Finally, Some Winning Marbles

In early 2010—almost 10 years after buying Trade Your Way to Financial Freedom—I thought I might be ready to try trading again on my own. I was still scared of losing, but believed that if I kept
my position sizes relatively small, I could stop trading and limit my losses. To promote discipline, I created a few simple rules for myself:

1. Never risk more than two percent of total account equity on any trade.
2. Always enter a stop-loss order along with an entry order (my broker allowed both to be entered at the same time as linked orders—very helpful).
3. Reduce my position size or just get out if I start to feel uncomfortable.
4. Use trailing stops to exit the market.
5. Focus on trading two low-risk ideas: (a) channel breakouts and (b) bounces off support.
6. Enter trades only when I believe there is a good risk-reward ratio of at least three to one.
7. Get out of the market completely for at least two weeks if I experience an account equity drawdown of 35 percent.
8. If a position is going against me or taking too long to move in the direction I thought it would move, exit before the trade hits the stop loss if I no longer feel good about it.

This set of rules was not even close to what Van would consider a comprehensive trading plan, but it helped me do enough things right to capitalize on some big, very profitable trends.

I waited until May to take my first trade of the year, a natural gas bounce-off-support trade. The trend was strong, and I added to my position as natural gas moved up, while locking in profit by
moving up my stops as the trade went in my favor. The trade ended up being a 5R winner—in other words, I made about five times I Just Made 130 Percent—and That Was Just the Beginning 21 what I risked on the trade. If I ’d lost on this trade, I ’m not sure I would have been confident enough to keep trading, which is very significant when you consider my results for the year.

While I still lost more trades than I won—I think I only won about 30 percent of my trades—the winners were big, and I did well. As of December 31, my account value was up more than 130 percent, and I never experienced a drawdown greater than 20 percent. I was excited—so much so that I took screenshots of my account equity each time I reached a new equity high, almost as if I needed visual evidence that my results were real. As much as I wanted to have a year where I made 100 percent+, I wasn’t sure I could really do it.

Despite the success, I made tons of mistakes that cost me some very significant money. My guess is that I probably would have made at least 180 percent, probably more, without the errors. For example, in December, my wife gave birth to our first child, and I didn’t follow my positions as closely as I should have while I was with her in the hospital. I had my stops in place, but I wasn’t able to exit on intuition as I did at other times when I saw the market wasn’t moving quickly in my direction.

Also, I held too many positions—sometimes as many as 15 at once—and it turned out that some of them were correlated. After experiencing a drawdown as a result of correlations, I subscribed to a correlation service. The service provided a matrix of correlations, and I was more careful only to take positions with little to no correlation over the most recent 1-, 5- and 10-year periods. Unfortunately, I learned the hard way that correlations on any given day don ’t really care about historical correlations over 1-, 5-, and 10-year periods—another lesson with a high price tag. Big ouch!

Also, as I continued to trade, I noticed that my criteria for taking trades became more lax. Sure, I still looked for breakouts and bounces off support, but I seemed to get less picky about only taking the trades that looked the strongest. I became more impulsive.

I found I really wanted to be in trades because I was afraid I might miss a big move if I wasn’t in the market, and missing a big move would be painful. As a result, I had far more losing trades later in the year and forfeited profits as a result.

I also wasn’t very methodical about keeping a trading log and reviewing it to find and address my mistakes. I looked over my trades and noted some of my mistakes, but I didn’t set aside the time I needed to do a good job of it. If I had, I have little doubt I would have avoided at least some losses.

I also risked way too much per position early in the year. After a couple of months risking about 2 percent of account equity per trade, the account fluctuations told me I was risking too much. I cut back to 1.5 percent and later to 1.25 percent. These reduced risk levels still allowed me to have significant gains, but, more importantly, they reduced my daily account fluctuations and improved my peace of mind. I find it funny now, but before 2010, I remember thinking, “How will I ever make any real money if I only risk 2 percent of equity per trade?” If this statement rings true to you, play the marble game risking 2 percent of equity per trade, and then do it again risking 10 percent of equity per trade, and prepare to be enlightened.

I firmly believe that looking for good reward-to-risk trades and using a reasonable position sizing method were the most important factors in my results. The scientist in me is the first to admit that there was some luck involved on individual trades—but it would be hard to make the case that luck was a major factor on the 100+ trades I made over seven months. Even with all of my mistakes, I used enough of Dr. Tharp ’s principles to knock the cover off the ball. So, what now? I ’ve stopped trading and am going to take some time—at least a year—to focus on becoming a more efficient trader. As Dr. Tharp defines the term, efficiency means reducing the number of mistakes you make to the point where they have little impact on your results.

I’ve mentioned a number of things I plan on improving, but I haven ’t talked about my psychology. You may recall my views about the value of “trading psychology”; at the start, I was doubtful that psychology was important, let alone a key to trading success. Dr. Tharp wrote about the importance of a trader ’s psychology in Trade Your Way to Financial Freedom and other books, but it didn’t completely resonate with me. After all, why would psychology matter if I had a good plan and stuck to it? Wouldn ’t that take psychology out of play?

It took about 10 years, but I ’ve come to realize the answer is probably “no.” Psychology was the reason I made those mistakes in 2010. Psychology is the reason I haven ’t invested more time in pursuing my dream of becoming a full-time trader; I was scared of walking away from a lucrative day job and of what my family would think. And psychology was responsible for the mental chatter, uncertainty, and discomfort I felt as I traded, and I ’m sure it cost me in terms of returns. So, as with other Tharp Think concepts I initially resisted, I ’ve come to believe that psychology is a big factor in becoming a consistently successful trader, and I ’m planning on spending the next few years getting mine where it needs to be.