysis of Trading Results" which discusses "deriving the p value, which is a significant test (one-tailed t-test) for the mean P&L being > 0."  The table on page 389 Adam used as an example looked similar to this (but without the t-value column):

The chapter didn't go into the calculation details, but with some helpful guidance that Adam emailed me, I was able to dust off  the cobwebs and think back to my college statistics class.  You can find out more about p value from here and here.

HOW DO YOU CALCULATE IT?

The steps are simple from within Excel.  Take each individual trade P&L and figure out: 1) the average P&L per trade, 2) the number of trades, and 3) the standard deviation.  If you use Tradervue, Greg will be rolling out the p value soon (if not already) within the reports section.

Then plug in the #'s above into a Excel spreadsheet with the formulas below.  This then calculates the t-value so that the p value can be derived.  It can all be in one formula, but I broke it apart to make it easier to read.

WHAT DOES IT MEAN?

A lower p value is better.  The lower the p value simply means that based on the series of trades analyzed, the results are less likely due to random chance or luck.  In general usage, a p value of < 0.05 is often considered to be statistically significant.

If you have a higher p value, that means your trading results, even if very profitable, could be likely due to random chance or luck vs. having some sort of edge.

For example, if your p value is 0.01, that means based on the data set analyzed, there's a 1% chance of seeing the analyzed results due to random chance or luck.  If your p value is 0.50, then there's a 50% chance your results are based on luck (i.e. not much of an edge).

CAVEATS

Like any calculation used to measure trading or investment performance, whether it's a straightforward % gain on portfolio, win/loss %, profit factor, average profit per trade, or more sophisticated calculations such as Sharpe, Sortino or Sterling ratios, there are pros and cons for each type of measure.

And if your risk based on account size varies per trade, analyzing the trading results based on an R-Multiple or %R should also be highly considered.  Adam Grimes discusses on page 392 that "standardizing for risk removes the position sizing effect" so that it could reveal that a system or trader via the p value could be "trading with a clear statistical edge, even though it was completely obscured by his position sizing decisions."

The p value has its fair share of criticisms, so it's just a reminder that one measure shouldn't be the ultimate judge.  It's best to look at trading results from multiple perspectives and take a holistic approach.  And of course, always use some common sense.

Using Tradervue for analysis of autotrading The Lincoln Million

Although it has been a while since my last in-depth reviews about Tradervue, Greg Reinacker has continued to build it into one of the premier trading journals.  It is elegantly designed and for all that it's capable of doing, it remains surprisingly user friendly.

Here are a few highlights of the improvements I've personally found valuable over the past year:

• Import trade data from more brokerages
• Calculate your performance statistics based on R-multiple and net of commissions
• Improved statistics (e.g. standard deviation, MFE and MAE calculations)
• Support for forex and options
• Ability to handle multiple accounts
• Even better tag based analysis and reporting
• Improved editing/admin tools...and lots more

For anyone who is serious in improving their trading performance, maintaining a trading journal is not an option, it's a must have.  And I believe Tradervue is one of the best out there.

USING TRADERVUE TO ANALYZE AUTOTRADING BY THE LINCOLN MILLION

Over the past several months, I've started to focus primarily on swing trading, which means collecting a meaningful population of trade data for analysis takes a lot longer (vs. daytrading).  And as I wrote in the prior post, I'm also focusing more on autotrading a large portion of my account.

Recently, I've gained enough data from autotrading The Lincoln Million (TLM) to perform an analysis.  TLM is a swing trading service where Doug has gained an impressive return on his own account, and one of a few services being autotraded in my account.

I've taken the The Lincoln List's Champ Camp trading course (worth it, recommended), and have seen Doug in action live within The Lincoln List and The Lincoln Million trading rooms (both daytrading and swing trading).  He has been very consistently profitable, but how would the autotrading results compare?

REPORTS AND CHARTS FROM TRADERVUE

Here are the actual results of The Lincoln Million's autotrades from January 1, 2013 through April 11, 2013 generated from Tradervue.  Although I've been autotrading the service since November, my $'s allocation per trade were not quite consistent and locked in until the beginning of this year, so I excluded that group of trades.

