Identify Errors and Evaluate Your Progress

In the trade record above, we tracked 30 data points which give us at least 5 things to consider as we work through the results and seek to improve our future trades.  These are:

1:  A Consistent Risk approach

Explanation: Are you risking roughly the same percentage of your trading account on each trade? (Remember risk is different from allocation). If so, the numbers in the Trade risk column should be very similar. In this example the trader began with a $100,000 account and risked 1% of their running account balance. This means the risk on each individual trade should be about $1,000. After 30 trades the account balance has increased by more than 10% so the risk grew to over $1,100 per position (rebalancing of risk). 

What errors look like: Traders who vary their risk amount are introducing statistical uncertainty in to their system. If the numbers in the Trade risk column were substantially different (say 2% on some trades and less than 1% on others) that would mean that some trades are, perhaps inadvertently, more critical than others. This kind of an error will sabotage your trading over time.

How to fix the error: This kind of an error is most likely a cognitive error that results from a miscalculation of the number of shares (or option contracts) to buy. To fix the error simply find a way to be certain that you are calculating the proper number of shares for each trade and that you are, in fact, using that number. 

If you have an accurate way of calculating these measures, but are simply not using that number, and you do this repeatedly, then this is considered a psychological error. You should evaluate your beliefs about why you are adding more units of risk to one trade and less to another, and see if you need to create new rules to add to your trading system to protect you.
 

2:  A Winning Percentage with an Edge

Explanation: Your winning percentage should be slightly higher than the baseline expected winning percentage for the probability profile you are using. For example, if you are risking 1 to make 2 (a win-big trading style), then your baseline percentage is 33%. You want to see your winning percentage at 36% or higher. The example trading results in this system were generated by risking 2 to make 1 (win-frequent trading style). The 76% win rate is well above the 67% baseline and shows a strong statistical trading edge. 

What errors look like: Assuming your stops and targets are properly set, a win rate less than expected for your profitability profile may mean that your system is not effective. Or it may simply be that the market moved opposite to your expectations and position direction during the time you made these trades. This problem will fix itself if you simply continue trading and the market starts trading in your expected direction. Experiencing a less than expected win rate in this scenario is likely to be the case if you have executed these trades within a single month. 

However if you experience loss because you have not applied market filters or rules that direct you to react to changes in direction, then you have introduced a cognitive error.

How to fix the error: Errors in this area can be fixed by adding new market filter rules or by simply continuing to trade. If this kind of error persists you need to check to see if your stop and target orders are properly set, and then you need consider a change to which trade setups you use.

3:  Well-Contained Losses

Explanation: You need to be certain that your trading activity does not risk more than you plan. If you are risking too much per trade, this will likely nullify the statistically beneficial edge you might otherwise have had. You need to evaluate your results and recognize whether your trading is generating unexpectedly large losses on some (or all of your) positions.

What errors look like: The size of your loss compared to what you anticipated risking is identified by the reward to risk ratio measurement (the last column in the table). If this number is less than negative one, then something went wrong for that trade. If you have several trades where this is the case, you have serious problems with your system and should stop trading until you can identify and fix them. 

Larger than expected losses can and will occur, but they should be rare, preferably no more than one in one hundred trades. Such an error can occur because the stock you were in gapped open to a price beyond your stop loss. This may happen because of unexpected company specific or macro economic issues.

How to fix the error: This kind of an error may be an anomaly, but if it happens more frequently than 1 in 100 trades, it is most likely a cognitive error that results in a miscalculation of your trade risk and timing. To fix the error you must find a way to be certain that you are entering and holding a trade only at times when earnings announcements (or other known events that frequently cause volatility) are not scheduled to occur soon after the initiation of the trade. 

If you have an accurate way of identifying these events, but are simply not paying attention to them, then this is also considered a psychological error. The best course is for you to evaluate your beliefs about why you are making such trades and decide if you want to keep making them. If so, you will need to modify your stop loss and reduce your trading size in order to accommodate such fluctuation.

4:  The Right Size for Winning and Losing streaks

Explanation: The length and frequency of winning streaks is greatly influenced by the probability profile you are using. For example, if you are risking 1 to make 2 (a win-big trading style), then your losing streaks will be frequent and relatively longer. When using a win-frequent trading style, your winning streaks will be more frequent and longer. 

What errors look like: Losing streaks longer than you expect are likely an indication that you may have had one or more trading errors along the way.  

How to fix the error: This symptom may actually be an artifact of the problem that causes the trade errors discussed above. However there may be additional causes. Each trade in the largest losing streaks should be closely reviewed for causes. This exercise will likely yield explanations for execution errors that can be avoided, cognitive errors that can be addressed, market filters that need to be applied, or psychological issues that may be nagging at you.  

5:  A Strong System

Explanation: An effective trading system should have an average reward to risk ratio (R.R.), or  expectancy, of greater than 0.2 to be profitable.

What errors look like: Scores lower than 0.2 indicate you may be trading a system that is unprofitable. You may want to reduce the risk amounts, and continue to trading to further diagnose the issue. 

How to fix the error: This symptom is not actually evidence of an error unless you had several trades where you did not follow your rules. The first fix is to carefully follow your rules. The second fix is to see if you need to add market filters to improve your system. If neither of these work then you may need to consider changing your probability profile or finding a different system to trade altogether.

Addressing Issues

No investor or trader is right all the time.  Even the “Who’s Who” of Wall Street is filled with people who guessed the wrong direction, who experienced losses, who lacked confidence, and who initially struggled to follow their system exactly.  You are not alone in your imperfections so don’t beat yourself up about them.  Learn from mistakes, continue disciplining yourself to follow your system and stop being swayed by individual market outcomes.  As you close each position, adopt the “Next!” mentality…you don’t care if your last trade was a winner or a loser…you’ve already moved passed it onto the next trade.  Don’t let the previous trade affect your next one.

