Psychological Pitfalls

Psychological Pitfalls
Here are some additional psychological pitfalls to avoid. Be wary of depending on others for your success. Most of the people you are likely to trust are probably not effective traders. For instance: brokers, gurus, advisors, friends. There are exceptions, but not many. Depend on others only for clerical help or to support your own decision-making process.
You may acquire trading methods or systems from others or from books, but be sure to test them carefully yourself before trading. Good systems that you can buy come with computer software that allows comprehensive historical testing.
Don't blame others for your failures. This is an easy trap to fall into. No matter what happens, you put yourself into the situation. Therefore, you are responsible for the ultimate result. Until you accept responsibility for everything, you will not be able to change your incorrect behaviors.
Stay long-term oriented. Don't adjust your approach based solely on short-term performance. Through luck, any horrible system can look great, even for relatively long periods of time. Conversely, the best systems have frequent losing periods. If you judge a system by short-term performance, you are likely to reject the best systems that exist.
Most traders have such an ego investment in their trading that they cannot handle losses. Several losses in a row are devastating. This causes them to evaluate trading methods and systems based on very-short-term performance. Don't start trading a system based on only a few trades, and don't lose confidence in one after only a few losses. Evaluate performance based on many trades and multi-year results.
Don't underestimate the psychological difficulty of successful trading. Robert Rotella describes the trauma in The Elements of Successful Trading: "Trading is one of the most stressful endeavors imaginable. Taking losses day after day with a strategy that, just a short while ago was working well, can be a terrible experience. Trading performance can be consistently volatile with good and bad times highly magnified. The market can batter your psyche and gnaw at your soul. These bad experiences will never end as long as you trade. The more successful you are as a trader, the more money you will lose."
Keep trading in correct perspective and as part of a balanced life. Trading is emotionally intensive no matter whether you are doing well or going in the tank. It is easy to let the emotions of the moment lead you into strategic and tactical blunders.
Don't become too elated during successful periods. One of the biggest mistakes traders make is to increase their trading after an especially successful period. This is the worst thing you can do because good periods are invariably followed by awful periods. If you increase your trading just before the awful periods, you will lose money twice as fast as you made it.
Knowing how to increase trading in a growing account is perhaps the most difficult problem for successful traders. Be cautious in adding to your trading. The best times to add are after losses or equity drawdowns.
Don't become too depressed during drawdowns. Trading is a lot like golf. All golfers, regardless of their ability, have cycles of good play and poor play. When a golfer is playing well, he assumes he has found some secret in his swing and will never play poorly again. When he is hitting the ball sideways, he despairs that he will never come out of his slump.
Trading is much the same. When you are making money, you are thinking about how wonderful trading is and how to expand your trading to achieve immense wealth. When you are losing, you often think about giving up trading completely. With a little practice, you can control both emotional extremes. You'll probably never control them completely, but at least don't let elation and despair cause you to make unwarranted changes in your approach.
Other common themes of good traders are self-understanding, balance and self-control. If you can master yourself, you can master the futures markets.
I wish you good trading.