Positives:

High winning %  (82%)
Solid profit factor  (2.10)

Potential concerns:

Average winning trade smaller vs. losing trade ($89 vs. -$414)

Average hold time of losers much greater than winning trades (26 days vs. 5 days)

The report below displays a graphic summary of the Win/Loss ratio as well as the P&L and drawdown curve:

The report below represents another view of the how long winning trades are held vs. losing trades:

One interesting analysis method within Tradervue is the ability to analyze your stop locations.  I didn't expect the chart below to so clearly delineate a potentially more advantageous stop location:

INITIAL THOUGHTS ABOUT AUTOTRADING THE LINCOLN MILLION

The past 5 months represent my first experience into autotrading, so I really didn't know what to expect other than mostly hands off approach, like a mutual fund.  There are some other services I'm also autotrading which are based on writing options credit spreads and each service has their own pros/cons.  I'll likely write about those in the future once I have more data.

With regards to autotrading via The Lincoln Million, here are a few thoughts:

• There have been a decent number of trades that The Lincoln Million alerted and got filled on his own account, but were not filled via autotrading.  As expected, nearly all the missed trades were winners
• Primary reasons for no fills: short shares no longer available, signal to execution time lag (generally takes 3-10 minutes for autotrade order to arrive at my broker via Global Autotrading), and impact of orders on thinly traded micro and small cap stocks resulting in slippage
• Unlike trading the very liquid ZB or ES (T-bonds or S&P e-mini futures) products where you can put on large size per trade ($1 million/trade is nothing), trading microcap stocks often have a much greater issues with liquidity.
• Therefore, actual results from autotrading is likely <= 50% of posted results
• However, if you are following the chat room alerts in real time and manually trading, I believe it's possible to achieve performance 75+% of posted results
• Better yet, once you learn the setups, you can probably do very well trading your own stocks, which is what Doug ultimately wants you to accomplish

I admit, I've experienced frustrations watching unfilled trades become winners, getting bad slippage on fills, experiencing underwater trades that are held multiple times longer than winning trades, and simply seeing average winners be smaller than average losers.  My initial expectations on what the returns from autotrading TLM should be were extremely high, and they were not being met.

But when I started to review the trading results via Tradervue and started looking at the results from various perspectives (not simply total % gains), there was definitely a high level of consistency that needed to be respected, even when the autotrading execution was less than ideal.

STATISTICAL SIGNIFICANCE

The final sense of a-ha was when I ran the trading results through a significance test (one-tailed t-test where mean P&L > 0).  I learned the method of determining whether you have an edge from Adam Grimes' book "The Art and Science of Technical Analysis" within chapter 12 (highly recommended, it's a keeper).

Even with all the slippage and missed trades, the p-value was 0.07 for The Lincoln Million autotrades, which means there's a 7% chance the results are random.  Lower p-value indicate the results are more statistically significant (better) and p=0.05 is a commonly used guideline for a significance level. 

This is an indication that even with all the challenges from autotrading, this system still has a solid edge based on the current data set.  

Assuming future improvement of missed trades and/or reduced slippage, or perhaps greater success from manually executing the trades, the statistical significance can potentially drop well below the p=0.05 significance level, further reinforcing the notion that this method has an edge.

And what if I take his published results over the same period and perform the t-test?  The resulting p-value is less than 0.01, which means there's less than a 1% chance his results are random or due to luck based on the particular set of data analyzed.  Doug's trading method definitely has an edge.

ADVANTAGES FROM AUTOTRADING

Perhaps the The Lincoln Million autotrading doesn't align perfectly with my personality (but then again, would any system you did not create yourself?), which is why having it autotraded without my biases or intervention has worked relatively well to date.

That's one reason why I'm approaching autotrading as a way to diversify my overall trading portfolio by 1) utilizing historically profitable trading services that 2) I couldn't execute consistently on a long term basis.  In essence, it's like I'm selecting and hiring traders with various trading methodologies and styles, and having them each trade a portion of my account.  And if I don't like how they're performing or how their performance blends with the other traders (services), I can easily "fire" them.

 So far, here's one of the biggest benefits from autotrading The Lincoln Million -- I have continued to track and follow the trade alerts with a much greater level of focus and involvement since I have "skin in the game."  I believe that has enabled me to learn this method much faster vs. a passive approach, and to discover certain Lincoln Million setups that resonate very well with my personality.

