Monday, December 21, 2009

Guest Article - Book Excerpt: Trading from your Gut

Keeping What’s Yours
by Curtis Faith
author of Trading from Your Gut: How to Use Right Brain Instinct & Left Brain Smarts to Become a Master Trader

The prime lesson or instinct for avoiding loss makes sense in more traditional circumstances. It takes effort to acquire any possessions: grain, cattle, sheep, shelter, and other items. We should safe- guard and protect possessions that require work to acquire. Novice traders naturally try to avoid losses, which is one of the main reasons they focus on high-percentage strategies. They want to have many more winning trades than losing trades, so they focus on anticipating the market and trying to predict its direction.

As I mentioned earlier, I am generally reluctant to comment on the market’s direction. Instead of trying to predict the markets, I focus on what it is doing now and what that means. The problem with prediction is that you can be very off with the timing. You can be right and still lose a lot of money because the market might take a long while to arrive at the same place. However, if you know what the market is doing right now and what it has done in the past, you can find times when the odds of the market moving a significant amount tip in your favor. Taking a trade is not the same as making a prediction. Master traders often take trades that they believe are more likely to result in a small loss than a gain based on their knowledge of past market movement. How much money they will make over time is the important factor, not how often they are correct.

A related problem new traders have is that they often look at losing trades as bad trades. This is related to their desire to predict. Their built-in circuitry equates losing with bad and winning with good. This evaluation is certainly correct over many trades and the long term, but it is an incorrect assumption in the short term. Master traders recognize that losing is a cost of doing business. They also recognize that the markets often reward behavior that is psychologically difficult for most traders to exhibit or manage. Trading strategies that are difficult to follow are usually significantly more profitably than those that are easy to follow.

Many new traders use easy-to-follow strategies, especially ones that seem obvious. Consequently, these strategies tend to work for only a brief period of time. Usually they stop working as soon as enough traders have started to follow them. Therefore, the desire to avoid losing trades can be a major disadvantage.

Master traders know that the percentage of their trades that make money is not as important as the amount of money they end up with. A few large winning trades can easily offset many smaller losses. Therefore, master traders often look for trading strategies that have many small losses and relatively few larger winners. The long-term, trend-following trading style we used as Turtles is one example of this type of trading strategy. In one year that I was up more than 200%, I had perhaps 10–12 winning trades and 45–50 losing trades. The winners were big (5%, 20%, 40%, or more) and the losing trades were all small (0.5% losses). If you were trying to predict the market, you would have been better off taking the opposite of my trades.

by Curtis Faith
author of Trading from Your Gut: How to Use Right Brain Instinct & Left Brain Smarts to Become a Master Trader

Reprinted with permission of the publicist and Copyright FT Press, an imprint of Pearson.

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