This article was originally published on November 14, 2005.
Much time and attention in these articles is dedicated to winning trades in the futures markets. Today will we will identify some of the reasons why traders lose and hopefully learn how to avoid a few of these common pitfalls. Losing is a major part of commodity trading. How you handle losses can be the difference between being a successful trader and becoming a former trader.
I have personally, at one time or another, made most of these mistakes in my own trading. Identifying common mistakes is the easy part. Overcoming human nature is a career long struggle in trading. No trader is perfect. Traders who can best avoid the pitfalls have the best chance of being successful over time.
The futures industry is full of trading adages that for the most part are sage advice. The following are some of the most common adages in the business:
Let your profits run and cut your losses short
The first loss is always the smallest
Plan your trade and trade your plan
Pigs get fat, hogs get slaughtered
The trend is your friend
The above adages have been around as long the markets have been in existence. Their wisdom and validity have stood the test of time. We will discuss three of my own trading dictums that are listed as follows:
Do you want to be right, or do you want to make money?
The hardest part of trading is between your ears
Would’a, should’a and could’a are the three best traders I know.
We will draw some parallels between trading and baseball. In the 2005 baseball season, Derrick Lee led all of major league baseball in batting average at .335. That equates to failing to get a hit 2 out of 3 times he steps up to the plate. Most players in the major leagues would be thrilled to bat .300. That would mean that 7 out of 10 times they batted, they failed to get a hit.
You may be starting to wonder what baseball has to do with trading futures. A baseball player knows that he will not get a hit every at bat. He also knows that if he goes 0-4 in a game, that he should not completely change his swing. The adage, plan your trade and trade your plan, draws a nice parallel to our baseball analogy. One of the most difficult parts of trading for most new traders is dealing with the losing. A few losing trades in a row and a trader is ready to try a different strategy.
The markets vary in their type frequently. Some of the time, markets trade in fairly well-defined ranges. At other times, markets experience well-defined trends. A person trading a trend following system will likely lose money when the market is choppy and directionless. On the other hand, a counter trend trader who sells resistance and buys support would tend to thrive in a choppy market. Neither of these strategies can be said to be better than the other, they just work better in different types of market conditions. It is difficult to see the big picture while you are in a trade, especially if you have had a string of losers. Many times, traders will switch strategies just as market conditions are about to change. These traders end up trading the wrong strategy in the wrong market and then switch strategies and do the same thing again only to find they are once again trading the wrong strategy in the wrong market.
Many times in trading, the best course of action is stick with your trading method. Going back to baseball, if Alex Rodriguez goes into a slump, he does not try a new swing or stance. What he will do is watch video of himself hitting at a time before the slump. He will find out what he is doing now that is different from what he did when he was successful. This will help him to return to his original method of success.
Human nature is a big part of the reason many traders lose. We are taught from the time we start grade school that we should be correct all the time. The way to get A’s in school is to get 93% correct on your exams. It is hard to get away from wanting to be correct or right and that can be costly in trading. Successful traders learn that they want to make money over time, not be right all the time.
Many trend following traders lose on upwards of 70% of their trades. They believe that the 30% winning trades will make enough for their trading activities to be profitable. The average new trader would never stand for a system that lost 7 out of 10 trades. They want to be right 93% of the time and get an “A”. Many new traders are attracted to programs and systems that advertise high winning percentages. Which is better, a system or method that wins 93% of time with $100 average winners and $1,000 average losers, or a system that wins 20% of the time with $1,000 winners and $100 losers. In this example, the 20% winning system is the better method.
The problem with low percentage winning systems is that after three or four losing trades in a row, the trader starts to doubt the validity of the system. Maybe the market has changed? Maybe the system is no longer valid? These are just a few of the thoughts that go through the mind of a trader who has had a several losers in a row. If an uninterested party were to view the big picture up to the most recent losing streak, they would easily identify that the method worked over time and not think about changing course. Successful traders learn to ignore these thoughts and focus on the fact that losing trades are part of their overall system.
Many novice and unsuccessful traders play the Would’a, Should’a, Could’a game. A trader sees a trade set up and does not act. He tells himself that he would have made money if he acted on the signal. The same trader is in a position that is making money and takes profit. The market continues in the same direction and our trader tells himself that he should have stayed with the position and made more money. A trader looks at the markets after the close of trading and tells himself that had he looked earlier he could have made had a winning trade. The words would, should and could are all past tense verbs. Trading the past is very easy because we know the outcome.
Trading is about making money, not being correct in market analysis or being a great prognosticator. Traders must be consistent in their approach and strive to completely remove emotion from trading decisions. This is often best achieved by having and sticking to a plan for every trade. We trade in the future markets, not in the past markets. We will never trade as well in real-time as we could by looking back. Trading in the past is an exercise in futility that will only harm your psyche going forward. You should view every trade you make as the best trade you could make at the time with the information available.
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