NEXT STEPS

• Since I only have around 30 trades for observation, which is barely the minimum data set required for a statistically significant test, I will continue tracking the system to see how well it continues to perform
• Continue to monitor the number of missed trades/slippage to determine how much of an impact it has on overall results
• At a certain point, I might consider manually executing the trading signals instead of autotrading to see whether I can obtain better execution, but having the time to trade is currently a constraint
• Keep track of what happens if a trade is closed out when it's at a loss > $400 (based on current trade allocation level) vs. letting it ride hoping for a recovery.  This will be easy to track within Tradervue using the tag feature and the MAE metric
• And finally, this exercise has reminded me of how I need to step up my trade journaling.  I know the more I leverage the power of Tradervue, the faster my trading will improve

My 2013 New Year's Trading Resolutions

Wow, time flies, has it really been that long since I last posted?  Well, now that it's March, most people have long forgotten about their New Year's Resolutions.  So it's time for me to zig while most zag -- better late than never.


TRADING RESOLUTIONS FOR 2013

1. Stop overtrading/revenge trading/daytrading
2. Lower expectations of returns and trade small to help build solid trading habits
3. Explore and implement other trading methods, products, and time horizons
4. Start thinking of returns based on % risk (R), not $'s

GOALS

• Overtrading/revenge trading to account for < 5% of total trades
• Too much intraday trading can emotionally charge my trading in a very negative way
• Even reducing my historical revenge/rouge trades (30% during my worst periods) by half would have a huge positive impact on my P&L
• Target consistent 2-8% returns a month
• Focus on limiting risk (not maximize returns) while building up good trading habits
• Initiate equity swing program, options writing, and further explore forex strategies
• Swing trading via newsletters/chat rooms/autotrading (target 50%+/year)
• Options writing via newsletters/autotrading (target 25%+/year)
• Forex strategies via alternative trading methods (target 100%+/year)
• Evaluate performance based on R multiples.  Reports and analysis are based primarily on %'s

TACTICS

• Stop daytrading
• Suspended my futures accounts
• Reduced equity/options accounts to significantly below < $25k to put PDT into play
• However, allow forex account for "penny slots" daytrading -- minimal absolute dollar risk
• Reduce % risk of portfolio per trade
• Average risk per trade <= 1% of portfolio
• Lotto plays <= .5%   (weekly options plays)
• Stronger conviction (rare) <= 2%
• Capture stop size as a metric to calculate returns based on R. Reports and analysis should focus on %, not $'s
• Implement autotrading initiative to explore other trading opportunities
• Research and initiate autotrading of equity swing trading newsletter(s)
• Research and initiate autotrading of credit spread options newsletters(s)
• Analyze and explore other forex trading strategies in increase # of trades and returns

RESULTS TO DATE

More details later, but based on implementing a large portion of the tactics above, I have been NET PROFITABLE both in my equities and forex accounts the past 3 months.

One of the biggest factors has been to SLOW DOWN.  Daytrading was fine when I started with profitable trades, but a few losing trades in a row often had the tendency to quickly snowball into revenge trading.  I'll eventually daytrade again, but not now.

Based on the past several months, I'm cautiously optimistic and looking to focus on even greater consistency with my overall trading process as I complete 2 years of full time trading.

A break from radio silence

Has it really been about 2 months since my last post?  A lot sure has happened since then.  Hurricane Sandy certainly disrupted life for a while, and when I returned to trading sometime in November, it's pretty clear I wasn't ready.  I was back from my hurricane hiatus, swinging for the fences, looking to make it big.  Probably as a way of lashing out at life's challenges. 

I was having upwards of 20-30 point daily P&L swings (both profit and losses) trading ES with only 1 contract.  I even had some overnight sessions with the flighty and volatile soybeans, trading late into the night resulting in 20 or more point P&L swings on a single contract. 

The only problem is that for every 20+ point day, there were more days where I lost 20+ points on 10 point range day.  Big recipe for disaster.

Yeah, I wasn't watching my risk...at all.  And I paid the price...big time.