Elements of a Successful Trading Plan--Manage Risk

Elements of a Successful Trading Plan--Manage Risk
The final cardinal principle of trading overlays all the rest. It is Manage Risk. This is as crucial as the others because it is by managing risk that you limit losses and preserve your capital.
The most important element of managing risk is keeping losses small, which is already part of your trading plan. Never give in to fear or hope when it comes to keeping losses small. Preventing large individual losses is one of the easiest things a trader can do to maximize his chance of long-term success.
Another element of risk is the market you trade. Some markets are more volatile and more risky than others. Some markets are comparatively tame. If you have a small account, don't trade big-money, wild-swinging contracts like the S&P 500 stock index. Don't be above using the smaller-sized Mid-America contracts to keep risk in proportion to your capital. Don't feel you have to trade any market that might make a move. Emphasize risk control over achieving big profits.
The biggest risks to commodity traders come from surprise events that move the markets too quickly to exit at their pre-determined give-up point. While you can never eliminate these risks entirely, you can guard against them by advance planning. Pay attention to the risk of surprise events such as crop reports, freezes, floods, currency interventions and wars. Most of the time there is some manifestation of the potential. Don't overtrade in markets where these kinds of events are possible.
Trade in correct proportion to your capital. Have realistic expectations. Don't overtrade your account. One of the most pernicious roadblocks to success is greed. Commodity trading is attractive precisely because it is possible to make big money in a short period of time. Paradoxically, the more you try to fulfill that expectation, the less likely you are to achieve anything.
The pervasive hype that permeates the industry leads people to believe that they can achieve spectacular returns if only they try hard enough. However, risk is always commensurate with reward. The bigger the return you pursue, the bigger the risk you must take. Even assuming you are using a method that gives you a statistical edge, which almost nobody is, you must still suffer through agonizing equity drawdowns on your way to eventual success.
It is better to shoot for smaller returns to begin with until you get the hang of staying with your system through the tough periods that everyone encounters. Professional money managers are generally satisfied with consistent annual returns of twenty percent. If talented professionals should be satisfied with that, what should you be satisfied with? Surprisingly, disciplined individuals can do better. It is realistic for a good mechanical system diversified in the best markets to expect annual returns in the twenty-five to fifty percent range.
One last thing about creating a trading plan. Don't be enticed into trading options as a less risky alternative to futures. While the dollar risk of buying puts and calls may appear lower and more certain, the probability of long-term success is remote.
Experienced professional traders, such as Larry Williams, agree: "Options are a very difficult game because you have to do two things: You have to beat the market and beat the clock. Perhaps some sophisticated people can trade options. I've been trading stocks and commodities successfully for over thirty years, but I don't trade options because it's too tough."
The best way to trade options is to sell them to small speculators. That's what options professionals do. However, selling options has more risk and is more difficult than trading futures. Unless you are well-capitalized and committed to a full-time career as a professional options player, stick to futures.
Although the commodity markets appear complex from the outside, making money trading is quite simple. You use an historically proven plan that trades with the trend, cuts losses short and lets profits run. You trade your system in a carefully-selected group of markets. You start with sufficient capital and pay close attention to managing risk. Richard Dennis made his $200 million following precisely this kind of trading approach.

Elements of a Successful Trading Plan--The Markets You Trade

Elements of a Successful Trading Plan--The Markets You Trade
Another trading plan consideration is the markets you trade. There are about forty futures markets with sufficient liquidity to allow prudent speculation. However, it is important to select a good universe of markets that are appropriate for your account size, risk level and trading style.
It also important that your market universe be diversified. There are always a number of big market moves every year, but no one knows in advance where they will be. If you trade a diversified portfolio, there is a greater chance that you will catch some of the truly big moves that make for successful trading.
Another consideration in choosing a market to trade is its historical propensity to have more big trending moves. Since the trend is your edge in trading, you can maximize your edge by selecting the most trendy markets. The following are some of the best trending markets in various trading sectors.
The currencies are the best trending sector. The currencies to trade are the Swiss Franc, the German Mark, the Japanese Yen and the British Pound.
Interest rate futures are also good trending markets. T-Bonds represent long-term interest rates and Eurodollars are for short-term interest rates.
In the energy complex, Crude Oil, Heating Oil and Natural Gas are good trading vehicles.
In the food sector, Coffee, Orange Juice and Sugar are recommended.
In metals, you can trade Gold, Silver and Copper.
In agriculturals, Corn, Oats, Soybeans and Cotton are the best.
Now you have the outline of an overall plan to trade commodities. The key to success is to test whatever strategy you intend to apply before you trade with it. Remember that the conventional wisdom that you read in books is mostly ineffective. When applied consistently, most trading methods don't work.
You can't test your plan unless it is specific. The rules must be precise and objective. Having a thoroughly tested plan is crucial to maintaining the confidence necessary to keep trading the plan through the inevitable losing periods that every good system and every good trader must endure.
The reliability of non-computerized testing is highly suspect. Using computer software that tests a particular approach or a variety of approaches is preferred. You must learn the correct way to test and evaluate trading approaches.

