Plunge Headlong into the Market Without a Plan of Action:
This is an excellent to way to lose money and to lose it quickly.
Why make a plan anyway? Would you drive from New York to Los Angeles without a map? You could. And you might be lucky enough to reach your goal without too many errors. Your might even enjoy it! But each error would cost you. When your aimless travels end, you’ll find that others have reached the goals faster and with less cost, both emotionally and financially. You want to take the ride for pleasure? That’s fine, but don’t expect to do it economically profitably or quickly without a plan.
If you trade without a plan, your chances of success are slim to none. Your may be one of the lucky few who hits big the first time, but the odds of doing so are minimal. Without a plan, you will find yourself buffeted by the winds of chance, the opinions of others, the persuasion of newsletters and advisors, the pandering of brokers and the bias of the media. Your responses will be whimsical. But the greatest danger is that you will not learn anything from your losses. If you are unaware of what you did wrong, the consequences of your actions will not be readily apparent to you. And you may run out of money before you learn your lessons.
But what exactly do I mean by a plan? Is it a trading system? A schedule? A set of rules? I define a trading plan as:
A system or set of indicators that will permit relatively objective evaluations of market entry and exit as well as risk management.
This could mean that you are following a computerized trading system, signals from a chart book, newsletter, astrology, random number generator, the I Ching, or your broker. Regardless of the source, the input must be treated as relatively unalterable and followed as closely and as often as possible.
There are various levels of adherence to a plan. Every trader must find his or her own level of comfort in deviating from that plan. Some traders will feel uncomfortable with only a minor deviation from the course, while others will be able to tolerate wide variances from their plans. The final determinant must be your results in the marketplace. You alone can determine the right formula by trial and error.
Read Many Publications, Watch the Television Business News and Follow the Consensus of Opinion
This is a surefire way to get confused and lose money at the same time. I call this approach Edsel trading, named after the infamous Edsel that was designed by a committee attempting to incorporate all of the changes and the features recommended by experts and consumers alike. While Edsel may have been a great idea, it failed miserably as a product.
When you attempt to trade on the basis of numerous inputs, you’ll end up with an Edsel trading system, a system that seems like it should work but it doesn’t. In fact, my research with contrary opinion indicators strongly suggests that you are better off trading against majority of opinion rather than with it. Futures trading is a loner’s game. Your must find a combination of indicators and tools that works for you, and you must shut out as much outside influence as possible.
Add to Losing Positions to Average Your Cost
Here’s a great method for losing your speculative capital. In fact, it works so well that many traders have virtually guaranteed themselves losses by following this time-tested strategy. The methodology is simple: whenever a position goes against you, hold on to it and add to it repeatedly to lower your average cost. When the market eventually moves your way, you will come out ahead. The reasoning is very logical in a game where no margin is required and time is not important. But in futures, and particularly in futures options, time passed is money lost. Contracts expire, margin calls continue, and the trend most often continues in its existing direction. While you may be right in the long run, you will most likely be broke in the short run.
Take Your Profits Quickly and Ride Your Losses
This is another popular strategy among losers. To see why this approach is so popular, let’s examine its psychology. Most traders are anxious. They are so worried abou t the ego-deflating experience of being wrong and losing money that when they have a profit they are afraid it will not last. They are inclined to jump out of their profits quickly to get the gratification of knowing that they have banked the money and that the market cannot take it back. However, when there is a loss, things are quite different. Traders simply cannot admit to a loss. There is the perennial hope that things will eventually get better, that the market will turn around. And each small turnaround rewards the trader for hanging on. Unfortunately, it is often a classic case of one step forward and two steps back as the position continues to erode.
Several years ago I was hired to speak at the Alabama Farm Bureau. After my speech serveral attendees introduced me to an elderly gentleman whom they claimed was the best trader in the area. He was most eager to show me his trading system.
“It’s really very simple”, he said as he produced a small leather pouch from his pocket, removing a metal ball connected to a bead chain.
“I take this here pendulum and I hold it steady over a chart of the market I want to trade. Then I let the pendulum loose and I watch it closely. Most often it’ll start to swing on its own. If it swings left to right, then I buy. If it swings top to bottom, then I sell. That’s it!’
He was obviously very proud of his system and I certainly did not want to burst his bubble. So I nodded approval, hoping to hide my skepticism.
‘Are there any other rules to your system, sir?’ I asked with a serious and analytical tone.
“Well, yep, there’s jus’ one more part of this here program, but it don’t amount to much, he drawled.
“What’s that?’ I asked skeptically.
‘Well, it’s a simple little thing. If’n at the end of the day my new position shows me a profit then I keep it. But if it’s a loser then I kick it out. And any day after that if’n my positions turns into a loser at the end of the day then I kick it out”, he stated with an air of childlike innocence.
I realized immediately that in this last simple statement rested the essence of his success as a trader; he kept the winners and liquidated the losers quickly! He did the opposite of what most traders do. In essence his system of trade selection was a random system. The key to his profitable trading was that he eliminated losing trades early in the game and winning trades until his “system” got him out. In so doing, he kept losses small and his profits large by comparison. It was a simple system indeed, so simple that it worked well.
Start with Limited Capital and Attempt to Parlay It into a Fortune
This is the trader’s utopian dream. The Horation Alger story is still the image that inspires traders to take their shot at making it big in futures trading. Most traders begin with limited capital seeking to hit the one big tradethat will propel them to success. However, the odds of doing so are slim. The simple fact is: the less you start with, the lower your odds of success. It’s a matter of logic. If you’re hoping to get on board that one big move, it may take ten consecutive losers before the winner comes. By then your capital could easily be depleted, and you’ll miss the move you were hoping for. My advice: be realistic. Begin with a good capital base. Be prepared for numerous small losses. Expect to be wrong five, even ten, trades in a row before you hit a big trade. When you do hit a big one, don’t be too quick to get out. Remember also that the less risk capital you begin with, the less likely will be your chances of success.
