Monday, February 29, 2016

A few more things I've learned about trading

Here are some other lessons I've learned the hard way from trading. My conclusions might be wrong, but this represents how I see things at this point.

You might not have read my original article about my learning experience in trading. Read it here!

... Anyway, let's mention a few things before we start:
- I assume you trade using "leverage" (you magnify your trade size by taking up a loan, this way you can make higher profits - but you will also lose quicker. You will not end up in debt, because the broker will not allow you to lose more money than you've invested out of your own pocket - read up on leverage and make sure you understand how it works)
- You know what stop loss (SL) / take profit (TP) is (you set up a trade to automatically close if you've lost a certain amount of your trade position. Take profit is the opposite, where you close the trade once you've reached a certain profit)

1) Don't risk your whole account.
Let's say you start with $1000. You make 10 trades using $100 on each. You want don't want to be stopped out too early so you have a stop loss at 100% of each trade. That means that the markets can go against you until you lost your whole trade size ($100 for each trade). It seems highly unlikely that it will come to that. Let's say you have set take profit at 50% (that means your trade will be closed if/when you reach a $50 profit). It seems much more likely that your trades will reach a 50% profit than a 100% loss - cause you have an edge - judging by your information you could very well be making a good trade. Let's say you close all the trades at the same time and you end up with a $500 total profit. Your balance is now $1500. Now let's say you make another 10 trades, but now you use $150 on each trade. You do good again and you make a profit of $750 (50%, remember?). Your balance is now $2500. You feel good, so you decide to do the whole thing over again, and this time - you guessed it - you spend $250 on each trade. However, this time the markets go against you and you lose all your money. So much for those nice winnings in the beginning. Let's say that instead of trading with your whole balance on the third trade, you limited yourself to your previous trade: spending $1500 on trades. In this case you'd still have $1000 left after losing with all your trades. It's an easy mistake to keep making bigger trades once your account starts growing.

Let's pretend to make a rule: Only spend 20% of your account.
Round 1: 10 trades, $20 per trade. $100 profit.
Round 2: 10 trades, $22 per trade. $110 profit.
Round 3: 10 trades, $24 per trade. $240 loss.
Balance in the end: $970. $30 loss. Not your whole account.

What if we trade with 50% of our account?
Round 1: 10 trades, $50 per trade. $250 profit.
Round 2: 10 trades, $62 per trade. $310 profit.
Round 3: 10 trades, $78 per trade. $780 loss.
Balance in the end: $780. $220 loss. Not your whole account.

What if we always make 10 x $50 trades?
Round 1: 10 trades, $50 per trade. $250 profit.
Round 2: 10 trades, $50 per trade. $250 profit.
Round 3: 10 trades, $50 per trade. $500 loss.
Balance in the end: $1000. 0 profit/loss. Not your whole account.

Not spending your whole account just makes trading more pleasant and it gives you more do-overs. It might feel like you can make money faster by putting it all on the line, but suddenly you've lost it all.

2) Be careful trading the same thing
Instruments (stocks, indexes, currencies etc.) are connected. If the EUR gets weaker, it will affect all currency pairs that involve EUR. But if the EUR gets weaker, it could also mean that the CHF is getting weaker. If you trade USDCHF and EURUSD, you are - in my experience - pretty much trading the same thing. So if you find a good opportunity on the USDCHF you might also find a good opportunity on EURUSD, thinking these are two separate, good opportunities. If you have a rule to not spend more than e.g. 10% on a single instrument, you might as well avoid spending more than 10% on EURUSD and USDCHF together, the way I see it. Sure, you could do 5% on each if you want.

Indexes are very often strongly connected. If the US indexes are going up, chances are that the European and Asian markets are going up as well. Be careful trading many of these indexes at the same time, thinking they all look like great opportunities. If one of them turns around, chances are that other ones will do it as well.