Elements of a Successful Trading Plan--Cut Losses Short

Elements of a Successful Trading Plan--Cut Losses Short
If you are following market trends rather than trying to anticipate them, the next important part of the plan is how to exit trades that don't work out. Here is where the second cardinal principle comes in. It is Cut Losses Short.
This is another sensible-sounding concept that is much easier to acknowledge than actually to execute when real money is on the line. No one wants to exit a trade with a loss. They don't want to lose money. More importantly, they don't want to admit they were wrong. You can always think of many reasons to hold on to a losing trade. You can hope that the market will suddenly turn around and give you a profit instead of a loss.
This is another example where successful traders have learned to do the hard thing. If there is one thing consistent in the stories of how good traders turned themselves around from being bad traders, it is their attitude about losses. Professional traders accept that losses are part of the game. Since the markets are mostly random, the best trading methods will always have numerous losses. Professionals do not equate losses with being wrong.
It is precisely because correct trading methods invariably generate many losses that it is important to keep the individual losses small in relation to the overall size of the account. In order to keep trading, you must preserve your capital. If you can keep trading in the direction of the trend, the big profits will come. However, if you take too many large losses, your capital will be wiped out before you can enjoy the big profitable trades.
The laws of probability insure that regardless of your approach, you will inevitably suffer some long strings of consecutive losses. If you are risking too high a percentage of your account on each trade, before long one of these unavoidable losing streaks will blow you away. Keeping losses to about one percent of your account size is optimal. With smaller accounts, the percentage will have to be larger. Five percent on one trade is probably the highest prudent level of risk.
Because of the randomness in commodity price action, you must allow the market a certain amount of leeway before giving up on a trade. In general, you must be willing to risk between $500 and $1,000 to trade most markets. For smaller accounts, the Mid America Exchange offers trading with smaller sized contracts that allow you to trade with lower risk.
While there are more sophisticated ways to decide when to exit a losing trade, getting out after a loss of a predetermined dollar amount is as good a way as any. The important thing is to respect your plan. You can place a stop-loss order with your broker that instructs him in advance to exit a trade if the market hits your loss limit. You should always do this to guard against inattention or changing your mind at the crucial moment.

Elements of a Successful Trading Plan--Let Profits Run

Elements of a Successful Trading Plan--Let Profits Run
The next part of the plan involves a more pleasant alternative: when to exit a trade that is profitable. The cardinal principle involved is Let Profits Run. In other words, stay with your profitable trades as long as possible because the trend is likely to continue and make your profits even larger.
Again, this is easy to understand but not so easy to do when real money is involved. The difficulty is that although your profit may become much larger if you stay with a trade, it may also decrease and even disappear. Human nature is such that it values a sure profit much more highly than the probability of a much higher profit. Thus, traders are inclined to take their profits too soon. This can be fatal to long-term success because big profits are necessary to overcome the inevitable collection of small losses.
There is a good way to let profits run while still guarding against the possibility that prices will turn around and take away much of your accumulated profits before the trend actually reverses. It is called a trailing stop. You include in your plan a method for moving an exit point along some distance behind your trade. As long as the trend keeps moving in your favor, you stay in the trade. If the market reverses direction by the amount of your trailing stop, you exit the trade at that point. You would also offset your trade and reverse position if the trend reversed.
One way to set a trailing stop is to protect a certain percentage of the accumulated profit. That will always insure that you keep some profit on a good trade.

Elements of a Successful Trading Plan--Getting Started

Elements of a Successful Trading Plan--Getting Started
The first element of any trading plan is the amount of capital you intend to invest. This is up to you, but you should understand that there is a direct relationship between the amount of capital you commit and your probability of success. The more you invest, the greater is the likelihood that you will make money.
What is the minimum advisable amount to start with? Most professionals agree that it takes a minimum of $10,000. If you try to trade with anything less, what happens to you will be luck. You won't have the capital necessary to apply proper risk management principles.
An important thing to keep in mind when deciding how much to commit initially to commodity trading is that the amount you invest must be "risk capital." Risk capital is defined as money you can afford to lose without affecting your standard of living. It should also be money that you feel comfortable risking. Think of your commodity account as an investment in a business. Many businesses fail. That's life. Make sure you won't be so afraid of losing money that it will affect your ability to make correct trading decisions.
The next part of your trading plan involves how you will make your actual buying and selling decisions. Under what conditions will you enter trades? When will you exit your trades? What markets will you trade?
There are four cardinal principles which should be part of every trading strategy. They are: 1) Trade with the trend, 2) Cut losses short, 3) Let profits run, and 4) Manage risk. These building blocks are so basic and important that I have written a whole book about them. You should make sure your strategy includes each of these requirements for success.

Elements of a Successful Trading Plan--Trade With The Trend

Elements of a Successful Trading Plan--Trade With The Trend
Trading with the trend is hard to do because a logical give-up exit point will be farther away, potentially causing a larger loss if you are wrong. This is a good example of why so few traders are successful. They can't bring themselves to trade in a psychologically difficult way.
You can define the concept of trend only in relation to a particular time frame. When you determine the trend, it must be, for example, the two-week trend or the six-month trend or the hourly trend. So an important part of a trading plan is deciding what time frame to use for making these decisions.
Do you want to be a long-term trader, also called a position trader? They hold positions for weeks or months. Do you want to be a short-term trader who holds positions only for a few days? There are even very short-term traders called day traders. They watch the markets during the day and always enter and exit their positions on the same day.
While it is perhaps easier psychologically to keep the time frame short, the best results come from longer-term trading. The longer you hold a trade, the greater your profit can be.
Day trading has great attraction because you can start each day fresh and sleep comfortably every night with no open positions. However, it is the most difficult kind of trading there is. Here's how legendary trader Larry Williams describes it: "Day trading is so stressful. You're going to end up frying your brain. All the day traders I talk with are losing money. Besides, it's really hard to come up with profitable day trading systems."
For the greatest chance of success, your time frame to measure trends should be at least four weeks. Thus, you should only enter trades in the direction of the price trend for the last four weeks or more. A good example of a trend-following entry rule would be to buy whenever today's closing price is higher than the closing price of 25 market days ago, and sell whenever today's closing price is lower than the closing price of 25 market days ago.
When you trade in the direction of this long a trend, you are truly following the markets rather than predicting them. Most unsuccessful traders spend their entire careers looking for better ways to predict the markets.

