To trade successfully, you have to stay in the now. If you get impatient or greedy or fearful, you can start to live in the past and the future and then you will start to fail.
The essential principles of trading are well-known: ride your winners, cut your losers, manage your risk, use stops, stick to your system and ignore the news.
But you have to follow them consistently and that is where most of us fail. This is because following these rules consistently is not a lot of fun and takes a lot of character because buying winners, selling losers and dealing with whipsaws is not emotionally easy.
Win or lose, everyone gets what they want from the market. – Ed Seykota.
The goal for the trader is to develop a system with which he is compatible. – Ed Seykota.
The most important thing in trading is harmony between a trader’s emotional constitution and trading technique. Trading technique can easily be codified but the emotions that a trader has when he uses the trading technique cannot be easily codified. It is important to realise that trading is 20% intellectual and 80% psychological. When there is incompatibility between these two, the trader fails. Knowing trading rules from an intellectual standpoint is not enough, it is necessary to know them from a psychological and self-awareness standpoint also.
We tend to seek pleasure and avoid pain. A lot of time we seek to avoid small pains which is necessary if you have to be successful in trading. But our ego comes in and we do not want to sell at a loss. But whether you are Warren Buffet or a novice trader, the single most important tool in your trading arsenal is: keeping your losses small. But we often do not take a small loss because we think if we hold on, the loss will become a profit. What usually happens is a greater loss.
To be successful, you need to clearly know when you will quit the position. Because in trading you will gain and you will lose. What is important is that your gains are far larger than the total amount of losses. The number of gains and the number of losses do not matter.
So if you gain 1000% in one position and lose 10% in 9 positions you would have a decent profit because:
- 100 becomes 1100 in one position; 100 becomes 90 in 9 positions
- Beginning Investment=1000
- Ending value= 1100 + 90 x 9=1910
- % gain = 1910-1000/1000 x 100=91%
So you can see that cutting your losses to 10% and riding your gains is what gives you good gains.
Taking these losses requires self-awareness and discipline, not intellect. To do that, you should not get emotionally attached to your investment. If you get emotionally attached, you lose the rational ability to keep your losses small. You have become emotionally attached to the outcome.
So, when you invest in something, it can go up, remain sideways or go down. In two of these three scenarios you are wrong and you will do well to get out. Trading is a process that focuses on keeping losses small. Focus on that process, not the outcome. Decide at what point you will get out and get out. That is what makes a successful trader.
A trader is someone who has let go of the emotional need to be right all the time and has learned to love taking consistent small losses the majority of the time, does not seek validation from trades, doesn’t need advice from others and has a strong personal discipline. He has married his technical knowledge with his feelings and the resulting inner voice is his greatest asset and ally.
Trading profitably is about mathematical expectation. Knowing yourself is more important than what you know. You need to know you have no control over what actually happens to the market or stock. You surrender to the market, you cut your losses short and follow the system that you can follow.
To do this consistently and successfully:
- Understand that you are human. You seek pleasure and avoid pain. Understand this and accept pain of a small loss if you want to be successful in trading.
- The strategy you choose for trading should be sustainable over time. You have to choose one that you can consistently execute and emotionally tolerate.
- You have to learn to let go. You do not need to be right all the time and you should not seek validation from your trades.
- You should learn to reduce your losses through self-discipline and surrender. By keeping your losses small, you will improve performance.
-notes from the book ” The Inner Voice Of Trading by Michael Martin”