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Five Fatal Flaws of Trading

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  • Five Fatal Flaws of Trading

    Just seen this elsewhere and thought it it may be of interest to some of you.

    Five Fatal Flaws of Trading by Jeffrey Kennedy, June 26, 2009.

    Close to ninety percent of all traders lose money. The remaining ten percent somehow manage to either break even or even turn a profit – and more importantly, do it consistently. How do they do that?

    That's an age-old question. While there is no magic formula, Jeffrey Kennedy has identified five fundamental flaws that, in his opinion, stop most traders from being consistently successful. We don't claim to have found The Holy Grail of trading here, but sometimes a single idea can change a person's life.

    Why Do Traders Lose?

    If you’ve been trading for a long time, you no doubt have felt that a monstrous, invisible hand sometimes reaches into your trading account and takes out money. It doesn’t seem to matter how many books you buy, how many seminars you attend or how many hours you spend analyzing price charts, you just can’t seem to prevent that invisible hand from depleting your trading account funds.

    Which brings us to the question: Why do traders lose? Or maybe we should ask, 'How do you stop the Hand?' Whether you are a seasoned professional or just thinking about opening your first trading account, the ability to stop the Hand is proportional to how well you understand and overcome the Five Fatal Flaws of trading. For each fatal flaw represents a finger on the invisible hand that wreaks havoc with your trading account.

    Fatal Flaw No. 1 – Lack of Methodology

    If you aim to be a consistently successful trader, then you must have a defined trading methodology, which is simply a clear and concise way of looking at markets. Guessing or going by gut instinct won’t work over the long run. If you don’t have a defined trading methodology, then you don’t have a way to know what constitutes a buy or sell signal. Moreover, you can’t even consistently correctly identify the trend.

    How to overcome this fatal flaw? Answer: Write down your methodology. Define in writing what your analytical tools are and, more importantly, how you use them. It doesn’t matter whether you use the Wave Principle, Point and Figure charts, Stochastics, RSI or a combination of all of the above. What does matter is that you actually take the effort to define it (i.e., what constitutes a buy, a sell, your trailing stop and instructions on exiting a position). And the best hint I can give you regarding developing a defined trading methodology is this: If you can’t fit it on the back of a business card, it’s probably too complicated.

    Fatal Flaw No. 2 – Lack of Discipline

    When you have clearly outlined and identified your trading methodology, then you must have the discipline to follow your system. A Lack of Discipline in this regard is the second fatal flaw. If the way you view a price chart or evaluate a potential trade setup is different from how you did it a month ago, then you have either not identified your methodology or you lack the discipline to follow the methodology you have identified. The formula for success is to consistently apply a proven methodology. So the best advice I can give you to overcome a lack of discipline is to define a trading methodology that works best for you and follow it religiously.

    Fatal Flaw No. 3 – Unrealistic Expectations

    Between you and me, nothing makes me angrier than those commercials that say something like, "...$5,000 properly positioned in Natural Gas can give you returns of over $40,000..." Advertisements like this are a disservice to the financial industry as a whole and end up costing uneducated investors a lot more than $5,000. In addition, they help to create the third fatal flaw: Unrealistic Expectations.

    Yes, it is possible to experience above-average returns trading your own account. However, it’s difficult to do it without taking on above-average risk. So what is a realistic return to shoot for in your first year as a trader – 50%, 100%, 200%? Whoa, let’s rein in those unrealistic expectations. In my opinion, the goal for every trader their first year out should be not to lose money. In other words, shoot for a 0% return your first year. If you can manage that, then in year two, try to beat the Dow or the S&P. These goals may not be flashy but they are realistic, and if you can learn to live with them – and achieve them – you will fend off the Hand.

    Fatal Flaw No. 4 – Lack of Patience

    The fourth finger of the invisible hand that robs your trading account is Lack of Patience. I forget where, but I once read that markets trend only 20% of the time, and, from my experience, I would say that this is an accurate statement. So think about it, the other 80% of the time the markets are not trending in one clear direction.