If you find yourself struggling with decision making errors, develop a structure of reminders, checklists, or triggers to help you make better decisions.  You may find that setting your entry, your stop loss, and your profit target (exit) is better done before you enter the trade.  If you make these decisions before the trade, work to follow them exactly while in the trade.

Investing and trading can act like a fillet knife cutting you wide open and forcing you to face your fears, self doubts, negative attitudes about money and the self-sabotaging emotions of fear and greed head on.  Though painful, this is actually a good thing.  Former patterns of behavior and emotional response have limited you and your financial future so don’t cling to them.  Embrace the change required to be successful in the markets.

As the pressure of putting your money to work in the markets builds, use it to shape new emotional habits.  Learn to act according to the rules of your system and not react in the markets based on your own emotional responses to market moves.  As you do, you’ll find your awareness of and ability to take advantage of opportunities growing.  This is great!  Now keep going.  Eventually, you’ll see increased success in your efforts to put your money to work in the markets giving you greater confidence in your ability to trade and increased financial freedom in your future.

Set Appropriate Expectations

Each probability profile and trade system carries within it expectations for wins, losses, winning or losing streaks, and trade frequency.  As you begin trading with real money, maintain appropriate expectations for the system you’ve chosen.  Don’t expect a Win big trading style to produce the same number of winning streaks generated by a Win frequently trading style. 

The truth is there are two main parts to financial empowerment.  The first is income generation and this is where most people place all their focus.  However, the second part is actually more important and that’s putting your money to work.  Retirement isn’t a function of age, it’s a function of how well you put your money to work.  Any of the trading styles we’ve shared in these lessons, combined with the trading edge you’ve gotten from your guru can help you achieve financial freedom.

The three main parts of putting your money to work are:  (1) Saving Rate, (2) Amount in Retirement Account, and (3) Annual percentage gain.  Most people focus on (1) and (2) and don’t really even know (3).  But focusing only on (1) and (2) often creates severe financial fear because most people know they aren’t saving enough (because few can save their way to retirement) and they know they don’t have enough in their accounts to retire comfortably…or even to retire at all. 

The reality is while the (1) and (2) are important, they almost don’t matter.  Given enough time, even a small amount of money (like saving $100 a month) can become millions of dollars simply by compounding at a high enough rate of return.  If your system and your probability profile suggest a 50% annual rate of return, stay centered and focused on this return and not on how much you have in your accounts or how much you can save.  Trust that your account will grow to an acceptable size over time as long as you continue matching or even beating your expected annual rate of return.

Single minded focus on the annual percentage gain smooths out the emotional responses to individual positions which tend to trip up new market participants.  And one of the biggest ways people trip up is to change their strategy mid-stream.  

If you enter a trade with one set of rules…please exit that trade by applying the same set of rules.  Don’t let losses affect when you get out…follow the rules for getting out.  Don’t let the losses of one trade (especially losses that came by following the rules) cause you to change your approach on future trades.  Stay with the position until your rules tell you otherwise and forget about it when you get out regardless of whether it was profitable or not.  What you want is a dependable, repeatable way to profit in the markets.  A consistent approach is the only way to consistent profits.  Otherwise you become a gambler.  

Such emotional reactions (and desires to change your system midstream)  can subtly alter your expectations for future trades.  When necessary, step back from your positions and review your system’s expected win/loss rate.  Review your trades to see if you have been following your system both for the entries and for the exits.  If you see discrepancies, swing back to center and refocus on the basics.  And reset your expectations as needed to keep centered and successful.

Putting your money to work in the markets is a journey not a destination.  Expect that your financial future will only improve through a series of trades made over a lifetime and not on one (or even a few) massive returns.  Keeping your eye on the annual percentage gain and not on your monthly saving rate, your total account size, or the outcome of any individual trade will help you avoid the mistakes caused by inappropriate expectations or unhelpful emotions often caused by near term position outcomes.

Conclusion

Making the transition to real money can be very emotional and intimidating.  We spend our lives focused on increasing our ability to make money and making the necessary sacrifices required to make more of it.  These are things we clearly understand and can easily control.  Markets are not like that.  However much we want to, we cannot control the outcome of individual trades.  But you don’t need to control the outcome of individual trades as long as you control the things you can…all the things we’ve shared in these lessons and in your training.

So focus on controlling the things you can like following your trade plan.  Your results will come as you work your system consistently every day.  And you can improve your results by carefully following the approach we’ve shared in this lesson.  

As you might have already noticed, we’ve used words like, “consistently,” “exactly,” and “carefully” throughout these lessons.  True success in the markets isn’t magic and doesn’t require a prognosticator.  All it requires is that you understand your trading style, fully implement your trading system (to get additional trading edge) and carefully make improvements to your emotional responses that stop you from following your rules.  

It’s possible to catch up a lagging retirement far more quickly than you ever thought possible but it does require you to become the kind of person who can make a plan, consistently implement the plan, and be aware enough of your results (and yourself) to improve that plan over time.  Stay focused on your plan and don’t allow the natural emotional responses you’ll have as you watch your account value move up and down stop your progress.

You can do this.  It might not feel easy but what good things in life are easy at first?  Don’t let that initial resistance or fear stop you before you even start.  And don’t put yourself in a position where a losing streak will force you out of the markets or ruin your trading account.  

Stay focused and careful and you will eventually be able to put your money to work at higher rates of return confidently and consistently.  Your financial future is in your hands.  You’ve spent a lifetime getting better at making money.  Now it’s time to get better at making that money work harder.  As you do, you create your own retirement lifestyle and live life on your own terms.  Go do it!