Don’t Get Cocky

You may have read my last post about my monthly results for February. With great returns like these it's easy to get cocky. It's very easy to feel good about what I am doing and forget about all the times the market has slapped me down… oh, and it has. One of the most valuable lessons I have every learned is that the market doesn't owe me a dime, regardless of how well I am doing. I think there is a tendency, at least with me, to start to feel good about winning trades and relax a little bit. By "relax" I simply mean that I might not be quite as diligent as when things are a little dicey in the market. This can manifest itself in many ways: Taking too long to take losses, getting sloppy on entries and exits, etc.

The counter to this is that losers tend to make one feel discouraged. For me, that means I get worried and stop trusting my system. I second guess my judgment. Frequently this causes me to not want to pull the trigger on good trades. I chicken out and miss good profits. In order to be successful in the long term, it's important to remain detached from the winning and losing. Gains and losses are all part of the business, so it makes little sense to gloat when I win OR to get discouraged with I take a loss. Emotions, however, are extremely hard to control. Over time there are a few things I've done to help manage my emotions:

• Testing: I have backtested all of my trading strategies for a minimum of five years. While "past returns are no guarantee of future results", this gives me some idea of how the trade should work out in the long run. It also shows me what losses typically look like. By seeing this in backtesting I am able to grow accustomed to the normal flow of profits and losses. By having my expectations set the wins and losses don't surprise me so much.
  
• Trading System: This really falls under the category of discipline. My having a VERY defined set of trading rules for each strategy I am able to remove much of the emotion from my decision making. I never have to think about, "Should I enter now?", "Should I take this loss?", "Is this a good profit point?", and the myriad of other questions that run through my mind in the heat of battle with the market. Instead, my rules are predefined and I know exactly what I will do at each point. At minimum, I know where I will take profits, and where I will take losses, before I ever enter a trade. In most cases my plan is a little more detailed, but that's the bare minimum.
  
• Detachment: It's useful for me to think of trading more as a game with points, rather than winning or losing money. Money is too emotional. Although in some cases it's just not possible. After all, it IS real money. Further, it's important to stay as unemotional as possible about the money I am trading. This is why I focus so much on controlling and limiting losses. I can stomach not making much, but I can't stand losing. Overall I think I have a pretty level head about it. As a Christian I try very hard to remember that all of this doesn't really matter. I actually think it's my competitive streak that eats at me when I lose. It's not the money as much as I just hate losing. Wanting to win is wonderful; needing to win is dangerous.
  
• Logging Trades: This might not seem like it assists in keeping a level head, but it will surprise you to see the effect of logging every trade. I make a habit of logging and reviewing every trade. I pay special attention to my losers (did I mention that I hate losing). Every time I have a loser I want to know why, and it really boils down to one of three things.
  
• • I made a mistake: This accounts for about 30% of my losers. Sometimes mistakes work out, but mostly they hurt me. I make less and less as I get more experience, but I still make them.
    
  • My system is not good: At this point I have tested and traded the same systems for so long that I don't believe this accounts for any losers, but it's a possible cause if you have losers.
    
  • It's the numbers: Even the best systems have some losers. For example I have one type of trade that wins about 75% of the time. Therefore I will have 25% losers. That's just the nature of the business. This accounts for about 70% of my losers these days.
    
    

  As I review and study my actual trades, and especially the losers, I learn about how my trading strategies and systems behave. I learn what to expect and what not to expect. In the end, this allows me to trade more mechanically and far less emotionally. I'm able to take the wins without getting cocky and the losses without getting discouraged (okay, maybe a little bit.)
  

Good Trading...