Showing posts with label personality. Show all posts
Showing posts with label personality. Show all posts

Tuesday, March 24, 2009

On Trading Rules and Guidelines

Last Friday’s post, Can Selling Options Make You a Better Trader? prompted quite a few emails and comments, including a request that I share some of my trading rules.

To be perfectly honest, I used to keep a list of trading rules handy to refer to at all times, but this is no longer the case. The rules are still valid, but after five years of full-time trading, I have retrained myself in the way I think about, react emotionally to and ultimately respond to the markets.

I do think, however, that the process of developing and codifying a set of trading rules and guidelines is one of the most important exercises that a new or inexperienced trader can undertake. Also, I firmly believe that veteran traders should constantly be evaluating their beliefs about the markets they trade and the guiding principles that provide the basis for various approaches to trading.

Before I decided to make trading a full-time business, I sat down and attempted to capture most of my beliefs about the markets. I originally started out with about 80 "axioms" (beliefs would probably be a more accurate term) and as I traded, I added to this list.

Originally I grouped my axioms/beliefs into the following categories:

  • Overriding Principles
  • Market Technical Analysis & Sentiment Indicators
  • Stock Selection - General (long-term, swing and day trading)
  • Stock Selection - Day Trading
  • Stock Selection - Shorts
  • Opening a Position
  • Taking Profits
  • Taking Losses
  • Pre-Market Activities
  • Intraday Activities
  • Post-Market Activities
  • Risk Control and Drawdown Rules

After a year or so of trading, I found that I had standardized on about 15 rules/guidelines that have changed only slightly since then.

As requested, here are ten overriding principles that have survived the past five years, through bull and bear markets:

  1. Always live to fight another day
  2. Entries must have a statistical edge
  3. Patience and discipline
  4. Be a jellyfish (swim with the current)
  5. Trade only liquid securities
  6. Focus on trying to capture the middle 80% of a move
  7. Know your exit points when you open a position (and stick to them!)
  8. When in doubt, reduce position size by 50%
  9. Limit losses to 2% of total equity for any single trade
  10. Start each day with a clean financial and emotional slate

The above list is relatively generic, but it helped provide me with a framework for organizing how I would approach trading as a business, what strategies I should adopt, how those strategies should be executed, and ultimately defining what success should look like.

Trading rules are vitally important – as is knowing when they should be broken. Even more important, I believe, is the process that one goes through in order to arrive at these rules and to make sure that as new market situations unfold and new blind spots are revealed, the rules and guidelines are enhanced to maximize the opportunity for the trader to continue to grow and develop.

Friday, March 20, 2009

Can Selling Options Make You a Better Trader?

I used to have a list of trading rules guidelines taped to my monitor. The list went through several iterations, but near the top were always reminders that a good trader needs “patience and discipline” to be successful. The list is no longer there, but by now the important ideas have been branded into my psyche.

On a related note, over the course of the past few years I have increasingly gravitated toward trading options. More often than not I find myself selling options, either with or without a directional bias, and enjoying time decay (theta) work in my favor to increase my portfolio value. Recently, it occurred to me that selling options has made me a better trader because it has cut down on the number of trades I make and enhanced my patience and discipline. How does this happen? Each morning I look at my portfolio and see what my portfolio’s aggregate theta is. This tells me how much money I will make from time decay alone if the market does nothing and I do not make any trades. As a rule, I try to structure my portfolio so that the aggregate theta is at least as large as my daily profit target. For this reason, I never rarely feel obligated to “make something happen” and force trades that should not be taken.

While there are many approaches to trading, I believe that every trader should be comfortable trading long positions and short positions, buying options and selling options. Better yet, traders should not have a built in bias toward long-only trading or only buying calls. Ideally, a trader should be directionally agnostic and equally comfortable with the full menu of possible trades.

Ultimately, a considerable amount of trading success comes down to the “know thyself” dictum. A trader that understands his or her personality type, comfort zones and preferences can do a better job of applying the appropriate psychological approach to trading. These skills are some of the most difficult for many traders to master. It is quite possible that selling options may provide a shortcut to developing some of those skills.

For more on applying psychology to improve your trading, the best resource on the web is undoubtedly Brett Steenbarger’s TraderFeed.

For more on theta and time decay, check out Theta, an excellent overview of the subject at Know Your Options, a promising new options blog authored by Tyler Craig.

Thursday, November 29, 2007

The Promethian Trader

I may be projecting a little here, but I suspect that most who are new to trading generally approach the subject as a problem largely consisting of how to build and implement a consistently profitable trading system.

While there are several excellent blogs that deal largely with the trader’s personality (most notably Brett Steenbarger’s TraderFeed and Corey Rosenblum’s Afraid to Trade), I have yet to say much of anything on this subject, even though I am strongly of the opinion that eventually all traders will realize psychology is the most important part of trading, even those who are using mechanical systems. In Trade Your Way to Financial Freedom, noted author and trading consultant (and occasional blogger too) Van Tharp puts it this way:

“When I’ve had discussions about what’s important to trading, three areas typically come up: psychology, money management (i.e., position sizing), and system development. Most people emphasize system development and de-emphasize the other two topics. More sophisticated people suggest that all three aspects are important, but that psychology is the most important (about 60%), position sizing is the next most important (about 30%), and system development is the least important (about 10%).”

With this in mind, I was most interested to recently discover that Tharp had published an eight part series outlining some of his thoughts on personality types and trading. For those who may still be skeptical of the importance of psychology, before dismissing the articles, be sure to jump down to Part Eight, where Tharp talks about the Promethian Temperament. Tharp tosses out two statistics that I found particularly interesting:

  1. The Promethian Temperament (xNTx in Myers-Briggs speak) occurs in his sample trader population at a rate more than twenty times that of the general population; and
  2. “Among our NT traders, about 10% show outstanding trading records—a higher percentage than any of the other temperaments.”

Tharp goes on to explain that despite the fact that NT traders are handicapped by a strong desire to predict, control and explain the markets, they overcome this and are successful as a result of their insistence on acquiring more self-knowledge, continuously improving their craft, and applying as much science as possible to potential trading approaches.

If you are an NT, as I am, you probably know all of this already, but you might want to read the article closely to look for the shortcomings that NTs are prone to. If you are not an NT trader, consider how your Myers-Briggs personality type my help to accelerate and simplify the process of identifying your potential strengths and weaknesses as a trader.

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