The following article is an excerpt from Dr. Thomas K. Carr's latest book, "Market-Neutral Trading" (McGraw-Hill, 2014). I have no affiliation with him whatsoever, I just read it where he posted it to VerifiedInvesting.com and thought everyone would find value in it. Here it is...
The 3 Most Common Causes Of Trading Failure
I have served as a trading coach and advisor to traders, investors and portfolio managers for over fourteen years. During that time I have worked with several hundred traders. Whenever I work with individual traders, whether they are newbies or experienced professionals, I put them through a trading profile inventory I developed. The results of this inventory give me a good idea what type of trader I’m working with, where his or her strengths and weaknesses lie, and thus how to tailor my coaching to best meet his or her needs. While this information is useful, I have discovered over the years that nearly all the clients I work with fall under one of two categories: either they don't know enough about trading to make it work for them; or they know too much about trading which causes them to be indecisive and unable, even unwilling, to follow any one system consistently.
All things considered, those in the first category are easiest to work with. Their lack of trading "baggage" makes them far more teachable and willing to follow the rules of successful trading. Let me tell you about one client who clearly fell into the latter category. Let’s call him Joel*. Joel and I met in the conference room of an airport hotel near our home. Joel had flown all the way from Seoul, Korea, and, despite his jetlag, he was alert and eager to get to work. On the surface of things, Joel had all the makings of a trading wizard. He had an Ivy League degree in business; he was clearly bright and a quick learner; and he was the only son of a successful private equity investor who had been grooming Joel to take over the business. Joel's problem was that he didn't want to work for his Dad. He wanted instead to make his living trading.
One year prior to our meeting, Joel’s father had given him a million dollar trading account to get him started. This was pocket change to the father, but to Joel it was his chance to live in freedom. Equipped with his business education, and quality experience gleaned from the years spent at his Dad's side, Joel put that money to work in the markets. Unfortunately, things didn’t go quite as planned. By the time Joel came to me, his account was down over 70%. He was desperate. From his profile inventory I learned that Joel was making a number of critical mistakes, not the least of which was allowing himself only three hours of sleep each night as he scanned the news for trades. To make things worse, his trading profile showed me that he was trading way out of his comfort zone. His temperament was better suited to a rules-based systematic approach, but his actual trading was more "fly-by-the-seat-of-his-pants" as he chased after every hot tip and trading "hunch".
I told Joel I could help him turn things around, but that he would have to do exactly what I told him to do. I explained to Joel that he would have to radically change his methods; but if he did, he would be a much happier and more successful trader. My approach was simple: I would teach Joel a clearly defined, long/short trading system, and that his first task was to work it -- and no other -- for three months. After that, I said I would slowly add more systems to his trading arsenal as long as he demonstrated complete fidelity to each one. Joel gave me his assent; or at least I understood his lack of complaint as a form of compliance. So, for the next three hours, I carefully explained to him one of my trading systems that was a good match for his profile. After a lunch break, we spent another two hours working through various scanning techniques, position management strategies, and live chart examples of the system at work. All the while, Joel seemed to me to be very engaged. My impression was that he was fully on board with what I was teaching him.
At the start of our last hour together I asked Joel whether he had any questions about anything I had taught him. I’ll never forget his response. "I only have one question", he said. He had my full attention. “Can you tell me if natural gas is going to keep going up?” It turned out that Joel was long his entire account in natural gas futures contracts. He didn't want to learn a better way to trade. He only wanted to know whether he was currently in the right trade.
Since Joel had flown a long way and was paying a considerable fee for my advice, I agreed to look at the chart. It was quite plain to me that the recent breakout in NG (this was late 2011) was what traders call a “head-fake”; i.e., it was likely to reverse course very soon. I suggested to Joel that he cut his position size in half and put a stop-loss at his entry on the rest. He said a polite “no” to both suggestions, then flew over twenty hours back home. Less than three weeks later, natural gas was down over 20%, a loss that would have wiped out his account – futures contracts are highly leveraged – and then some. I never learned whether Joel cut that loss, but I suspect he is now fully committed to working in his father’s business (which may well have been the father’s plan all along)!
This sad but true story is one that is too often repeated among traders, even experienced ones. I’ve even seen a version of it in my own trading over the years. Contained in this story are the three most common causes of all trading failure:
failure to follow a systematic entry-to-exit trading program,
failure to use reasonable position sizing,
and failure to account for market risk.
The demons lying behind these causes are legion. They include adrenaline addiction, fear of success, a “poverty” mindset (a condition of believing one "deserves" financial failure which is most often caused by deep-rooted shame), lack of self-discipline, stubbornness, and sheer rebellion against any form of authority (as represented by the trading system or coach). While exorcising such things is a complex and often lengthy process, their effects – at least in terms of trading – can largely be mitigated by following a clearly laid out trading system with a proven track-record.
Systematic trading (as opposed to discretionary or "seat-of-the-pants" trading) neutralizes the three causes of trading failure: it offers a series of entry-to-exit trading rules that can be followed mechanically; it determines in purely objective fashion how to size every position, and with continuous long/short exposure, market risk is not only accounted for, it is also harnessed for profit. Trading a well researched, real-money tested long/short system (or systems) can help many traders get past their stuck places of mediocrity and failure to find at least a modest measure of trading success. And for some who really take to it, it can be a very powerful and reliable generator of wealth.
*Not his real name
Great read for traders right here...
