Top 10 Lessons I Learned Reading 150 Trading Books. The Top 10 Lessons I Learned By Reading 150 Trading Books

Transcription

1 The Top 10 Lessons I Learned By Reading 150 Trading Books 1

2 Disclaimer This disclaimer applies to all products and services provided on (hereinafter referred to as Website ) and products and services provided by AMS Trading & Investments Pty. Ltd. The website is owned and provided by AMS Trading & Investments Pty. Ltd. (Hereinafter referred to as us or we or Company ). The website also includes it owners, employers, officers and associates. The content of the website and our products and services are for educational purposes only, and they are not to be interpreted as any type of advice, and are not an intent to replace any kind of individual research or licensed investment advice. Trading any kind of financial asset including, but not limited to: currencies, stocks, bonds, futures, options, e-minis, etc. involves high levels of risk, and there is substantial potential for loss. We do no guarantee any kind of results and your trading results may vary. No representation is being made that the content, products or services, or any associated or training / coaching, will guarantee profits, or not result in losses from trading. Neither the products sold by us, nor any training services held in conjunction therewith, including, without limitation, through online seminars/webinars, coaching, alert services, in conjunction with our advertising and promotional campaigns, during our in-person seminars or otherwise, should be construed as providing a trade recommendation or the giving of investment advice. The purchase, sale or advice regarding any kind of financial asset can only be conducted by a licensed broker/dealer or investment adviser. Neither we nor any of our affiliates, or other partners and associates involved in the in the production and maintenance of these products, services or this website, is a registered Broker/Dealer or Investment Advisor. All purchasers of products and services referenced at this site are encouraged to consult with a licensed representative of their choice regarding any particular trade or trading strategy. Lastly the user, browser or a buyer of any our products & services should be advised that even a relatively small market movement in any of the financial assets discussed may have a proportionately larger impact on the funds you have deposited. You may sustain a total loss of your funds. Since the possibility of losing your entire cash balance does exist, speculation in any kind of financial market should only be conducted with risk capital you can afford to lose which will not dramatically impact your lifestyle. EARNINGS & INCOME DISCLAIMER: There can be no assurance that any prior successes, or past results, as to income earnings or percentage gain, can be used as an indication of your future success or results. Trading performance (monetary and income results) are based on many personal factors. You may and should assume you will probably lose money trading. Therefore we do not guarantee or imply that you will be a successful, profitable trader, or make any money at all in your trading using our services. Users, analysts, mentors, staffers and users of the website can and often will talk about trades and their trading systems, their entry, their exit and how much they might have made or lost on a trade, group of trades or in using a particular trading system or systems. These claims may be made based on live or historically simulated trades and may or may not be accurate. We do not condone, encourage or promote others to claim performance results that are not true. We encourage traders, regardless whether or not associated with us, to only share correct information if they chose to disclose trading performance results. We do not verify disclosed performance results by its users. It is up to the user of the website to make the judgment about whether claims made should be relied upon. Users should ignore and dismiss any claims heard, seen or read on the website by any user or those associated with us. Users should use their own judgment to determine if any claim should be taken seriously or not. Our products and/or services may involve unknown risks, and are not suitable for everyone. Making decisions based on any information presented in our products, services, or website, should be done only with the knowledge that you could experience significant losses, or make no money at all. You agree that we are not responsible for the success or failure of your financial decisions relating to any information presented by us, or our products or services. COPYRIGHT NOTICE: This document is protected by copyright under international conventions. It is provided for your personal use only. The reproduction, distribution or retransmission of the contents of this document is prohibited without prior written consent from AMS Trading & Investments Pty. Ltd. 2

3 Table of Contents Disclaimer... 2 Introduction... 4 The Top 10 Lessons Explained... 5 Lesson 1: The search for the Holy Grail is a waste of time... 5 Lesson 2: Trading systems are the best solution for most people... 6 Lesson 3: Your trading system must suit you... 7 Lesson 4: Positive expectancy is the key to success... 8 Lesson 5: Curve fitting is your evil nemesis... 9 Lesson 6: PPP - Preserve Precious Capital (don't lose too much) Lesson 7: Risk a (very) small % of your account on each trade Lesson 8: You MUST have a written trading plan Lesson 9: Diversification is the only free lunch - get all you can! Lesson 10: Trading Mistakes are extremely expensive - eliminate them! Conclusion Special Bonuses