Although my forex account has quietly gained well over 150% for the year, I ended down in my futures accounts over 70%.  Luckily, in absolute dollars, I had started with a minimal sized account just to trade, so there's hardly any impact to my overall financial condition. 

But from the psychological capital perspective, I was hit hard. 

I usually think primarily in percentages of portfolio, and when I took the hit in November, I wasn't even thinking in terms of percentage of portfolio risked (only thought how much $'s I could/should make).  In hindsight, this is simply not acceptable.  This is not what a professional trader does.  This was pure gambling.  In order to prevent myself from truly blowing up all my accounts, I took preemptive action and transferred money out.  Time out.

I've learned through experience that it's so easy to destroy your money with reckless trading, but so much more difficult to accumulate profits.  All it takes is one bad day of senseless trading to wipe out days/weeks/months of hard work.  It's a similar concept trusting someone -- what takes years to build trust with someone, can be forever broken in just moments.  I need to respect this concept.

During the darkest hours, I admit, I had thoughts of quitting. 

This doesn't happen often, but I needed to think of an alternative life to trading, and strangely enough, this usually brings me back to trading.  Trading is something I've been planning on doing full time for the past couple decades, and I've realized after careful consideration that there's no better time than now to continue charging ahead.

By the 2nd quarter of 2013, I will have been trading full time for 2 years.  It sure does seem like I've been at it a lot longer.  I remember hearing many others say it takes on average 3-5 years in order to become a consistently profitable trader (for those who even make it that far), and I always thought I could accomplish it in a year...or less.  Sure hasn't been the case.

Where has this trading journey taken me so far? 

I started it all in early 2011 with stocks, and after about half a year, I lost about half my account, literally all the losses were commissions.  I was breakeven on a gross basis, even with all my revenge/rogue/impulse trades.  I discovered that there were certain defined setups that worked very well for me, but just couldn't be patient enough to avoid the revenge and rogue trades.

As an escape, I decided to switch to futures which had more leverage and no pattern daytrading rules to worry about, and ended up losing over 70% in about a year.  A little less than half of my losses were due to commissions.  Unlike stocks, I definitely had a gross loss trading the ES and nearly all of my losses came on a handful of weeks where I went on tilt and got sucked down a death spiral of revenge trading. 

In hindsight, the leverage/tick size/contract size of the ES emini in relation to my account size really put me at a disadvantage.  I couldn't size down below 1 contract and reduce risk/scale out of positions as I easily could with stocks.  My thought was that if I couldn't be consistently profitable with 1 contract, why even bother sizing up?  I was stubborn to try and make it with an all-in all-out trading style using 1 contract. 

What and how I'm doing now

And due in part to this last experience of pain, I've recently escaped again.  However, instead of focusing more on forex (which has continued to work relatively well since I started trading full time) I've decided to explore stocks once again and for whatever reason, utilizing options heavily. 

I'm currently trading with a very small equities account and don't want to get triggered as a pattern day trader, so I only swing trade.  This restriction has reigned in the revenge and rogue trading significantly, since I can only execute a few trades a day and thus have the time to think them out.

During December to date, I've only had about 18 trades, of which over 70% are winners with a profit factor greater than 3.00.  In comparison, a bad revenge filled day from the past would produce more than 20 trades with an accuracy of < 30%, so this is significant change. 

I am hopeful and optimistic that maybe, just maybe, I'm starting to make the turn.  But then again, I've had this feeling before...which then lead to me to overconfidence, which then led me to falling off the discipline wagon in spectacular fashion. 

So I am determined more than ever to stay the course of maintaining a consistent and disciplined trading process, rather than focusing on P&L.  I also have to credit the stock trading room I've recently joined, which has making a big difference in the way I think and trade.  More about that in the future.

2013, here we come!

Since I'll be traveling over the holidays next week, this year is essentially over for me and I'll be shutting down.  So this will likely be my last post of the year. 

I'm really looking forward to seeing my old friends and family back in San Francisco.  Hard to believe it has been about 2 1/2 years since we moved from the beautiful Bay Area, so there will be a lot of wonderful catching up to do.

I look forward to 2013 with renewed optimism and confidence.

Happy Holidays to all, and best wishes for a great 2013!