Survival of the fittest. That’s how we could describe the retail trading environment. Most traders think about making money so their focus tends to center on finding opportunities, deploying risk capital and hoping for the best. Unfortunately I haven’t personally seen any traders survive for very long, using this approach.
When market conditions are favourable, there is naturally a wealth of opportunities and all being active is required. But when volatility dissipates and there is uncertainty regarding either interest rates, growth or some large geopolitical event (e.g. Brexit), trying to be active will most likely get traders into trouble.
My own experience, and the experience of fellow retail traders that have survived for more than a season in the markets, suggests a different approach alltogether. There are key habits that will help you survive the tough times and thrive in the good times – but unfortunately they are unpopular and require more discipline than the average trader possesses.
Survival of the Smartest
In trading, the key is to work smart not hard. It’s not a 9 to 5 job where “being busy” is useful. In trading, there are times to be busy and times to stay on the sidelines and this is particularily true on the retail side.
As traders we should think in terms of Risk (because we are operating in an uncertain environment where risk is present) which we can control, not Reward (which is uncertain and out of our control). We should always be reasoning in terms of Van Tharp’s SQN or the more common Sharpe Ratio: Reward/Risk. It doesn’t have to be complex: the Sharpe Ratio simply takes a given return and divides it by the standard deviation of returns, offering a measure of “risk adjusted return”.
Thinking in terms of Sharp Ratios is like thinking about what kind of risk, and how much risk you are taking on, in order to produce a certain return. As retail traders we all have limited resources (risk capital) so we should always strive to maximize the return per unit of risk. But risk is not just about how much you can lose on any given trade. Here are other three situations that frequently pop up as bad habits I have seen time and time again in retail traders:
- If you trade when your edge is not present, there is high risk and lower reward.
- If you trade more frequently, you are exposing your account to higher risk.
- If you trade when market conditions are less favourable, there is higher risk.
- If you fail to establish risk limits per day, week or month (depending on your trading style), there is much higher risk.
Keeping your equity curve steadily rising, with minimal drawdowns, is difficult – period. We need to keep the unforced errors to a minimum and make sure we take advantage of the times when the markets are really cooperating.
The Habits of Highly Successful Retail Traders
Here are the habits that my best students adhere to, which keep them afloat during the bad times.
- Know your edge extremely well. All successful traders know what their “edge” is. What consistently repetitive behavioural trait does the market show them, that inspires action? One trader spent over 400 hours studying his edge on a diversified basket of instruments (FX, Bonds, Indices, Commodities) and as such has become a specialist in his field. He has a very good idea not only of the edge he uses, but also the kind of performance he can expect over the medium term.
- Track market conditions. On the retail side there are three elements every trader can track with consistency: market type, volatility and market drivers. Market types are essential to recognize because, for example, if your edge requires a trending market then it’s essential you avoid trading unless the market is clerly trending. When volatility is low, the markets are “quieter” for whatever reason, and this means that some strategies will perform poorly. Staying in touch with sentiment drivers will direct your attention to the instruments that will most likely have higher volatility and some action.
- Trade Less. Once you know what your edge is, wait for the absolute best situations and ignore everything else. By trading less, you’re being more protective of your hard earned risk capital, you will get into less trouble, have smaller drawdowns and be in a better place to recover and get to new equity highs when conditions are favourable. But this requires patience and discipline.
- Trade Small. Make sure you have well-defined risk limits that are connected to the expectancy of your system and allow you to know what your drawdowns will look like. Keep your Risk of Ruin as close to zero as possible.
- Diversify. Don’t just focus on FX, but widen your reach. Look into Indices, Bonds, Metals, Commodities and even stocks.
- Focus on being Consistent. It’s not about the money. Focusing on the money will only get you into trouble. Your focus should instead be on consistency. Be disciplined and mindful about your actions.
- Maintain a balanced, sustainable lifestyle. It’s almost impossible to trade your way out of a hole, if you are under pressure to perform. Make sure trading is just one part of your life, not the main focus of your days. Here are some tips from my own experience: be disciplined and prove to yourself you can in fact trade profitably before leaving your day job; be well diversified and do not depend on trading for your income; stay healthy and fit.
Over to You
Surviving comes before thriving. The right mindset for retail traders is to take trading almost as a “hobby” moreso than a job. If you take it less seriously, you won’t be compelled to look for action every day. You won’t be pressed to “make it work”. There will be less pressure and more patience. You will be less tempted to take action. All this will implicitly work in your favour as it reduces the amount of trades you take and you will probably only take action when something is sticking out like a sore thumb.
Bad habits only die if you explicitly set out to eliminate them. Take a good look at your equity curve and ask yourself whether you might want to give these suggestions a try, or continue doing what you’ve always done.
About the Author
Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.
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