4 Introduction I have been a profitable systems trader for over 10 years and starting with just a small amount of capital - $10,000 plus savings over time, I have made many hundreds of thousands of dollars trading. I have never worked for an investment bank, never been a trader for a hedge fund, never worked for a broker and I have never been an 'insider'. I am a normal person just like you. You don't need insider secrets - they don't exist anyway. All you need to become a successful trader is the determination to succeed and the willingness to learn and grow. During my trading journey I have read over 150 trading books. There is a lot of fantastic information and insights out there, but there is an awful lot of garbage too. To help you on your journey, this special report describes the top 10 lessons that I learned reading over 150 trading books. There are many other lessons that I have learned, but the 10 below are the most important ones. As a special bonus, at the end of this report I have also listed the trading books that have most influenced my trading success, and provided a link to a Trading Assessment which will provide you with more specific feedback on your current approach. The top 10 lessons are listed below, and explained in each subsequent section: 1. The search for the holy grail is a waste of time 2. Trading systems are the best solution for most people 3. Your trading system must suit you 4. Positive expectancy is the key to success 5. Curve fitting is your evil nemesis 6. PPP (Preserve Precious Capital) 7. Risk a (very) small % of your account on each trade 8. You MUST have a written trading plan 9. Diversification is the only free lunch - get all you can! 10. Trading Mistakes are extremely expensive - eliminate them! 4

5 The Top 10 Lessons Explained Lesson 1: The search for the Holy Grail is a waste of time One of the first things I realised when reading the Market Wizards series of books by Jack Schwager is that there are many ways to make money trading. Despite this, many people get caught up the search for that one secret method that will make them a fortune in a very short space of time. After reading interviews with many of the traders in the Market Wizards series, and other Trader interviews in books such as Art Collins 'Market Beaters', it becomes very obvious that there is no one secret trading method that will make you rich. Anyone who claims to have THE SECRET METHOD is nothing but a scam or a con artist. You see every trader interviewed in those books is phenomenally successful, but every trader also approaches the markets differently. The main thing they all had in common was that their trading style suited them completely. What this means for you is simple - there are lots of ways to make money in the financial markets, so stop looking for the secret method that will make you a fortune, and design a trading approach that fits your personality, your objectives and your ideal lifestyle. The most successful traders are all totally clear on what their methods are and they apply these methods consistently with confidence. Traders who try a method they 'discover' from some guru only to get frustrated and switch to a new method several months later don't succeed. This is not because the methods are flawed, but because they have not given them time to work AND / OR because the methods don t fit their personality. For example, trend following is profitable. There is absolutely no question about this because I have used it for over 10 years in many markets with great success. However, when you first start trading with a trend following system there is always a drawdown. It does not matter when you start; you will have a drawdown because you will always go through a bunch of losing trades while you wait for a winning trend to come along. When the winning trend comes along it makes up for all those loses and more, but you have to stomach the drawdown first. Figure 1: Drawdown at the commencement of a trend following system. Many people are not prepared for this drawdown and give up before the equity curve comes back to break even and heads for the stars. The people who are too impatient or can't stomach the drawdown never get to the point of profitability and give up and so they throw away that strategy and continue on their search for the holy grail (and keep on losing). 5

6 Lesson 2: Trading systems are the best solution for most people Establishing a trading system is an excellent way for most traders to ensure they have a profitable approach to the markets and reduce their mistakes to the point that they can be consistently profitable. In Curtis Faith's outstanding book Way of the turtle he talks about the many biases that people have which make them lose money trading. There are many things we learn through our upbringing, our education system and in our professional lives that make most people terrible traders. Even human nature makes people terrible traders because our ability to make good decisions goes down when emotions go up. Just think of the last time you were stressed or angry did you make the smartest decisions you could have made? Probably not! When I started trading I did what most people do - I used a whole host of information sources and made discretionary (gut) trading decisions based on what I thought all that information meant. What I realised early on (after quite some losses and frustration), was that I had two choices - spend years working on my psychology OR remove myself from the equation altogether. I took the simpler and quicker option and decided to build a trading system and I never looked back! Van Tharp provides excellent context for what a trading system actually is in his book Trade your way to financial freedom. This book is a must for all traders whether you will be using a trading system or not. A complete trading system consists of the following components: Figure 2: Components of a complete trading system. By following a system, most of the biases and problems most traders face are eliminated and what is left becomes much more manageable. 6

