Guest post by Jason Stapleton (ForexGuy) of 4xtraderslive
I’m a good trader. What I mean by that is I am consistently profitable. I have found a way to win with consistency. Winning has become a habit much the same way losing was a habit during the early years of my trading.
For those of you who missed that last statement, I did say years. I have worked very hard for a very long time to achieve this end. I gave up many times, blew out 3 accounts and suffered more emotional breakdowns than I care to recall. But I was no different than most traders when I got started. A love for the market was not my initial lure to trading. It was money. I wanted something different for my life and saw the market as a way to achieve that end.
I’m traveling to Dubai today. The long flight is giving me a chance to reflect on this month’s trading. I have been reviewing my trade journal and trying to see what I might do differently next year to improve my performance. You see, December was not a great month for me. For those of you who would like the numbers, I finished up a mere one half of one percent. Now, any month the account grows is a good month but this one fell far short of what I find typical. I am lucky because I keep a good trading journal which allows me to review each trade I have taken. You would be amazed the information you can glean from a review of your decisions, emotions and expectations months after the trades have been completed.
For those of you hoping to receive some secret insight into how I moved from a state of confusion to one of profitability, prepare to be disappointed. There is no secret. No magic. No strait forward formula to success. In truth it was simply a process of identifying habits that were destructive to my trading and then working to break those habits and install new ones. It seems simple enough now, but it was hard work.
With all that in mind I thought I would take a moment today and point out one of the many destructive expectations I had early on that lead to a quick end to my first trading account.
You Are Not a World Class Trader
Take a guess at what the most successful and profitable money managers return each year as a percentage of equity. Any idea? It’s about 20%. That’s it. The most successful men in the world with all the advantages that come with trading on a large scale are only averaging about 20% a year. Now they have some disadvantages. Most trade huge sums of money making it difficult to enter and exit the market. They have longer term time horizons and cannot suffer large draw downs for fear of driving investors away. But in reality these men are the very best at what they do.
I opened my fist account with five thousand dollars. At that time I was focused on equities. I got caught in the hype and allure of great wealth and high returns. I of course, wanted to be conservative. I wasn’t looking to double my account each week. All I wanted was about 1% a day. (You may find it difficult to read my sarcasm here, but I assure you I am laying it on thick.) Is 20% a month really all that much to ask? That’s a mere $50 a day. I found a paper online that showed me the power of compounding. I’m sure you have all seen it. It looks something like this.
Starting Account 1% A Day Total
$5,000.00 $50.00 $5,050.00
$5,050.00 $50.50 $5,100.50
$5,100.50 $51.01 $5,151.51
$5,151.51 $51.52 $5,203.02
It seemed so reasonable. And since I was being so conservative I was highly confident that I would do much better than I forecasted. But I reassured myself that being conservative was the best way to go.
I did a quick tally and determined that if I was able to average a mere 1% a day, at the end of the year my account would have grown to a whopping $53,923.53! At the time I was only making about $30,000 a year. As far as I was concerned I would be able to quit my job after only a few months of trading. (Just as soon as I had a little “buffer” to handle any slow trading weeks.)
For the life of me I can’t remember what gave me the impression that I could make money trading, much less 1% a month. I’m sure it came from some sales page success story I read. What the story failed to mention was this little thing they call a drawdown. You all know how this story turned out. My first day I made $25. “No problem, I’ll make it up later in the week” I thought. Day two I lost $30. By the end of week one I was down $150, far short of my “conservative” goal of $200. So I began to over trade, double down increase my position sizing, all in an attempt to “get even”. It took me less than a month to lose all five thousand dollars.
Most of the traders who come to me have similar expectations. They really have no idea how devastating high leverage and poor position sizing can have on ones trading account. They too feel like 1% a day is conservative and they want me to help them do as good or even better. I have stopped trying to convince these traders of the error in their thinking. I simply inform them that if they want my help, I will be focusing on consistency not profit.
Successful traders know that return on equity is simply a matter of arithmetic. If you know a few key numbers such as win/loss ratio, positive expectancy, max drawdown, average drawdown and risk/reward profile you can determine with a high degree of accuracy the return you are going to get based on your risk. If, for example I know I can achieve a 20% return a year as long as I can stomach a 10% drawdown it is a simple exercise in arithmetic that will tell me I could create a 40% return a year by simply doubling my exposure. I would however need to account for a 20% drawdown at some point.
What keeps most traders from succeeding is the drawdown. They cannot stay consistent through the losing weeks and months in order achieve those new equity highs. It is the drawdown that insights a need to “get even”, over trade and generally make poor decisions. When you combine that with a high degree of risk and poor position sizing you exacerbate the problem.
Here is a wild concept. Why not create an environment where you cannot lose? Now, when I say lose I mean go broke. Just like in poker you need a chip and a chair. If you run out of chips you lose, but until that last chip is gone you are still in the game. FOREX is one of the most inclusive vehicles for trading because of the wide variety of account types. You have standard accounts, mini accounts even micro accounts. Thus, the bar for entry is much lower.
So let’s take that five thousand dollar account I started with all those years ago but his time let’s put it in a FOREX micro account. And instead of using some arbitrary rule for money management such as, “never risk more than 2% on any trade”, let’s trade 1 micro lot each time we enter the market. Now I’m sure some of you are saying, “One micro lot? That’s only 10 cents a pip. Even if I make 100 pips a week that’s only $40 a month, a mere eight tenths of one percent. And that’s if I make 100 pips a week!”
But let me ask you this; if you cannot make money consistently trading 1 micro lot at a time, how is increasing your position sizing going to change that? The way I look at it, you could lose 100 pips a week for the next 2 years and not go broke. Think of all the knowledge and experience you will gain by focusing on being consistently profitable rather than swinging for the fences as you try to achieve an unrealistic and unproven rate of return.
Last thing, and write this down. This entire article can be summed up in the next sentence.
The most important thing for any trader is to ensure no matter what happens they will be able to come back to the market tomorrow and trade.
If you can make forty dollars a month consistently out of a five thousand dollar account there is no limit to what you can achieve. But if you trade too aggressively I fear you will count yourself among the untold millions who are now left with an empty rack of chips, and no seat at the table.
Until next time, Good luck and good trading.
Jason Stapleton (ForexGuy)
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