Find a Trading System, Advisory Letter or Money Manager That Has Performed Well and Latch On
Now here is another surefire way to lose your shirt. The time to go with a winner is when it has had a string of losses. Unfortunately, this is not the way most traders make their decisions. The temptation to go with a system or money manager is greatest when their performance has been outstanding, when they have attracted the most attention by their performance. I suggest that you find a good performer, wait until it has experienced a good sized decline and go with it. However, please note that your incentive to get on board will not be very high when the decline in performance is in process.
Quit Your Job, Withdraw Money from the Bank, Get a Computer, Subscribe to a Quote Service and Begin Trading
I have seen more traders lose money this way than any other way. Futures trading is a profession. It takes time to learn the techniques, and it takes experience to implement those techniques succesfully. There is no substitute for actual trading experience. It never ceases to amaze me how many doctors, lawyers and engineers quit their otherwise stable lucrative professions to take up trading. Even more amazing is the sad but true fact that these professionals think they can make money by taking a few courses or seminars, or by reading a few books. When their efforts meet with losses, they are surprised that they have failed. What they have failed to understand is that futures trading is not like being a doctor, lawyer or engineer. The rules are not as well defined, nor do they produce positive results as regularly as do the rules of their professions.
My advice is simple. Don’t quit your job. Don’t buy expensive quote equipment or computers. Don’t fool yourself into thinking that the right system, the right computer or the right broker will make you successful. Trial and error, experience, self-discipline and consistency will, in the short run and in the long run, make you more money than will expensive equipment.
Use Spreads to Avoid Losses
This may seem like a sophisticated strategy. In actuality, it’s just another way of avoiding a loss until it gets big enough to cause serious pain. While thre’s nothing wrong with trading spreads as spreads, there’s everything wrong with spreading a position to avoid a loss. The only thing this will do for you is to lock iin the loss. Often both sides of the spread will work against you, and you will end up increasing your loss. The time to take your loss is when the time to take your loss has come-it’s not time to spread the position to avoid a loss. When used appropriately, spreads are good vehicles that may be used very profitably. They are vehicles used by professional traders by virtue of their consistency and adherence to seasonal patterns. However, when used to avoid a loss, they can be deadly.
Pyramid Your Position as It Becomes Profitable
Pyramids are burial vaults. Unfortunately, many traders mistakenly believe that as a market moves in their favor, they must add successively larger numbers of contracts to capitalize on the move. What happens, of course, is that the pyramid is built upside down. These individuals will buy one unit at the start of a move, add two or three more at a higher price, and add five or six more at an even higher price. The pyramid becomes top-heavy, and the slightest change in tred sends it crashing to the ground along with the trader’s profits.
If you’re going to build a pyramid, build it with a sound base. Establish your largest position at the beginning of a move and add successively smaller numbers of units as the market moves in your favor. You will still have a good –sized position when the move comes to an end, and your average cost will be much better than if you had built the top-heavy pyramid. In spite of all we know about futures trading and all that has been written about the ill-advised procedure of the top-heavy pyramid, there are still traders who think this strategy will work for them. In practice, success with this type of pyramiding is rare indeed.
Attempt to Pick Bottoms and Tops as often as Possible
After all, the better your entry and the better your exit, the more money you stand to make. The reasoning sounds good, and if there were a good way to pick tops and bottoms with a high degree of accuracy, the reasoning would be correct. But tops and bottoms are elusive, and they are dangerous. There is often a great deal of volatility associated with tops and bottoms. This makes them hard to find and hard to stay with once they have been found.
Larry Williams, peharps the most prolific systems developer and one of the most aggressive traders I know, once shared his thoughts about top and bottom picking with me. He remembered the words of an old and experienced futures trader who told him, ‘Trying to pick a bottom or a top is like trying to catch a falling knife; it’s very dangerous. Don’t try to catch a falling knife. Wait until the knife hits the ground and digs its way into it. And then don’t pick it up until it stops quivering.’ In the long run you will be much better off attempting to enter after tops and bottoms have been established, and better off trying to take a part of each trend than in attempting to pick a bottom or a top.
Buy Futures Options to Limit Your Risk
This is a wonderful way to throw your money into the deep dark hole. At first blush this strategy seems just as logical as do many others. Joe Granville used to say, “If it’s obvious, then it’s obviously wrong.” This is especially true in futures options. In practice, a vast majority of put and calls expire worthless. To buy a call when you expect an uptrend or to buy a put when you expect a downtrend is often a waste of time, money and commissions. Options lose time value quickly. Your timing with options must be even better than it is with futures; it’s a case of double jeopardy. You buy an option because you think you’re buying time. You think that your timing need not be as precise as it is with futures because you can only lose your premium plus commissions when you buy options, but this is the illusory aspect of the situation. Consider options strategies as opposed to an outright long or short in options.
Professional futures traders who make money with options are most often sellers of options since they know that most options expire worthless. They sell a deteriorating asset and the odds are clearly in their favor. Thus, if you’re going to trade futures options, do it in a professional way by using options strategies and by being an options seller rather than an options buyer. Unless you’re willing to approach options in a professional way, don’t even bother getting involved in this market. The ods are against the options buyer.
