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The Three (Preferred) Stages of Trader Development


In my experience, I've found that the preferred, but not common, stages for traders to go through in their development into confident and successful traders are these:

Stage 1. Cover the basics. This consists of three parts.
  • Make sure you understand the core concepts of trading, the markets, charts, indicators, etc. If this is something that you sincerely wish to make money at, make sure you know what you're doing.

  • Seek out the mistakes commonly made so that you can avoid them. Mistakes cost big time in a leveraged activity, so knowing them in advance will let to give you the opportunity to avoid the hard lessons that others before you have already learned.

  • Set up your trading business. Any activity engaged on a regular basis for profit is a business and trading is no different. It is not just something you do.

Stage 2. Systemize your operation and refine it.

The goal of all traders is consistent profits, and the only way that you'll get consistent results is to be consistent in what you do.

This goes beyond just your trading system, the set of rules and indicators used for placing and executing trades. You need to systemize your trading operation as well. All mature businesses recognize this, and franchises are based entirely on it.

Once you have it systemized, then you need to analyze the key aspects of your trading: both the system and your operation.

Start with your trading system by backtesting it to verify that it will at least make money when tried on real historical data and make sure that you prove it to yourself. You'll get two things out of this:

1. If it can't be shown to make money in the past, then you should re-think risking money with it going forward, and

2. If it does backtest satisfactorily, at least you can have a measure of confidence in it going forward. It's not a guarantee that the system will make you money in the future, but at least you'll know that it has proven out before.

Now track your progress on the key measurables. Businesses in all industries keep an eye on the aspects of the business that are critical to the bottom line.

Same goes for trading, and there are a handful of metrics to pay attention to, not a huge list, but there are several.

Keeping an eye on your metrics is important to ensure that you keep heading in the right direction. This also gives you the opportunity to make refinements in a controlled manner and keep your focus on the bigger picture.

Stage 3. Get a handle on your emotions.

Once you have the other two down, you have to keep your head on straight and trade your system well. Even if you have the perfect system, you won't make all you can if you aren't following it.

If you find that you're in a rut or repeatedly having discipline issues (in the form of deviating from your trading plan/system), then get help. When you're stuck in a situation where your emotions have the upper hand, you will probably need an outside perspective to help you pinpoint the root cause so that you can address it.

Please go ahead and post your thoughts here for discussion.

I agree with your idea of being systematic (what I call being methodical). For me this includes the morning's activities prior to the trading session, that is, following a set routine of behavior in preparation for the trading day. The idea being to get the day started on the right foot and in a good frame of mind: confident and focused on the job at hand.

This leads to a couple of additional suggestions for consideration...

Develop good trading habits. Maintaining a trading journal can help a new trader identify repeating behavior (habits). Plateaus are often reached when a limiting behavior hinders further natural progress and learning.

The biggest hurdle new traders face is inexperience. It takes a lot of years to experience the wide variety of market conditions (what I refer to as phases). Inexperience leads to designing a system or trading method that does a good job of fitting into the current market phase. Unfortunately, every market phase runs it's course and is replaced by a new market phase which will usually punish those systems curve fit to the last market phase being replaced. Thus the trader must be adaptable: the traders plan should have some flexibility to allow for changing market conditions.
Originally posted by pt_emini

...get the day started on the right foot and in a good frame of mind...

That's so important and such a simple thing to misunderstand:

If you're in a bad mood you will be looking for a quick fix to sort out your mood and put you in a better mood. A profitable trade will do that. So your reason for executing the next trade is to put yourself in a better mood - which is the wrong reason to trade.
A couple more thoughts new traders seriously need to consider on the subject...

1. Make sure you have a genuine edge in your basic trade setup or pattern.
It's really important to be as robust as you can in testing the pattern. A good healthy dose of skepticism about the genuine validity of the pattern can save you a lot of money later. On this point the best approach is try and prove the pattern is not valid, throw everything you can at it and see if you can break it. If it holds up to a genuinely robust test, then it might actually be valid.