7 Lesson 3: Your trading system must suit you Something that I learned from Richard Weissman s fantastic book "Mechanical Trading Systems" is that your trading system must fit you. Every trader has a different personality, different objectives and a different ideal lifestyle. It is also clear that different trading strategies have different psychological challenges which make them suited to different types of people. Figure 3: Each person is different, so the trading system must suit the trader! For example, let's say you are the sort of person who likes action, you like rapid fire decisions, you keep your focus by opening and closing many trades each day, you like to bank your winners quickly and move on, and most of all you love watching the markets, so you look at the screen constantly when your markets are open. You may have a great system and you may make tons of money, but if you gave that system to me I could not trade it - I would make mistakes and lose money. Why? Because I am pretty much the opposite of everything that I described above! It would not work for me, I would find it stressful, I would hate waking up in the morning and I would not be able to follow the system consistently. Your trading system must match what you like for you to be successful. I have tried many systems, most of which should have been profitable, but only the ones that fit my personality, objectives and ideal lifestyle have ever made money for me consistently. 7

8 Lesson 4: Positive expectancy is the key to success In Trade your way to financial freedom Van Tharp explains that for any approach to make money in the markets it must have a positive expectancy. Put simply, expectancy is the amount of money you expect to make per dollar that you put at risk over the long run: If you are a math s person, here is the formula: Figure 4: Formula for expectancy (Exit Price Entry Price) ( (Entry Price Initial Stop Loss) ) Number of Trades If you are not a math person, here is how you calculate expectancy: Get a sample of at least 30 (preferably over 100) trades generated by your trading system or your actual live / simulated trading, and then follow these 4 steps: 1. Calculate the risk per contract for each trade (Entry Price - Initial Stop Loss) 2. Calculate the return per contract for each trade (Exit Price - Entry Price) 3. Divide the return per contract by the risk per contract to get the R-Multiple for each trade 4. Average all R-Multiples to get the expectancy (If you design your trading system on a back testing platform then your software will probably be able to give you the expectancy automatically.) If your expectancy is negative after accounting for the cost of slippage and commissions then you will lose money in the long run and you should not trade with that approach. The larger (positive) the expectancy, the more money you expect to make for each dollar that you risk, and the more profitable your system or approach should be. Many people who trade based on intuition or gut feel have no idea what their expectancy is, and therefore do not know whether they will ultimately make money or not. There is no excuse for this. If you do not know what your expectancy is then you are taking a huge gamble! Take some time now and calculate your expectancy if you haven't already - you will not succeed in the long run if you have a negative expectancy. 8

9 Total System Profit Top 10 Lessons I Learned Reading 150 Trading Books Lesson 5: Curve fitting is your evil nemesis When we design a trading system we devise a set of rules that determines when we will enter and exit our trades. If we code these rules and test them on historical data then we can evaluate how well our system would have worked in the past. What we typically do after designing our initial set of rules is try to find ways to improve the system by changing or adding rules, or by optimising the parameters used in each rule. We then retest the adjusted system on the historical data and determine how much better the new rules are. By far the best explanation of how to design and optimise trading systems correctly is provided by Robert Pardo in his excellent book "The Evaluation and Optimization of Trading Strategies". This book is a must if you are serious about creating a profitable trading system and avoiding problems like curve fitting. Traders run into trouble because they focus on getting the best historical back test rather than the highest likelihood of future success Most commonly traders do this by adding lots of specific rules to their trading system and optimising every rule to get the best possible back test results. When there are too many rules that are specific to the historical data, the system looks very profitable when you run it over the past data, but when you trade it in real time with new data it has no predictive power and it loses money. Traders need a small number of simple and logical rules for a trading system to work in real time. Once you have those rules, you then need to optimise the settings for each rule to find the most stable level ie. the level that is also surrounded by other equally profitable settings. This is important because the best setting in the past will not be the best setting in the future, so you need to choose the setting that is surrounded by the most other profitable settings see below: Example Optimisation - Length of Moving Average Length of Moving Average Figure 5: Example optimisation showing the total profit for different lengths of moving averages. The 4 day moving average produces the best results, but this is curve fitting because the surrounding results are losers. The 17 day moving average is a better choice because it is surrounded by a wide range of good performance results. You can test how curve fit your system is by doing an out of sample test. For example, you designed your trading system using Australian stock data and tested the system on US stock data as your out of sample test. If your system is curve fit then the US performance will be much worse than the Australian historical test. If the system is robust and simple with a real market edge then it should still work on the new data. 9

