Alvin Chow writes informative articles on themes of interest to investors. He is the founder of BigFatPurse.com , loves the financial market, and curious to find out what work and what doesn't work in investing.
Why I Stopped Trading
I have been making good returns from options trading since the unfortunate blow up in Jan.
I restarted the account with US$10k capital and the track record was as such by the end of Sep 14:
- No of trades = 29
- No of wins = 20
- No of losses = 9
- Win Ratio = 69%
- Loss Ratio = 31%
- Total Amount Win = $8,820.32
- Total Amount Loss = $6,332.43
- Av. Amount Win = $441.02
- Av. Amount Loss = $703.60
- Expectancy = $85.79 (or +0.12R)
It is very important to track your trading records in this way so that you know if the strategy has a positive expectancy. Traders have losses and winners, and summing them up over the long run should give you higher winnings. As you can see the expectancy is positive in this case, it means I would make $85.79 for each trade based on a capital of $10k.
In percentage returns, the portfolio gained 25% in 8 months. A pretty good returns I should say. The natural response to this is to scale up. Increase the number and size of trades and I can trade for a living. Key in a few trades and enjoy the rest of the day at Bahamas.
But I have decided to stop trading. Before I go on to explain, let’s rewind back in time to understand why I started trading.
Why Do I Want To Trade In The First Place?
I knew I wanted to make more money and trading seems to have a low barrier to do it. I just have to dump some money in a trading account and press a few buttons to edge out profits from others. Overconfidence bias told me that I am better than most other traders. I can win their money. Haha, fat hope.
As a young guy, I wanted to make money fast and investing, being associated with buy-and-hold, was deemed too slow and boring. That’s for old folks. Trading is fast and you see instant gratification or pain. We all like to know the results fast and today’s trading platforms enable us to do it. It creates endorphins and dopamines in our brains and the feeling can become addictive. The kind of trading done by most people is no different to gambling. They trade or gamble for excitement, and not focusing on honing their art and discipline to do it well.
So there I was, started out gambling in the stock and forex markets when I thought I was trading.
Of course, the market didn’t make it easy for me. I made money and I lost money. Over the years, the results made little difference to my net worth. I began focusing on honing the art and I know losses are part and parcel of the game. I roughed it out, tried various types of strategies and I found that most of them do not have positive expectancies. Some have positive expectancies but they do not suit my personality so I didn’t pursue. In the end, I found options trading to be both profitable and suitable.
The funny thing is that I decided to give up trading when I found a profitable strategy, and not during those years of unsuccessful results. It bewildered my friends.
The Next Blow Up is Very Real
The blow up in Jan left me a very profound insight to trading. Many people see options selling as a very risky endeavour. But what I saw was deeper than that and people were learning the wrong lessons from my lesson. We see what we want to see perhaps.
Trading in general is a very risky activity. It doesn’t mean it is less risky when you trade forex and stocks. They are equally risky. Let me explain why.
Every trading strategy has rules to keep us sane and rational when we buy and sell. Hence, the mantra is always follow the rules and then follow the rules and still follow the rules.
But we know that we have mood swings. Somedays we feel upset and some days we feel happy. And our moods can also be triggered or exacerbated by the gains and losses in the financial markets.
A married couple knows that arguments are usually irrational and they need to be objective and control their emotions so that they would argue less. It is easier said than done because when the emotions runs amok, we say the worst things. Likewise, we know that trading requires us to be rational ALL THE TIME, but we know it is impossible. A trader cannot vow that he can remain emotionless in every trade he makes. We are humans and fallible. We let emotions hijack us more often than we think.
We think we follow rules well. We actually follow our emotions better.
Think about this, you were rationally following the buy and sell rules for 9,999 times and you have been making good money. In the 10,000th time some how the emotions get the better end of you and you decided to forgo your rules. Do you think the market will forgive you since you have been very nice in the past 9,999 trades? This is what could happen in this faithful day: You put on a size that is bigger than normal. Market moves against you. You tell yourself this shouldn’t be because you traded this way for a long time and you know it works. You wait and watch your position goes deeper into the red. The dreaded margin call comes and ask for more capital to be put up. You either throw more money after the bad, or you just give up. This is how blow up happens.
It doesn’t matter how many good trades or how much money you have made in the past. The market has no memory. You are only as good as your next trade.
Regardless of stocks, forex, options, or futures, you stand a good chance to blow up as long as the instrument is leveraged. The table below shows the ‘margin of safety’ you have when you leverage your trades. The day you cannot follow the rules to cut loss and the effect of leverage will get you.
Why Not Just Trade Small?
One way to reduce the emotional swings is to trade a small capital. I talked about knowing your Psychological Capital (PC) previously. You should be trading a capital that you have no problems cutting losses. The art is to know how much is your PC. You need to figure it out by trial and error.
The downside of this is that if you feel nothing about the losses, you will feel worse than nothing about the winnings (lack of dopamine). We have loss aversion bias. If the pain of loss is small, the joy of gain would be three times smaller. This has a major implication. If the rewards are too small, we will most likely give up trading after a while even though it is profitable. Or we increase the capital beyond our PC and risk blowing up one day.
If most of us can only trade small to remain rational and thus profitable, how can we make a living out of it or grow our net worth meaningfully? Shouldn’t we put our capital and time in more worthwhile activities?
All is Not Lost, How to Make It Big In Trading
Who can make it big in trading then? Don’t we see successful traders by the millions they have made in the markets?
Do you know Alain Robert? He is known as the French Spider Man who climbs buildings around the world with no climbing equipment. In 2010 he scaled the Singapore Flyer. In the following year he scaled Burj Khalifa, the world’s tallest building with the help of a safety harness in part of the climb. Can everyone train hard and be like him? The answer is no.
Trading is daredevil sports. Few people have the aptitude to make big money from it. That explains why the mantra is true, 95% of the traders lose to the top 5%.
Tom Yuen, whom I have interviewed for my book, said that ‘it is all about size’. I cannot agree more. The best traders in the world who can make millions are few and far in between. Their Psychological Capital is enormous and they trade big sizes without flinching. He also told me stories of these traders blowing up millions as well, and how they make the money back. I knew my personality is not suited for extreme sports. I couldn’t take this kind of ride.
Why I Stopped Trading
I will summarise in the next few lines why I have stopped trading in case you have not understood by now.
I am an emotional creature and I cannot vow that I can trade emotionlessly. I cannot battle a mind that has evolved for millions of years. If so I will face many blow ups in the future because I will continue to be fallible. There is no point trading a small capital to manage my emotions better, because it won’t make a big difference to my net worth. I can make better use of my time and capital in other ways.
Knowing my limits and vulnerability is liberation.
- See more at: http://www.bigfatpurse.com/2014/10/why-i-stopped-trading/#sthash.MHfbqLK0.dpufSource: http://www.bigfatpurse.com/2014/10/why-i-stopped-trading/
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