By Don Dawson, Online Trading Academy E-minis and Commodity Futures Instructor
Before I started writing this article today, I decided to take my motorcycle out to Starbucks for a cup of coffee, then a short ride to the mountains. While riding and enjoying the beautiful scenery, I noticed three other motorcycles coming up behind me at a fairly quick clip. Since I was in no hurry, I waved them on past me to allow them to ride as they wished. The road I was on was a typical mountain road with plenty of tight turns. As these bikes went past me, I was watching them as they came to the first corner. I could tell right away who the novice riders were and the one who had some experience riding. The experienced rider was leaning his bike with proper body posture and acceleration through the turn. This comes from actual road experience and not from reading a book. The other two riders were not so fluid and I watched them as both were running at very fast speeds with very little control of their motorcycles going into the curve. For most of my rides, that would have been the last I would see of them, but not today.
Just like in trading, there is very little involved with getting a motorcycle and then driving it on the roads. Without any mandatory training, you can purchase a bike with little money down, get your license and buy a helmet. For a trader to start out, he just needs to open a trading account for as little as $5,000 (controlling as much as $100K with leverage) and have an internet connection and he can start trading. Both of these events are missing key elements – training and experience.
As I rode further, I came around a rather sharp curve and I found a motorcycle lying in my lane on its side. Across the street was another motorcycle upside down. Both riders were thrown from their bikes and had some serious injuries. I stopped to offer some assistance and helped get the bikes out of the road. Turns out the two that crashed were the novice riders and the experienced rider made it through the same curve. Apparently, these guys went into the curve with too much speed and panicked, causing them to lose control and crash. I am not faulting anybody for the accident, because we all accept that risk when we ride. But as I rode home today, I could not help but think how much a novice trader and a new motorcycle rider have in common when it comes to a lack of proper training and experience.
Trading Futures can be a very lucrative and rewarding career for those who take their time to learn how to trade and then exercise patience and discipline while they get screen time (experience).
Unrealistic expectations are another area that causes many a new trader to fail. Far too many times, novice traders come into the Futures arena thinking they are going to make a living with their $5,000 trading account, without any other source of income. There is just no way you can pay your living expenses and allow for the normal draw downs in trading with these small accounts. You can start your trading career with this amount of money, but you must have some other income to help support you as you learn how to trade and build your account to a more appreciable size.
Thinking you can read a book to learn how to trade is another mistake. You just cannot get the feel for trading by reading alone. There are too many emotional states we have to deal with in trading that you can only experience from hands-on trading.
Let's review some areas that novice traders should be aware of in trading:
- Stress
- Over Trading
- No Mentor
- Leverage
- Unpredictable Outcomes
Stress
Markets typically have very unpredictable outcomes. Combine this with your initial start up cost, and you could possibly have a negative impact on your health. Since trading does not guarantee a paycheck every week, you must also accept there will be no paid benefits and insurance. The stress from just these situations could easily lead to medical conditions like high blood pressure or some other related illness. Since trading can be a very isolated career of working alone all day, you will have to adapt to this solitude. Sometimes this solitude can lead to some forms of psychiatric conditions that might need to be addressed.
Over Trading
With electronic trading, we are exposed to a platform with bright lights flashing and sometimes sounds going off. These are all acting upon our sensory system to stimulate our minds into taking action, usually making you want to click your mouse buttons. When we are sitting in our home offices alone, it is way too easy to just keep clicking on this platform because we do not have anybody to answer to until our P&L statement comes in the next day. I always place my trading matrix on a monitor off to the side so I do not get caught up in the fast moving numbers that could let my emotions creep into my trading.
Today our commissions are very inexpensive compared to several years ago. Sometimes people justify taking extra trades because commissions are so low. They just think of this trade or another, but don't annualize the expense of commissions. Just like any other successful company, we must monitor our expenses of running our business and commissions are one of those expenses.
Some over trading is the result of traders trying to get back to even, or making up for a losing day. Make sure your trading plan spells out how much you can lose per day before you stop trading for the day. This will keep you from revenge trading and running your account into the ground on any given day.
No Mentor
As I wrote in a previous paragraph, electronic trading is a very isolated business. At least when we used to phone our orders to the broker, or the pits we had some human interaction. When we are starting our trading careers, finding a trading partner or mentor might help us. Having another person to discuss your feelings, actions, responses to events and strategies will create a support team. We are not looking for somebody to tell us where to buy or sell or how to manage our trades. This is not trading for yourself and has no benefit to you at all. This other person is someone who will know how you trade and understand your strengths and weaknesses. By telling another person what our reasons were for doing what we did or plan to do, we are holding ourselves accountable for our own actions. Most of us have probably put on trades before and realized very quickly that it was just an emotional trade and not part of our plan. We think to ourselves that we are glad nobody saw that mistake, but if we have to explain our actions to another person, you can bet we will follow our plan more seriously. It's just human nature that we do not want to embarrass ourselves in front of friends.
I remember an incident in my early years of trading where I was trading the 30 Year Treasury Bonds and the morning had not been good to me at all. Allow me to rephrase that, something was distracting me or my strategy was not conducive to the markets that day, but I insisted on trading through this thinking I could fix the problem. This happens to be a weakness most men suffer from, but we will discuss that in a future article. This was a typical novice mistake I was making. My plan was thrown out the window and I was just trading on pure emotion because I was losing. Fortunately, I had a broker whom I had to call each time I wanted to place a trade. Another red flag warning should have been what day this was. This event occurred on the Friday of a July 4th holiday, a three-day weekend. After trading so poorly in the morning, I decided I would come back after lunch and get my money back. How many of you have tried this? As I am watching the Bonds trade, I again feel (yet another emotional trade) like I see a trade setting up. I call my broker and say, "George, sell me 3 Labor Day (September) Bonds at the market." Normally, George was immediately filling my order. This time there was a momentary silence and George says, "Don, you have not had the best day trading so far and there is only an hour left in the trading day for Bonds and the pits are empty. Why don't you take the afternoon off and come back Tuesday after relaxing over the weekend?" At first I was very upset that somebody was trying to stand in my way of getting my money back, and then I realized something. Here is a man who is paid by the frequency of trading I do recommending that I stop trading. I agreed with George and thanked him with true sincerity for offering me this advice. I find it totally amazing how out-of-control we can get when we start trading emotionally. If I was trading electronically at that time, I probably would have wiped out my account that day because I did not have the common sense to stop trading after I lost a certain amount of money.
Leverage
Using leverage entails using borrowed money (interest free in the Futures markets) to finance a position in the market. When you place a trade, your broker will require you to post an initial margin that is usually about 8-10% of the contract value. The difference between the amount you put up as margin and the contract value is known as leverage. Depending on the market you are trading, there can be leverage anywhere from 10:1, all the way up to 20:1 and beyond. This basically means that for every dollar you invest, you are essentially controlling 10 dollars or more.
This leverage can act as a double-edged sword that will even get professional traders in trouble. With this kind of leverage, even the smallest price movement can reap some handsome profits, while at the same time, this same move against you can cause severe losses if not acted upon quickly. Most people don't have trouble with leverage when the market moves in their direction, but when the market makes an adverse move against a trader who has trouble taking losses, this leverage becomes a serious problem, much like the novice motorcycle rider who goes into the turn too fast and freezes up because he did not know what to do when the time came to react to a situation.
I recently received an email from a student who had sent out a mass email to some fellow trading friends about what caused him to finally start trading more contracts. Fortunately, this trader has experience in the markets and is well aware of the consequences he could face if he started trading too many contracts too soon. In his email, all I read was how he got angry with himself because another trader had made more money than him on a trade because they were trading more size. He mentioned in his email that he had planned to increase his contract size earlier, but had failed to do so, and this incident ignited a fire under him to do so now. I replied to him and asked if the increase in trading size was written in his trading plan to justify the change. His reply was yes and I would not have expected anything different from him because I know he is a good trader. The problem I had with the email to his trading friends was that he did not spell out why he increased his trading size other than the anger that another trader had made more money than him. I requested him to send out another email describing how his trading plan tells him when to increase contract size and that it was not just an emotional decision.
Unfortunately, in trading and motorcycle riding, the skill levels vary from pre-novice to the very experienced. When you send out a list to that many traders, you are addressing this same spectrum. You could possibly cause damage by leading another trader to think that making a decision to increase contract size on emotion alone is safe to do. Novice traders tend to take what they read and hear at face value.
Unpredictable Outcomes
One of the lures to Futures trading is the ability to make fast money by using the above mentioned leverage. Regardless of what got your attention to start trading Futures, whether it be a friend saying how easy it is, or some company promising you guaranteed returns while using their trading system or advice, there are no Holy Grails or guarantees that you will make money. Actually, some good advice is if anybody does make you this ridiculous promise - run away quickly.
The trading business is one of the most unstructured careers that I know of unless you make it structured by creating a trading and business plan. Otherwise, there are no guidelines to give you direction.
Before you started trading, hearing about political, economic or other market moving news events probably meant little to you. Once you become a trader, you will soon realize that even the smallest event can have huge impacts on the markets you are trading. These events can cause large financial losses in a matter of seconds if you are not prepared for them by having your protective stops in the market while you are trading.
I am usually a glass-half-full type of person, but when it comes to trading, I prefer to manage the risk first and focus on the profits later. The nature of the markets is to prove the most people wrong as quickly as it can. Learn to manage risk and you will have a much better chance of surviving in the trading business.
Futures trading is a career that will challenge you like no other. Being challenged is something that can be embraced by many. Unfortunately, it can also cause us to lose our self-control at times and make some major mistakes. I believe that with the proper trading education and time allotment to get experience, that you can make trading more of a career than a hobby. Do not rush this process of inner-growth that comes from time.
"Life is like riding a bike. It is impossible to maintain your balance while standing still." Linda Brakeall
Hold on to them winners,
- Don Dawson
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