10 Lesson 6: PPP - Preserve Precious Capital (don't lose too much) Warren Buffet has said that the two rules for investing are: 1. Never lose money 2. Never forget rule number 1 We all know that not all trades will be profitable (every trader has losses), so how do Mr Buffet's rules apply to traders? We have to think beyond individual trades to our overall account. The key insight is that the more you lose, the harder it is to recover. For example, if you lose 10% of your account you need to make 11% to recover, but if you lose 50% of your account you need to make 100% to recover. This challenge of requiring disproportionately higher returns to recover from higher levels of drawdown is discussed by Michael Covel in his book Trend Following. The implication is that keeping maximum drawdowns to a low level makes consistent profitability easier to achieve. The diagram below shows how it becomes increasingly difficult to recover from large losses. At the extreme end, if you lose 90% of your account you then need to make 900% to recover - this is essentially impossible. Even recovering from a 60% drawdown in your account is extremely unlikely. Figure 6: Return required to recover from increasing levels of drawdown or losses So the lesson for traders in this is to ensure your maximum drawdown (the percentage drop from your highest account balance to the next low in equity) remains small so that it is easier to recover to make new equity highs. 10

11 Lesson 7: Risk a (very) small % of your account on each trade Most outstanding trading authors devote a lot of effort to explaining how to manage risk. Van Tharp, Curtis Faith, Jack Schwager, Thomas Stridsman and many others all stress low risk per trade as a critical ingredient to long term trading survival. Poor understanding and management of risk, and excessive risk per trade, are probably the biggest killers of novice trading accounts! Figure 7: Relationship between risk per trade and expected profit...risk too much and you go over the edge of the cliff! The only safe way to trade is to ensure you are in the safety zone for your. This means risking less than is historically optimum. This is important because the market shifts over time and what was optimum yesterday will not be optimum tomorrow. You need to ensure that market shifts do not push you over the precipice into the red zone. The only trouble is you won t know till it is too late, so you need to risk less than the historical optimum. The higher your level of risk per trade, the greater your chances of losing all or most of the money in your account. In the vast majority of cases this is how I think about risk per trade: 1. Risking >10% of your account on each trade is guaranteed suicide. It is just a matter of time before you lose everything in your account and maybe even more than that. 2. Risking 5-10% of your account on each trade is really wild trading. You will probably have huge swings in your equity curve and one short losing streak could wipe you out. 3. Risking 1-5% of your account is starting to approach something sensible; however, for most traders this is still too much! Most systems are way too volatile with 5% risk per trade. 4. Risking <1% of your account is more likely to keep you safe. Of course you still need to watch your total risk levels, but you can survive a fairly long losing streak if you keep your risk this low. Note that in my own trading I risk much less than 1% on each trade! Stay in the game keep your risk low to ensure you don t get wiped out! 11

12 Lesson 8: You MUST have a written trading plan Writing a great trading plan will set you apart from the 95% of traders who ultimately lose money and quit. This is probably the single biggest difference between successful and unsuccessful traders. John Forman provides a very good discussion on trading plans in his book The Essentials of Trading. My view on the components of a complete trading plan is influenced by John Forman, combined with many other good authors and my own experience in this area. A good written trading plan makes a huge difference to your chances of success and should cover the following 8 areas: Figure 8: The 8 components of a complete trading plan. No matter what stage you are up to in your trading, if you do not have a written trading plan, creating one should be very high on your priority list. In fact, the only things that I would rate as a higher priority are ensuring your position sizing is not too aggressive and that you have a positive expectancy trading system. A good trading plan template will help guide you through the process. Of course I recommend you purchase the Trading System Life "Trading Plan Workbook", because it is very thorough and will make the process much faster and less painful for you than starting from scratch on your own. Of course I also use the Trading Plan Workbook for my own trading plan! Your trading plan is not something that you will complete in a day, but as you continue to work on it over the coming months you will be amazed how much clarity it brings to your trading - it certainly did for me! 12

