Every business has its numbers, every business has its Income Statement. Remember the old formula Assets – Liabilities=Working Capital from accounting 101?
Well trading is a business your assets are your trading Capital, and your liabilities are your off trades (losses). Your liabilities are also every thing you do to produce those losses. Yes you do produce those losses, so take responsibility for them, so you can choose to do better.
In trading like any other business you need to know all the details of your business. You need to know what your expenses are vs. your income, you need to know your profit vs. loss relationships. So in order for you to be in this business for the long haul, you need to know your numbers.
When I teach personal students my insights on Trading Psychology, I go over methods on how to control losing attitudes and behavior, The tasks of good trading, and several other key factors. The one I express in the beginning for an instant improvement is keeping a trading log or diary. It amazes me that even though I stress it few people do it. When I attempt to do a review of their performance they have no details of how they achieved their trading results(Good or Poor). We cannot go over what caused their performance. They only have their account statement with a net number in it. Are they afraid of what they may find out about themselves? How can you move forward if you don t know your own thinking process in the trading arena?
“We can’t solve problems by using the same kind of thinking we used when we created them.” Albert Einstein
Only knowing your account balance is NOT the way to improve your trading. You need to have a full picture of how well you are performing at all times. Accurate Diary keeping and knowing your risk to reward ratios provide you with important information you need, seeing clearly how the rules you set up are working out for yourself. You will be intimately Self Aware and this will prevent you from making a serious mistake ( Moving A stop Loss, Adding to a loser that was not pre-planned, cutting a winner to quickly).
“No Trader Gets To Be A Market Wizard Without A Review Of His Moment To Moment Thought Process.” Tom Strignano.
“Among the hazards of speculation the happening of the unexpected – I might even say of the unexpected – ranks high.” Jesse Livermore
“The game does not change and neither does human nature.” Jesse Livermore
Once you have disciplined yourself to keep an accurate diary, you will need to calculate your numbers. We are dealing with probabilities, we can never know with 100% certainty that our trade is on the correct side. Once we execute we will have a gain or loss. Its in these ratios where the success or failure of a trader lies. When we stay focused and follow our trading system and plan we can tip the edge into our favor. The magic numbers to build on are a 42% wining trades to losing trades with a 2:1 PROFIT TO LOSS RATIO.
The risk to ruin matrix is based on 100 trades with a possible draw down of 30%.(That is a large draw- down, if you draw-down 20% you need to stop trading and rethink your system.) According to this Matrix if you do 100 trades (all executed following the same rules) and you have 42% winners to losers, and you pull out $2 for every one you risk, your probability of ruin is less then 14%. What is the most important information on the matrix? Let me help you out, having a high winning percentage is not an indication that you will be a net winner. If you have a 55% win ratio with a 1:1 risk to reward(because thats all your system can convert) your risk of ruin is higher at 27%
“When the market goes against you, you hope that every day will be the last day – and you lose more than you should had you not listened to hope. And when the market goes your way, you become fearful that the next day will take away your profit and you get out – too soon. The successful trader has to fight these two deep-seated instincts” T.S.
So it is better to have a system with a higher gain percentage, with a lower Win Ratio. That’s where the old adage “Cut your Profits short, and let your winners run comes from.
In order to exploit the probability of ruin in your favor you need to know what your numbers are. You need to know how you think on a moment by moment basis. How you process information the market is giving you Once you have that knowledge of yourself, you can begin to develop changes to exploit your strengths and minimize your weaknesses.
Simple changes can make a huge difference. One Trader I mentor realized he made his most profits trading Monday -Wednesday. Thursday and Friday he gave a lot back. We concluded he was market wary by then. So what’s the solution? If you trade Thursday and Friday limit your loss to a small % of your gains. If lost go on a long weekend and rest up. With this he improved his ratios greatly. In the trading arena, we need to keep detailed records. Because we deal in probabilities and a certain amount of our results are not in our control. We need data on ourselves to help us change for the better, what is in our control! Always remember, the wining Ratios. Keep a log (Diary) of why you do what you do, and finally always know your numbers and ratios.
Some Important Axioms To Strive at the Business Of Trading:
“It sounds very easy to say that all you have to do is to watch the tape, establish your resistance points and be ready to trade along the line of least resistance as soon as you have determined it. But in actual practice a man has to guard against many things, and most of all against himself – that is, against human nature.” WD Gann
Health – No Drinking ~ “Don’t misunderstand me. I never allowed pleasure to interfere with business. When I lost it was always because I was wrong and not because I was suffering from dissipation or excesses. There were never any shattered nerves or rum-shaken limbs to spoil my game. I couldn’t afford anything that kept me from feeling physically and mentally fit. Even now I am usually in bed by ten. As a young man I never kept late hours, because I could not do business properly on insufficient sleep.” WD Gann