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The Basis of Trading Success: Stick to Your Plan!

“In the short run the market is a voting machine. In the long run it’s a weighing machine.”

— Benjamin Graham

The above quotation from the father of value investing sums up the difference between investing and trading.

Investing is a long-term proposition, where the value (i.e., the weight of discounted cash flows) of a stock eventually determines its price. By contrast, trading is a short-term activity, where supply and demand (i.e., the votes of buyers and sellers) determine a stock’s current price.

As I’ll explain below, successful traders use a plan AND have the discipline to stick to it.

Trading Works 

The fact that some traders are billionaires suggests that short-term trading can be profitable if you do it right.

Quant trader James Simons of Renaissance Technologies is reportedly worth $20 billion, Stephen Cohen of S.A.C. Capital (SAC are his initials) is worth $12.9 billion, Ken Griffin of Citadel is worth $9.9 billion, and traders Paul Tudor Jones, Bruce Kovner, Cliff Asness, and D.E. Shaw are all said to be worth more than $3.5 billion.

So what are these guys doing right?  To be honest, I don’t really know because they are all private hedge fund managers who are secretive by nature.

A Story About Turtles

But don’t lose hope!  We may still be able to learn the basics of a successful trading system.

Remember the Turtles? Not the teenage mutant ninja type, nor the 1960s rock band, but the group of novices assembled by commodities traders Richard Dennis and William Eckhardt back in 1983 to test the “nature vs. nurture” theory of trading.

Dennis believed that successful traders could be grown just like Singapore grew turtles, whereas Eckhardt thought successful traders were born, not made. Dennis taught the novices his trading methodology for two weeks and then let the Turtles loose with some trading capital.

After four years, the Turtles had collectively earned over $100 million dollars in profits and Dennis had won the bet. 

To be sure, less than half of the 23 original Turtles were long-term successes, but this was not the fault of the trading methodology. Rather, it is emotionally difficult to follow a trading system consistently. Some simply broke the rules (to their detriment) because their gut said the system was wrong.

It’s Psychology, Stupid!

As original Turtle Curtis Faith explains in his book “Way of the Turtle,” he succeeded whereas other Turtles failed because of his emotional makeup, not because of any superior intelligence:

By some freak of biology or upbringing, it was not difficult for me to be consistent in my trading. It seemed crazy to me. We all had been taught exactly the same thing, but my return was three times that of the others. The difference in return had nothing to do with knowledge and everything to do with emotional and psychological factors.

There you have it. The secret to successful trading is really no secret at all; it is simply having the emotional discipline to stick to a trading plan.

Trading Checklist

Van Tharp, investment psychologist and author of “Trade Your Way to Financial Freedom,” says that successful trading must have three components:

  1. Positive expectancy
  2. Sufficient trading opportunities
  3. Position size rules (i.e., money management)

Let’s discuss each component separately.

Positive Expectancy Part 1

Do you want to be right most of the time or do you want to make money?

Trading is not a one-shot deal. Rather, it is a never-ending series of trades that collectively should make money.  Some will be winners and some will be losers. In fact, according to Tharp, the best traders have a win rate of only 35%-50%. You heard me right: the best, most successful traders lose more often than they win. They are successful because their winners are much more profitable than their losers are unprofitable.

Many beginning traders think that accuracy is the most important thing. They think that one who wins on 9 out of 10 trades must be a better trader than one who wins on only 4 of 10 traders.  Professional traders realize that accuracy is irrelevant to success. What is important is the expected value of your trades – i.e., how much profit your trading system generates. As Curtis Faith writes in “Way of the Turtle”:

The ego is not your friend as a trader. The ego wants to be right, it wants to predict, and it wants to know secrets. The ego makes it much more difficult to trade well. If you want to be a great trader, you must conquer your ego and develop humility.

Humility allows you to accept the future as something that is unknowable. Humility will keep you from trying to make predictions. Good traders don’t try to predict what the market will do; instead they look at the indications of what the market is doing.

Humility will keep you from taking it personally when a trade goes against you and you exit with a loss. Humility will let you embrace trading that is based on simple concepts because you won’t have a need to know secrets so that you can feel special. 

Positive Expectancy Part 2

Since positive expectancy and not accuracy is the key to success, let us define expectancy:

(Probability of winning) times (average profit per winning trade)


 (probability of losing) times (average loss per losing trade)

For example, if your probability of winning is 35%, your average winning trade profits $10, and your average losing trade loses -$3, the expectancy of your trading system is:

(35% * $10) + (65% * -$3) = $1.55 

This trading system has a positive expectancy because over the long-term, it should yield an average profit of $1.55 per trade.

Think of a casino. The odds are in its favor on every single game played, whether it be roulette, craps, or blackjack. Sure, it could lose any single game at any time, but over the long run it knows with mathematical certainty that it will come out ahead.