13 Lesson 9: Diversification is the only free lunch - get all you can! What happens when your trading system has a period where it loses money? With just a single system you have to trade through it and wait until your system returns to profitability. These drawdowns are part of trading any system, so how can we get around it and improve the consistency of our profits? Diversification is the answer! In his excellent book, 'Mechanical Trading Systems', Richard Weissman gives an overview of diversification which is very useful for all system traders. There are several levels of diversification that traders can use to improve their profitability and consistency: You can diversify: Instruments: Having multiple instruments in your portfolio (not just trading one stock) Parameters: Use several different parameter settings for the same system simultaneously Systems: Use multiple different trading systems Direction: Trading both Long and Short Timeframes: Apply trading systems to different timeframes e.g. Intraday and long term Profit Drivers: Systems that profit from different conditions e.g. long / short / volatility The key is to realise that while all systems have drawdown, these drawdowns don't always occur at exactly the same time If you add a second trading system that behaves slightly differently to the first, then the second may be making money when the first is losing money and vice versa. As it turns out, provided there is some difference in the timing of the drawdowns in each system, adding additional systems can be very beneficial. The second system may be a variation on your first system, or it could be trading a totally different strategy. The less correlated the system equity curves are, the more benefit you will get from combining the systems. If you have a profitable long side system and you combine it with a profitable short side system then you should notice some fairly significant smoothing in your overall equity curve. Even if you have a long term trend following system and you combine it with a swing trading system or a mean reversion system which trades the same portfolio you will find some significant benefits. Short systems also have the added advantage that they benefit from market crashes (assuming you have some short exposure when the market crash occurs). I find that having some short exposure helps me sleep better knowing that if there is an extreme event, I have some positions in the market that should benefit. Once a trader has learned how to build a trading system and has the discipline to execute it with consistency, the next wave of benefit really does come with diversification. I suggest you look at the different types of diversification listed above and see how you can build them into your trading to improve the consistency of your returns. 13

14 Lesson 10: Trading Mistakes are extremely expensive - eliminate them! A trading mistake is anything you do that is not consistent with your trading plan or that costs you money unnecessarily (note that taking a trade that makes a loss is not a mistake if it is consistent with your trading plan). Van Tharp explores the impact of mistakes and how the trader s psychology contributes to these in his excellent book Super Trader. This book covers many of the psychological challenges of trading and fitting your trading approach to your own personality. The impact of mistakes on your profitability can be so severe that you could even lose money with a profitable system if you make too many trading mistakes. Many good trading books talk about mistakes, so I haven't listed any specific book here. On my website (here) I demonstrate the financial impact of mistakes on your trading account. The output of my website example is here: Figure 9: Impact of infrequent large mistakes and regular small mistakes on trading system performance. Click here for details of the assumptions. Eliminating mistakes is so important, but most traders don't even realise they are making mistakes! Below is a list of common trading mistakes. I hope that in reading this list you will start to identify and eliminate some of your own trading mistakes and thereby improve your profitability. Each mistake has been grouped with other similar mistakes under specific headings. Note that this list is not exhaustive and many traders seem to make up new and ever more creative trading mistakes to limit their profitability. Trading System Mistakes: Trading without a written trading plan Attempting to trade with a system that does not suit you Not having a complete positive expectancy trading system Breaking trading plan rules Not having documented all aspects of your trading plan Not having spouse buy-in to your trading plan Failing to do an out of sample back test Not having specific entry and exit rules that are not subject to discretion Copying someone else's trading strategy or trading system that does not suit you Selecting a trading strategy or trading system that does not fit your personality Making 'great product' the sole criteria for investment in a fundamental trading strategy Taking profits early for winners Not back testing your strategy in all market conditions (up / down / sideways and volatile / quiet) Adding to losing trades 14