Learning To Trade Correctly

Learning To Trade Correctly
One way to learn how to trade correctly is to find a successful trader and have him or her teach you exactly how they do it. However, even if you could find such a person and even if they would be willing to spend the time with you, it would not necessarily make you a successful trader. You might not have the capital necessary to trade the way they do. You would definitely not have the years of experience they had developing their successful approach. You might not have the personality profile necessary to execute their style of trading.
Another way to learn is by trial and error. This is the method of choice for most people although they probably don't realize it. The trouble with trial and error in futures trading is that you don't always take a loss when you trade incorrectly and you don't always make a profit when you trade correctly. Some of the best methods generate losses more than half the time. You can take many losses in row applying a very effective system. On the other hand, if you are lucky, you can makes tons of money trading quite stupidly. Psychologists call this random reinforcement, and it makes good trading impossible to learn through trial and error.
The most obvious and practical way to learn how to trade correctly is to read books. Find the best books by the most respected authors and the best traders and learn from them. While this may work in other areas of life, it is more problematic in commodity trading.
One of the few real secrets in commodity trading is that most of what you read in books about how to trade does not work in the real world. Even books by respected authors are full of trading methods that lose money when put to the test. You may find this shocking, but almost no commodity authors demonstrate the effectiveness of the methods they advocate. The best you can hope for are some well-chosen examples or a few cursory tests.
Learning to trade is a combination of being exposed to ideas plus practical experience watching the markets on a day-to-day basis. This is not something that can happen in only a few weeks. On the other hand, you can become a great trader even with only average intelligence. Professional trader and money manager Russell Sands describes the makeup of a successful trader: "Intelligence alone does not make a great trader. Success is equal parts of intellect, applied psychology, practice, discipline, bankroll, self-understanding and emotional control."
Furthermore, to be successful you don't have to invent some complex approach that only a nuclear physicist could understand. In fact, successful trading plans tend to be simple. They follow the general principles of correct trading in a more or less unique way.

Separating the Winners and Losers

Separating the Winners and Losers
A very high percentage of those who try commodity trading eventually lose money. The ratio of losers could be as high as ninety-five percent. However, this does not necessarily mean that your chance of failure is that high. If, before you begin, you identify correctly the reasons most people lose, you can improve your odds significantly.
There is a small percentage of full-time professionals and highly skilled part-time traders who have learned how to trade correctly and generate consistent profits year after year. It is not impossible to determine what separates these people from the crowd.
Because trading well is not easy, you must approach the task very seriously. This is not something to treat as a hobby. Perhaps, first and foremost, this is what separates professionals from amateurs. Professionals look at their trading as a business. There are substantial profits to be made, and they will not just fall into your lap.
Another crucial difference between successful and unsuccessful traders is that the successful ones have a plan and they follow it. Considering the amount of money involved and the potential risks, it is remarkable how few traders actually have any kind of plan for their trading. They go from trade to trade applying various ideas they have learned without any consistency and without any testing. They make decisions based on hot tips, something they read, today's news. They are acting from emotion rather than using a proven methodology. While they may not want to admit it, they are really gambling in the futures markets rather than trading intelligently.
Trading by emotion in an unstructured way certainly adds fun and entertainment to the enterprise. Taking positions on instinct is exciting, especially when they work out . . . as they often do. But in the end, this kind of trading will lose money.
Good trading is boring because you've thought out your strategy and tactics in advance. You trade according to a carefully tested system or method, not from what moves you emotionally that day.
Two psychological traits that separate winners from losers are patience and discipline. It is not enough to have a carefully tested trading plan. You must also be able to follow it religiously. This is not as easy as you may think.
Every experienced trader knows how great the temptation is to stray from the plan. There is always what seems to be a good reason. The true professional can resist this temptation and stick to his plan. He has the patience to wait for his method to signal a trade and not take trades he may be emotionally attracted to that are outside his plan. He has the discipline to follow his plan and take all the trades that it signals even when there appear to be strong reasons to make an exception.
This may sound easy, but when real money is on the line--your money--nothing is more difficult. The kind of trading that really works is emotionally demanding.
It is hard work to create a winning trading plan. It is hard psychologically to follow the plan after you create it. This is why so many people fail. Perhaps you have what it takes to be an exception.