In contrast, consider a trading system that wins 90% of the time gaining $1 on average but loses $20 on average on the 10% of losing trades:

(90% * $1) + (10% * -$20) = -$1.10

This trading system is worthless despite its 90% success rate because it has a negative expectancy. An example of such a losing system is selling deep out-of-the-money call options. You win most of the time but the few times you lose destroy your trading account. Bad idea.

Sufficient Trading Opportunities

Some people are so afraid of losses that they ensure winning trades by making the criteria for entering a trade extremely stringent. So stringent, in fact, that the system only triggers once every year or even less frequently.

For example, let’s say that your criteria for entering a buy order requires a stock to be trading for less than 50% of its cash on hand or when the stock price is 40% below its 200-day moving average. Almost never happens, so even if the system has a high positive expectancy of $50 per trade, it only triggers once per year so your profit is capped at $50 per year.

Just like the high-accuracy, negative-expectancy trading system described above, a positive-expectancy trading system that trades only once in a blue moon is virtually worthless and cannot make big money.

Position Sizing

How much of your trading capital you risk on a trade is the most important aspect of your trading plan. Yet, most trading seminars and books virtually ignore the topic and spend all of their time discussing the triggers for entering and exiting trades. According to Van Tharp:

Position sizing dramatically adds to the potential profits or losses that can occur throughout the course of trading. In fact, position sizing accounts for most of the variation in performance of various money managers.

If you bet too little of your capital per trade, you make too little. If you bet too much, you risk going broke. There is no such thing as a risk-free trade; there is always a chance (however small) of losing money. If you bet the farm on a trade and it turns out to be one of the few times that it loses money, game over.

As I discussed in my article “The Great Investment Truth”, losing too large a percentage of your capital makes it virtually an arithmetic impossibility to gain it back. Consequently, a trader must find the optimal “middle ground” position size for her trades. 

The Turtle trading system had a maximum position size per trade that risked 2% of capital.  For example, if a Turtle had a $100,000 account and his trading system mandated a stop-loss exit trade $5 below the entry price, his maximum position size would be: (2%*$100,000)/$5 = 400 shares.

In his book, Van Tharp describes a simulation he ran based on a $1 million portfolio and a trading system that took 595 trades over a 5.5 year period. He ran it several times with the only difference being the position size of each trade.

The results showed a huge difference in the ending account value, ranging from a gain of only $32,567 to a whopping gain of $2.1 million. Let me reiterate: all trades (both entries and exits) were exactly the same in all simulations except for position size. Conclusion: position size is all-important!

Profit Exits

When designing a trading system with entries and exits, one must recognize that there is only one entry rule but there are two completely separate exit rules that need to be determined.

First is the stop-loss exit, which I have already discussed and comes into play when the trade is a loser. The second exit rule comes into play in the case where the trade is a winner. Should you take profits at 20%, 50%, of 100%?  The answer is none of the above. 

The Turtle trading system was based on trend-following, which means that it waited for a breakout from a price range (i.e., a price above the high of the past 20 days) before entering a trade, hoping that the stock or futures contract would continue in the direction of the breakout. Since trends sometimes continued for gains of way more than 100%, the Turtles didn’t want to artificially limit their gains with some arbitrary profit number.

Since a majority of breakouts don’t actually start a trend, a majority of their trades were losers and they relied on the huge gains from their minority of winning trades to create the positive expectancy.  Consequently, a winning trade would not be exited until the price action told them that the trend was actually over (i.e., a price below the low of the past 10 days). 

According to Curtis Faith, profit exits were psychologically the hardest part of the entire trading system to adhere to. Why? Because waiting for an exit to trigger sometimes meant allowing 50% or greater profits to evaporate. But back testing showed that the only way to achieve the truly humongous trend gains needed to make the trading system profitable was to wait it out and not take profits too early.

Five Trading Takeaways

  1. A trading portfolio should be well-diversified in order to reduce risk. Position sizing is one way to ensure that such risk-reducing diversification occurs. 

  2. A trader needs to be humble and trade in the direction of current market action rather than try to predict future market direction.

  3. Traders must keep in mind both stop-loss exits and profit exits. 

  4. Psychological discipline is important. The toughest part of trading is remaining consistent and following the rules — even when your gut tells you otherwise.

  5. Lastly, don’t be paralyzed by fear of the unknown and the possibility of losing money on any particular trade. Perfection is the enemy of the good. Accept limited losses as a cost of doing business.

As they say in the state lottery, you’ve got to be in it to win it. So devise a sound trading plan, put some money down on short-term stock or option positions, and watch the profits start to roll in!

I’ve just explained why it’s important for traders to develop a plan and have the discipline to stick to it. That’s a guiding principle behind my “Velocity Profit Multiplier.” This money-making method can turn stock moves as small as 1% into triple-digit gains.

I’d like to show you the secrets of my trading system, but I’m limiting access to only 500 people. If you want to join my inner circle, click here now for details.

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