3) Accept losses
Above I mentioned having a stop loss at 100%. This can work if you also take profits that are high enough. If you have a 100% SL and lose 1 out of 3 trades, then you need to make sure that you - on average - makes a profit of more than 50% of the other 2 trades to at least break even (taking for granted that the trades are of equal size). It's so easy to let losers go and to close winners too early. You need to let the winners go to be able to justify a 100% SL.

2 / 3 winners is just an example. Maybe losing 100% of your trade size is highly unlikely and that you can make 25% profits on the instrument multiple times before losing (100%). If you have 10 25% winners before you have your 1 100% loser, your profit from the instrument would still be 150% of the trade size. It's a numbers game.

Anyway, there are other ways to trade successfully. You can have a tight SL. The problem with tight SL's is that you can easily be stopped out by a "false breakout" against you. And sometimes if your broker is a "market maker" you can get stopped out easily by a sudden 1-minute drop-and-rebounce. If the instrument doesn't test your SL limit, then you have a good trade going with little risk.

You could have a not-so-tight SL. Let's say you set it to be 25% of your position size (trade amount). If you find good opportunities, this could work out well. But if you lose 1 of 3 trades, you need to make sure that the 2 winners are at least 12.5% profit each (average) to break even. However, should the market test your SL limit you might be tempted to move the SL further away. This is often a slippery slope. Sure, sometimes it will work out; the instrument will turn and you will get a profit. But what if it doesn't? What if you keep moving the SL all the way down to 100% loss? Or even further? You can inject more money into the position to accept a even higher loss; 150% or 200%. Let's say you lose 200% on the trade. Now your two other trades needs to make 100% profit each to help you break even. There's no shame in a having a 25% loss on your record.

4) Take my own advice.
Despite all the things I said above, I still trade poorly. It's psychology. It's a mind game. The markets still make me insecure enough to trade inconsistently.

Sunday, February 21, 2016

What I've learned from 4 months of trading

A few  months ago I met a guy who had recently become unemployed. He was working in the oil business and as you might know: things are not going so well in the oil business. As he was trying to find a new job he was also learning how to trade. I had no clue about stocks, indexes, EFT's and currencies, but I found it some how interesting as I am too looking for other ways to make some money (other than my job and some business ideas I've invested some time and money in). After a 10 day vacation in Italy I signed up at an online broker. It was around October 20th 2015. During the following days I wrote some Facebook posts about my first days as a "trader". It was my uncle who then suggested I should write a blog about this subject. Today I found the motivation to at least write a blog POST about it.

During my first few days I was a bit lucky. The US markets were rocketing more than they had in many years from a relative LOW ("support line" - a low point where people tend to buy) to a historical HIGH (making a "resistance line" - a high point where people tend to "short". A short is when you "borrow" a certain amount of units of something and sell it for a price and then later on you have to buy it again to give it back to the lender - if you can buy it back at a lower price you will make a profit on it). So these fantastic days created an illusion for an amateur like me. I thought the market always was like this and I made stupid "buy"-trades at any time thinking it could not fail. I also made these buys with a ridiculously high "leverage" (Leverage is like taking up a loan to make a trade - however, as soon as you are about to lose more than your own money on this trade, the trade will automatically close so that the broker can have their money back - they don't want to lose THEIR money - obviously). Needless to say, after having made some nice profits, I soon started losing most of my money simply because I could not wrap my head around the fact that markets SWING and that means you'll have up-times and down-times - usually within certain boundaries. 

It's interesting how things you learn can be transferred into other contexts. A couple of years ago I started playing chess again. I played a bit when I was little, but hadn't really played for a while and I was not very good at it anymore. I started playing online and I lost and I lost and I lost. But I kept playing. And I kept learning. Watched some You Tube-videos about various strategies etc. So I got better and better. I started identifying some weaknesses about my own personality (shocking!). For example, I was pretty bad at thinking AHEAD. In Chess I would often "shoot blanks" at other players. By that I mean that I'd do silly moves that I thought would some how "bluff" the player to make a mistake. As I realised this I tried to correct it by trying to always make a plan that had good potential - but very low risk. If it works: great. If it does't work: No problem! I tried to learn this in my daily life as well. For example: Some times I would make claims that I could not prove - I just believed in it strongly. Thinking that the people I spoke to would not be able to disprove it. Normally, people should be careful about making absolute claims unless they can back it up. So I've become better at either 1) Find proof to back me up, or 2) State that I'm not sure and that it's merely my opinion/belief (belief with good reason though).