    That may explain why I believe that for any given time frame, there are only two or three really good trading opportunities. For example, if you’re a long-term trader, there are typically only two or three compelling tradable moves in a market during any given year. Similarly, if you are a short-term trader, there are only two or three high-quality trade setups in a given week.

    All too often, because trading is inherently exciting (and anything involving money usually is exciting), it’s easy to feel like you’re missing the party if you don’t trade a lot. As a result, you start taking trade setups of lesser and lesser quality and begin to over-trade.

    How do you overcome this lack of patience? The advice I have found to be most valuable is to remind yourself that every week, there is another trade-of-the-year. In other words, don’t worry about missing an opportunity today, because there will be another one tomorrow, next week and next month ... I promise.

    I remember a line from a movie (either Sergeant York with Gary Cooper or The Patriot with Mel Gibson) in which one character gives advice to another on how to shoot a rifle: 'Aim small, miss small.' I offer the same advice in this new context. To aim small requires patience. So be patient, and you’ll miss small."

    Fatal Flaw No. 5 – Lack of Money Management

    The final fatal flaw to overcome as a trader is a Lack of Money Management, and this topic deserves more than just a few paragraphs, because money management encompasses risk/reward analysis, probability of success and failure, protective stops and so much more. Even so, I would like to address the subject of money management with a focus on risk as a function of portfolio size.

    Now the big boys (i.e., the professional traders) tend to limit their risk on any given position to 1% - 3% of their portfolio. If we apply this rule to ourselves, then for every $5,000 we have in our trading account, we can risk only $50-$150 on any given trade. Stocks might be a little different, but a $50 stop in Corn, which is one point, is simply too tight a stop, especially when the 10-day average trading range in Corn recently has been more than 10 points. A more plausible stop might be five points or 10, in which case, depending on what percentage of your total portfolio you want to risk, you would need an account size between $15,000 and $50,000.

    Simply put, I believe that many traders begin to trade either under-funded or without sufficient capital in their trading account to trade the markets they choose to trade. And that doesn’t even address the size that they trade (i.e., multiple contracts).

    To overcome this fatal flaw, let me expand on the logic from the 'aim small, miss small' movie line. If you have a small trading account, then trade small. You can accomplish this by trading fewer contracts, or trading e-mini contracts or even stocks. Bottom line, on your way to becoming a consistently successful trader, you must realize that one key is longevity. If your risk on any given position is relatively small, then you can weather the rough spots. Conversely, if you risk 25% of your portfolio on each trade, after four consecutive losers, you’re out all together.

    Break the Hand’s Grip

    Trading successfully is not easy. It’s hard work ... damn hard. And if anyone leads you to believe otherwise, run the other way, and fast. But this hard work can be rewarding, above-average gains are possible and the sense of satisfaction one feels after a few nice trades is absolutely priceless. To get to that point, though, you must first break the fingers of the Hand that is holding you back and stealing money from your trading account. I can guarantee that if you attend to the five fatal flaws I’ve outlined, you won’t be caught red-handed stealing from your own account.

    What's new in version 1.2

  • #2
    Thanx and I may need some help with No5

    work in progress.......


    • #3
      Im guilty of all 5 charges m'lud


      • #4
        Thanks, i read some usefull things.


        • #5
          All very good points, and most pretty relevant. I think point 3 though, in regards to sports trading, and maybe even financials, maybe even a little floored. Markets change. If you can't adapt and rely on stale ideas, then you will fail in the long run, imho.

          Also like to add, that number 5 should be number 1. Money management is the key. Doesn't matter how good you are at trading. If you are bad at money management, then you will still fail.

          Nevertheless, a very good read, and something I may look into doing. I have defined the way I trade in my head, but in order to adapt to my next strategy, I need to define that, and will be writing that down. In regards to my trading, I have only ever written one thing down. "Wait For The Opportunity". No idea where that went, thinking about getting it tattooed on my hand, which in thinking about it, covers every point made there.


          • #6
            Originally posted by Temujin View Post
            In regards to my trading, I have only ever written one thing down. "Wait For The Opportunity". No idea where that went, thinking about getting it tattooed on my hand, which in thinking about it, covers every point made there.
            I'd agree with that one Temujin, too many traders trade as if the market they're in is their last race etc. Fatal Flaw No. 4 is very relevant to the racing markets opportunities do arise in every market but not every 5 seconds or so. You need to bide your time and wait for those clear trades to appear and then cash in. I see so many blogs where people have managed a profit only to turn it into a loss by going in for extra trades probably all done with no set strategy.