15 Trading System Execution Mistakes: Failing to determine the worst case exit point for every trade prior to entry Not placing a stop loss for each and every trade Deciding to hold a losing trade 'for the long term' rather than exiting at the stop loss Skipping trading signals from your system because they make you uncomfortable Placing market orders in illiquid markets so you end up with terrible fills Breaking any rule written in your trading plan Placing market orders in illiquid markets Paying commissions to buy an instrument that you can buy commission free direct Not being patient to get a good price when executing a trade Buying something that is falling rapidly Don t try to catch a falling knife Taking any trade that is not triggered by your trading system Not double checking orders before placing them Fat finger problems like wrong price / volume or buying instead of selling Moving protective stops away from the current price to give it more room to move Not buying or selling when the position hits the target price that you determined before entering the trade Risk Management Mistakes: Not controlling the number of correlated positions in the portfolio Taking on excessive leverage without understanding of the downside Failing to set risk tolerances at a portfolio level Trading positions that are so small that commissions are a large percentage (>1-2%) of the trade Failing to understand the risk / reward ratio on each trade Failing to reduce your trading size when you are losing Buying an investment vehicle when you don t know how it works Psychology Mistakes in Trading: Trading when you are emotionally compromised (births / deaths / marriages / divorces / moving house / lost job etc) Letting any form of emotion into your trading Trusting your emotions or gut when they are telling you to break one of your trading plan rules Making decisions like This company has awesome products, therefore I must own the stock Seeking (or getting) any form of excitement through your trading Following the herd (making an investment or trade because others are doing it) Risking more (or less) than your trading system says you should Letting losers ride hoping they will come back to your target loss or to break even Not keeping a trading journal Allowing yourself to be sloppy in your trading Financial Management Mistakes: Undercapitalisation (trading with too little capital) given your trading system s largest historical drawdown and your position size / risk management strategy Paying higher commissions than you need to (not shopping around for the best brokerage rates) Trading with money that you cannot afford to lose Not accounting for taxes, fees and charges Trading with a dealing desk who is trading against you After reviewing the above list and being truly honest with yourself, the chances are you have identified a long list of trading mistakes that you need to address. Reducing your trading mistakes should improve your profitability dramatically with relatively little effort! 15

16 Conclusion These are the ten most important and influential lessons that I learned from reading over 150 trading books. I have applied them in my own trading with huge success so I can tell you from personal experience they are all priceless lessons. Apply these lessons in your own trading and watch the benefits. Some of the lessons may be familiar to you, so treat this as a reminder and take a good look at your trading approach to ensure you are really applying them. In all my interaction with traders over the years, I have observed that the most common area they fall down is on Lesson 8: You MUST have a written trading plan. I am sure this is because it is overwhelming and takes a lot of effort to think about what should be in the plan, let alone actually writing it. Because of this I decided to take the hard work out of writing a trading plan and I have created the Trading Plan Workbook to make it easy for you to create your own plan. Click here and enter your to pre-register your interest (no obligation) for my trading plan workbook and I will give you a 50% discount AND three special bonuses. If you want to learn more about trading systems in a very quick and easy to understand format then I suggest you register here to learn more about my trading systems crash course I will even send you the first 5 lessons for free so you can see what you get and how easy it is to learn in my special short video lesson format. Special Bonuses I have read many trading books on my journey and there was a lot of garbage out there. But a small number of books stand out for me above all the rest as providing huge reward for the comparatively low cost of the book. As traders isn't this exactly what we want - high reward / low risk trades! Books that most influenced my trading journey: Way of the turtle - Curtis Faith Trade your way to financial freedom - Van Tharp Trading systems that work - Thomas Stridsman Trading Systems and Money Management - Thomas Stridsman Market Wizards - Jack Schwager The New Market Wizards - Jack Schwager Stock Market Wizards - Jack Schwager Hedge Fund Market Wizards - Jack Schwager The Evaluation and Optimisation of Trading Strategies - Robert Pardo Mechanical Trading Systems - Richard Weissman Quantitative Trading Strategies - Lars Kestner See reviews of these and other books here If you want a very fast and easy way to get more personal feedback on how to improve your trading, then you should take my Free Personal Trading Assessment. Just spend 3 minutes to complete the 20 multiple choice questions and I will send you a comprehensive feedback report with explanation of the areas and actions you can take to improve your trading immediately. Take the Trading Assessment Now 16