Trading has also taught me something. Make a plan and stick to it - at least as long as nothing unforeseen happens. Take a look at this chart first:

Let's say I "buy" at the 4th arrow from the left in the chart above. I can see from 3 previous low points (the 3 leftmost arrows) on the chart that I could be able to make - let's say - $100 if I wait until the value reaches the expected "top level" (resistance line). However, once the value increases and, if you close the trade, your profit could be maybe $10. It might be tempting to close the trade because you feel like you might miss this opportunity. What if the value goes down again - then you get nothing. I've done this many times. But patience is the key. Long term! I don't know what the real answer is. What if it reaches $80 and goes back down? You could miss out on $80 because you were stubbornly waiting to make $100. 

My current strategy is still a "work in progress". It's real painful to stick with a trade, hoping it will make it all the way to the top. Right now I like to make many small trades. Let's say I open 4 "buy"-trades. I could close the first trade at 25% of expected max. Close the second trade at 50%, 3rd trade at 75 and 4th trade at 100%. And if I close the first one at 25% and the value goes back to square 1, I could make the trade again. Making similar profits repeatedly. As soon as the level reaches it's full potential (according to my strategy) I might start opening "short"-trades - expecting the value to go down again. However, should the value exceed the "max expected value" significantly I would be very careful. Now the instrument (for example an index or a currency pair) has broken out of it's regular pattern - something could have happened in the world that might affect this instrument significantly. I should not be tempted to take advantage of this situation, because it's too risky - I have less edge now than I ever did. The previous behaviour on the chart might not mean anything anymore.

Trading "knowledge" can be transferred into real life as well. It can help you "learn" to focus on long term profits rather than panicking and "settle" for a short term profit. It sounds very easy to do, but for many people it's simply not. In my first months of trading, a professional trader could have told me to "hold on to a trade" because it would give me the best profit, but I would still close it early to gain a small profit. To this day I close trades too fast. But I'm getting better. It's an adjustment I need to convince myself about based on personal experience. In the end I will definitely say "I should have listened to the pro's from the start". The pro's can say something like "Spend max 2% of your equity on a trade". I have easily spent 30% of my equity on a trade. But then again, what is your real equity, is it what's deposited to your broker, or is it what you have in the bank. 

Trading is not for everyone. But it could be if you're willing to lose, wait, learn and adapt. I've seen plenty of videos, listened to a handful of audio books, programmed many scripts for back testing. It has all added up to a certain understanding of how markets work. 

Currently my trading strategy is this: I will find an instrument that has been stuck inside a certain frame on the chart for a few weeks/months. That way I will conclude that it's likely that the instrument will keep swinging inside this frame for a while longer. So I can make a few buy-trades in the low zone and a few short-trades in the high zone before the instrument eventually breaks out of its pattern and I will lose a few trades. But as long as the instrument stays within the frame, my trades will always make a profit. So let's say I manage to make a $1000 profit before the instrument breaks out and then I lose $300 because of the break out. It's still a $700 profit in the end. Time to find a new instrument that I can - possibly - rely on. 

I've tried to write about what I can think of, in no particular order. If you have any questions, please write them in the comment area and I will give my best response. Keep in mind that after about 4 months of trading I'm still not a successful trader, however, I did make a 50% profit over the last 7 days. That means that my equity increased by 50%. That is good, but it does not cover up all my losses before that. And it is no guarantee of future earnings. Trading is hard!

Hope you liked it!