            So far this year we've already had over 4000 races, doesn't take a genius to work out you only need to take a small amount per race to make a decent return. People need to stop looking for that big win and concentrate on the long term return.


            • #7
              Another golden rule

              Don't let the odds get in the way of good judgement

              I layed Con overall majority on election night but was spooked by early 10% average swing to Tories. Looked at odds approx 1.2 for overall con majority and reversed position and backed con majority loosing loads by the morning! I had judged it right but was swayed by the low odds when I should have layed even more!

              Don't let the odds get in the way of good judgement!


              • #8
                A very informative post.... im guilty of flaw 5 time and time again, ill spend all day trading with small stakes finishing each race maybe 50p or a £1 up.... come the end of the day i get confident up the stake a little and something herendous is garenteed to happen! before i wipe the days profit out and more!

                All these post are interesting on here although i still dont find any giving me any kind of hint what i should be looking for, i mean i am guilty of Flaw 1 aswell i suppose because i am not sure which signals to believe all the time, any kind of help would be appreciated!

                Edges are ten-a-penny, execution is everything

                Read My FULL-TIME Racing Traders Blog Here!!
                T F YouTube


                • #9
                  I tend to force trades, at set trigger points, rather than waiting for the potential opportunity to present itself. I went through 6 months worth of trades and found it was more profitable to be in the market expecting something to happen rather than waiting for it to begin to happen, i hope that makes sense. To, hopefully, clarify i'd get in to a trade, more than likely showing an early loss, rather than waiting for a 'trend' to happen. Accepting losses is key, as with any trading strategy, and seems to be where most fail. I had a good friend sit with me on betfair and he had a good idea of the markets and how they worked but for the life of him couldn't accept a loss, many say it's an ego thing, and, more often than not, let his losing trades run away from him making profitable trading a virtual impossibility. We went through it again and again that if he's laying something at 3 and it goes off at 2.5 it's obviously 'off' and is expected to run very well and the backer has obviously got the value as the markets are nigh on 100% but he's still sitting with a lay at 3 which he's very likely to let go in running and which we all know will kill his bank eventually! He lasted 3 months but seemed to have many of the attributes to be a good trader but let his ego get in the way. People make points about money management, which is obviously vital, and discipline etc but the majority are linked and if your mindset isn't correct you wont win and should go and do something else! Unless you're a very small stakes player who's just after a bit of entertainment and fun of course


                  • #10
                    thankyou for that informative response inandout..... i understand fully what your saying, i was hitting more at how some people on youtube mainly sit and watch graphs and manage to jump on just before a 'wave' id like to master that if its possible.... however i get your point and find if im selective i can profit without much trouble as i have no trouble taking a loss... just a bit green i think but the more i change my way of thinking i learn a little more i find

                    Edges are ten-a-penny, execution is everything

                    Read My FULL-TIME Racing Traders Blog Here!!
                    T F YouTube


                    • #11
                      I dunno what videos you have been watching on youtube but I would guess that most of them have been selected precisely for the things that you mention, Ie they "appear" to have some sort of second sight and be able to predict a wave. They dont show the losing trades that they will surely have.
                      It is what I was saying about trading by probability. If there is a 60% chance that the market will move when they see a set of attributes( WOM, current price, activity etc) then they can still make money by entering the market every time they see those attributes, even though 40% of the time they will be losing trades.
                      It is a bit of a false picture that you see in the Youtube videos tho as they never show the losers


                      • #12
                        yes i do realise that neeel, some of them i think are geared up to help sell software aswell, i see your point and maybe to think you can see it before is a little nieve, im working on watchin it and working around the probablitiy and when to scratch if its going bad, made £2.98 today from £5 stakes well chuffed with myself lol.
                        Edges are ten-a-penny, execution is everything

                        Read My FULL-TIME Racing Traders Blog Here!!
                        T F YouTube