Weekend Food For Thought – Mar 16, 2012

DEFENSIVE TRADING – LESSON 4  

Trade because you have a trade.

Never trade because you have to trade.

That simply means that if you don’t have anything to trade, don’t trade anything. It also means that you should only trade when there is an opportunity for a low risk trade. What it mostly means is that you shouldn’t be trading anything for the sake of trading something especially when there is nothing to trade.

In order to do that, about the only way to know if you do have a trade is to look at your charts. This is when we become over-dependent on our charts and start looking for ways to get “the edge” over the market.

And this is when everything starts to fall apart.

Too many times, traders don’t let the charts tell them what it wants to tell them. Instead, traders see only what they want to see or hope that what they see is what will happen. In many cases, traders allow themselves to get lulled into indications that the market might make a move.

They use things like MACD, Stochastics, RSI and a whole bunch of exotic indicators with all sorts of permutations to find that “edge”.

Common sense will tell you that there is no such “edge” … there hasn’t been such an edge for centuries. All you have to do is ask yourself a simple question and you will see how silly it is to go looking for that edge;

How did the traders in the 50s and 60s trade without computer technology?

Here’s another dumbfounding question;

How did the Japanese do it 400 years ago when communication was only as fast as the horse (denma) could run?

For years and years, traders have looked for that holy grail, that magic formula and that all-winning strategy. Many experimented with different styles, technology and strategies. Their results were always the same – they ended up nowhere and their accounts dwindled. Meanwhile, the ardent and conventional traders went on to make their money the old fashioned way using risk management, financial management and psychological management – all the three defensive arms of a successful trader.

It is hard work. It does take a lot of practice and it definitely takes a lot of experience. There is no easy way to do this and there is no short-cut to this success. All a trader can do is to use his experience and skill to know when to take a trade because there is something to trade. He will never know if the trade will work out but he has eliminated all the major risks before considering this position. If there is too much risk, then there is nothing to trade.

There never was and never will be a way to know what the market will do next or which direction it is going to take. It will swing back and forth regardless of macroeconomic influence, historical tradition and mathematical probabilities. One can never fully factor in all the possibilities because the market is made up of the widest myriad of players;

Some are pros who stay rational, others are novices who are irrational, some are long term players that hardly react and others are short term traders who over react.

Then you have those who are experienced and savvy versus many others who don’t know what they are doing, some who second guess the market and predict it against those who stay with the trend.

Then you have those who will swear by fundamentals in the long term and those who only use technicals in the short term

So how can any one system or method or indicator or technique or strategy fully take in all the amazing dynamics that the market has to offer? How can a trader find an “edge” to beat the odds? What can he possibly see in the charts that will tell him for certain what the future holds?

The greatest traders that ever lived could never answer that question and the great ones who still live still can’t answer it.

Then comes the second mistake – When we don’t have a trade, we go looking for a trade.

Traders will use software or screeners to “find the best trade” without using common sense because common sense will tell you that the “best trade” is the one that has already happened. Chances are, you’re already too late. No screener or software is going to tell you which trade is going to be the best.

The best software available is the one that will shortlist the lowest risk trade. That is as good as it gets. But that software is base, without doubt, on a mathematical probability. Any software for that matter is based on math. And common sense tells you that the market is not a mathematical place – it is highly emotional. No math on earth can calculate the human emotion or what the next emotion will be. To put the case beyond any reasonable doubt,  no math can calculate the most common emotion in the market – irrational behavior.

The long and short of it is that it takes hard work, patience and lots of practice to gain the experience needed to be a successful trader. And the reason why there are so many more losers than winners in the market is simply because the few winners are the ones who have done what the many hate to do – work hard, be patient and practice. That is the only way to get the experience needed to succeed. Experience takes time and time cannot be rushed.

The few winners are the ones who specialize and use their vast experience to trade what they know too well. They don’t have to scour the whole market to find the best trade because the best trade is the one they do everyday. On days when their specialty is not favorable, they don’t trade. On certain days when the risk is lower, they take the trade. Thus,

Never trade because you have to trade.

Only trade when you do have a trade.

The only edge you can have will be illegal and its called “Insider Trading”. But we won’t go there.

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Comments

You are so right mr conrad. I always told myself that to be focus and disciplined. perhaps due to little time to trade as i am in NS. I have this problem of feeling the urge to find a trade. Even though i knew it is not going to work, i just reason with myself that it will work, going against my experience and the technical analysis i am using.
I still have a long long journey for me to go, and will do my best to change the way. Hopefully, there will be a lesson 5 from you mr conrad :)

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