The Truth About the Commodity Markets

The Truth About the Commodity Markets
In order to be a successful trader, you must understand the true realities of the markets. You must learn how the professionals make money and what is possible. Most traders come into commodity trading, lose a substantial portion of their capital and then leave trading without ever having a correct perception of what good trading is all about.
For many years college professors have argued that the markets are both random and highly efficient. If this were true, it would be impossible to gain an edge on other investors by having superior knowledge or a superior approach.
Professional traders, who make their living trading rather than studying the markets from afar, have always laughed at these ivory tower theories. A good example is George Soros, who has made billions of dollars from trading and is perhaps the greatest trader of all time. Here is how he responds to these ivory tower academics: "The [random walk] theory is manifestly false--I have disproved it by consistently outperforming the averages over a period of twelve years. Institutions may be well advised to invest in index funds rather than making specific investment decisions, but the reason is to be found in their substandard performance, not in the impossibility of outperforming the averages."
Mathematicians have conclusively shown the financial markets to be what are called non-linear, dynamic systems. Chaos theory is the mathematics of analyzing such non-linear, dynamic systems. The commodity markets are chaotic systems. Such systems can produce random-looking results that are not truly random. Chaos research has proved that the markets are not efficient, and they are not forecastable. Commodity market price movement is highly random with a small trend component.
Most beginning traders assume that the way to make money is to learn how to predict where market prices are going next. As chaos theory suggests, the truth is that the markets are not predictable except in the most general way.
In his book, Methods of a Wall Street Master, famous trader Vic Sperandeo, whose nickname is "Trader Vic," warns: "Many people make the mistake of thinking that market behavior is truly predictable. Nonsense. Trading in the markets is an odds game, and the object is always keep the odds in your favor."
Luckily, as Trader Vic suggests, successful trading does not require effective prediction mechanisms. Good trading involves following trends in a time frame where you can be profitable.
The trend is your edge. If you follow trends with proper risk management methods and good market selection, you will make money in the long run. Good market selection refers to trading in good trending markets generally rather than selecting a particular situation likely to result in an immediate trend.
There are three related hurdles for traders. The first is finding a trading method that actually has a statistical edge. Second is following it with consistency. Third is consistently following the method long enough for the edge to manifest itself on the bottom line.
This statistical edge is what separates speculating from gambling. In fact, effective trading is actually like the gambling casino rather than the gambling customer. Professional trader Peter Brandt explains successful trading in just this way: "A successful commodity trading program must be based on the simple premise that no one really knows what the markets are going to do. We can guess, but we don't know. The best a commodity trader can hope for is an approach which provides a slight edge. Like a gambling casino, the trader must earn his profits by exploiting that edge over an extended series of trades. But on any given trade, like an individual casino bet, the edge is pretty meaningless."
Unsuccessful and frustrated commodity traders want to believe there is an order to the markets. They think prices move in systematic ways that are highly disguised. They hope they can somehow acquire the "secret" to the price system that will give them an advantage. They think successful trading will result from highly effective methods of predicting future price direction. These deluded souls have been falling for crackpot methods and systems since the markets started trading.
Prolific futures trading author Jake Bernstein describes how these desperate traders are victimized: "Futures trading is ultimately very simple. Any attempt to make trading complex is a smokescreen. Yet for self-serving reasons an army of greed-motivated promoters try to make things complicated. Too many market professionals consider it their mission in life to obfuscate. Why? Because in so doing they give the appearance that their efforts are scholarly and important. They create a need for more information, and then they fill it!"
Books on how to trade commodities are famous for showing a few well-chosen examples where a described prediction method previously worked. They never show what would have happened if you had applied the method religiously for many years in numerous markets. Those who have tested these methods have found that in the long run almost all of them don't work. Be wary of any trading method unless you see a detailed demonstration showing that it has worked for at least five to ten years in a variety of different markets using exactly the same rules.
The job of the person who wants to trade commodities rationally and prudently is to ignore the promises of those promoting pie-in-the-sky prediction mechanisms and concentrate on finding and implementing a proven, integrated methodology that follows market trends.