2. Learn everything you can about risk management.
Your goal must be to carefully predefine the risk in each trade, and protect your working capital from an unexpected significant event (or string of adverse events). This involves things like correct position sizing, stop loss placement, ect... Think of it this way, if your risking 1% of your working capital (account balance) on each trade, it will be nearly impossible to blow out your account, no matter what happens. The idea is to still be able to trade the next day. This feeds back to my comments on the actual time it takes to gain the market experience you need to develop a genuine capacity to trade the markets with consistency.
That second point's a good one - i.e. risking just 1%. An excellent example is the Six Sigma trading system which has just had a trade that lost almost 50% of the portfolio's total capital.
Many new traders tend to underfund their trading account starting out. When I say underfund, I am referring to exposing the account balance to an unrealistic level of risk per trade. I feel this is a result of two factors:

1. New traders tend to over-estimate the results they will obtain from their new endeavor (as well as under-estimating the difficulty of achieving success), that is they tend to come into the game with an overly optimistic set of expectations. New traders tend to overestimate their level of trading skill.

2. Not understanding the debilitating effect of drawdown on a trading account and the traders confidence in the system. New traders need to take into consideration the probability of experiencing the maximum drawdown the system is capable of producing in the future as well as rationally accepting the maximum dollar loss associated with that drawdown event. For example, a 10% probability of the system producing a 50% account balance drawdown needs to be factored into the overall risk control plan and trader expectations.

Proper account funding and risk:reward management is a double edge sword. On the one hand we want to maximize returns (profits) and thus have the incentive to maximize trade size in relation to our available working capital (account balance). On the other hand we need to temper our enthusiasm with the reality that any trading system will experience drawdown events. A highly profitable trading system may also expose the trading account to significant drawdowns. This inherent risk combined with incorrect risk control (underfunding) can lead quickly to account failure (ie. the account balance is wiped out). Thus the trader needs to find the proper balance of reward verses risk for the trading system under consideration.

Optimal F provides an objective measure of the minimum funding required per contract for the specific system in order to maximize profits...the problem with Optimal F is that it does not account for system drawdown. Thus when used in isolation, Optimal F will lead the trader to mistakenly underfund the trading account, leaving the trader's working capital exposed to unacceptable risk of loss (eventual failure).

Fixed percentage at risk is a technique used to control the effect of drawdown. Using a fixed percentage of working capital at risk per trade dynamically adapts to the drawdown event as it unfolds, by reducing the trade size as the account balance shrinks.

Combining fixed percentage at risk with Optimal F gives a reasonably accurate range of risk and reward boundaries to work within for a given trading system.

In my previous posting I suggested a fixed 1% at risk per trade as a good safe starting level for a new (inexperienced) trader to begin with. More advanced and experienced traders with a proven track record will want to balance that conservative level of risk with the Optimal F level of reward in order to boost the reward side of the account management equation.
Excellent post pt_emini - thanks! In your last para I would say that a new/inexperienced trader should not risk anything and should be paper trading (even with its limitations) until they feel or can prove to themselves that they are no longer in the new/inexperienced category.

The probability of a new/inexperienced trader losing money in the first year of trading is at a conservative guess over 50%. So why not remove that risk altogether and not trade until you are already showing a profit.

Of course that's nearly impossible because everyone wants to have something to show for their time, effort and money at the end of a year and that is normally more money and you're not going to get that paper trading. Nobody wants to say at the end of a year of trading that they are now an experienced trader but have never executed a trade.
Yes I agree paper trading is certainly an important step in the development process. During this phase the trader is gaining experience using the trading system of choice, and as importantly learning the discipline required to follow a plan and produce consistent results. Developing this experience and skill takes time, which does take a lot of patience. Skipping these developmental stages will lead to problems later.

Experienced traders learn that good trades almost always involve an element of patience... waiting for the best quality setups, then waiting for the new trade to reach it's full potential. Conversely, a lot of basic trading mistakes can be traced back to a lack of patience.

Perhaps if new traders take the perspective that the first two years are educational in nature, similar to the investment of time required to complete a formal trade school certification or college degree. Consider the time investment in the formal educational process highly skilled professions require, such as that of a surgeon or a commercial airline pilot.
Great comments, everyone. About a month ago I posted an article on my thoughts on simulation trading, which I am very much for, with caveats. For those who want to read the article, here's the link: