David Waring

In our last lesson we introduced the concept that money management in trading and the psychology of money management as the most overlooked but most important component of trading success. In today’s lesson we will begin to look at one of the most important components of the psychology of money management: a willingness to be wrong.

Humans in general grow up being taught by their environment of the importance of always being right. Those who are right are envied as the winners in society and those who are wrong are cast aside as losers. A fear of being wrong and the need to always be right will hold you back in general, but will be deadly in your trading.

How Most People Associate Profitable Trades:


How Most People Associate Unprofitable Trades:

With this in mind lets say that you have been watching my trading video lessons and feel that I am an intelligent trader, so you want me to give you a forex trading strategy. I say fine and give you a method and tell you that the method will trade 100 times a year with an average profit of 100 points for winning trades and an average loss of 20 points for loosing trades. You say great and take the trading strategy home to give it a try.
A few days later the first trade comes and quickly hits its profit target of 80 points. Great you say and call a bunch of your friends to tell them about the great system you’ve found. Then a few days later the next trade comes but quickly takes a loss. You hold tight however and then the next trade comes, and the next trade etc until the trade has hit 5 losers in a row and amounting to 100 points in loses on the losers so you are now down 20 points overall, and all your trader buddy’s who started following the system after the first trade are now down 100 points.

Now you feel really dumb and are the joke among the group of guys that you trade with, so the next day you come back to me yelling about how bad the system I gave you is. I say ok and tell you I have another system for you. This one also trades 100 times a year but has a higher success rate that I think he will be happy with. You take this system home and the next day it quickly hits a winner followed by another then another and then another until over the next few days you have 5 winners in a row totaling 50 points in gains for your account. Getting very excited you call all of your trader friends and tell them that this time you have found it, you tell your wife how you haven’t lost on a trade in two weeks and you rub your perfect trading statement in the face of all your trader buds as revenge.

So now ask yourself this question. If you were really the trader in this example which system would you rather have?


I can tell you from experience that the large majority of traders will take the second system without a second thought, and on top of that will stick with it even if it hits a few losses that wipe out most or all of its gains.

Although the successful trader will want to know a lot more about both these systems which we are going to learn about in the lessons that come before deciding which one to trade I can tell you that what they will glean from the above information is the following:

Not including transaction costs such as commissions and slippage, for the first system I only need to be right 1 time for every 5 times that I am wrong in order to break even. With this in mind seeing the system trade for one profit and 5 losses is not giving the system a chance to prove itself. It would not be out of the ordinary for a system such as this to hit even 10 losers in a row and still end up profitable for the year.

As I did not give the trader success rates for the second system there is no way to know for sure but the first suspicions that the successful trader is going to have of the second system is that it is simply a system which sets tight profit targets and very wide or no stops at all. What this means is that the system is going to take a lot of small winners and a very few large losses which have the potential to wipe out all the gains in the account and possibly a lot more.

Most of the successful systems that I have seen fall into the category of the first one we looked at in that they take a lot of small losses and make their gains for the year on a few big winners. As in this example however most traders do not have the mental toughness to stay with these types of systems during the long loosing streaks and give up on them prematurely, and throwing a profitable methodology in the trash without giving it a chance.

This concludes this lesson. You should now have a good understanding of the affect that losses have on ones decisions in trading and can begin to prepare yourself for the losses which are going to inevitably come with any trading methodology whether good or bad. In tomorrow’s lesson we are going to look at two common trading mistakes that often knock traders out of the market.

As always if you have any questions or comments I encourage you to post them in the comments section below so we can all learn to trade together, and have a great day!

mattman

Hey Dave great video as usual.

I am still trying to put together my trading system. I realize that I will be wrong on many trades. I just hit my stop losses on the last 3 trades for the week; however, by remaining disciplined and not holding the losses I am still up for the month. Do you have a ball park figure for percentage of profitable trades vs. unprofitable trades a "good" trader can generally make?

I generally look for trades where the payout for being right is higher than the loss if I am wrong. Under this system even if I am right only 40% or so of the time I can still be a profitable trader.

David Waring

Hi Mattman,

Glad to hear from you and thanks for the compliment I am glad you like the video.

The percentage of correct trades is really all over the map from my experience. Generally however longer term traders have a much lower successrate on a per trade basis but a much higher profit to loss ratio which is what keeps the good ones profitable. On the other hand profitable short term traders have a much higher success rate but a much lower profit to loss ratio on winning trades.

Hope that helps and let me know if there are any other questions.

Best Regards,
Dave

__________________
My Free Courses: Forex Course - Stock Course - Futures Course - Basics of Trading - Subprime Crisis - Prorealtime Charts

Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.

waruinge1

I am a college student and trade stock options. As you know being a college student I do not have a large capital trade with. I want to develop my own system of trading and not depend on anyone. My question is how do i get started building my own system ?

Thank You

Tekmnd

Hi waruinge1,
To build a good systems, some things to consider are-
What are you going to trade and when.
How you are going to enter the trade.
How you are going to exit (your exit strategy is as important as your entry if not more so)
How you are going to protect capital- where you set your stop, position size, risk management.
Expectancy- when you trade your system, how often does it work when you trade it, verses how much you make when it works, verse how much you lose when it doesn't. In other words, over time, will this system make money and how much on average?

As far as general option strategies, there is a new option video section in the free course section above.

To work on option strategies, if you don't already know them, learn "the greeks" and study option volatility. Google both, there is really a lot of great info out there.

Cheers
Tek

Tekmnd

I thought I would add this. It is worth watching-
Cheers Tek

David Waring

Hi waruinge1,

Glad to hear from you.

To add to what Tek has said here I would also recommend checking out the following:

The 20 Components of a Successful Trading Plan

As well as:

Automated Strategy Development - InformedTrades

Hope that helps.

Best Regards,
Dave

__________________
My Free Courses: Forex Course - Stock Course - Futures Course - Basics of Trading - Subprime Crisis - Prorealtime Charts

Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.

3mg523

What does a good game plan look like??

Thanks.

3mg

Tekmnd

Hi again 3mg

There is a PDF file at the beginning of this thread that contains details to make a trading plan. It is pretty good. At the bottom the the thread, I posted a link to a site that has about 50 links to trading plan examples.
If you have any questions after checking this out, feel free to ask
Trading Plan Template

Cheers
Tek

David Waring

Hey 3mg,

Thats an awesome one that Tek gave you and here is another resource that you may find helpful with this as well.

The 20 Components of a Successful Trading Plan

Hope that helps.

Best Regards,
Dave

__________________
My Free Courses: Forex Course - Stock Course - Futures Course - Basics of Trading - Subprime Crisis - Prorealtime Charts

Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.