BarroMetrics Views: Single Most Important Reasons for Success
The other day, I was reflecting on why so many fail at trading (i.e. fail to make money) and why some succeed (i.e. consistently make money). If you think about it, we have seen massive strides:
- In learning theory (e.g. Deliberative Practice)
- In human understanding (e.g. science of Neurology)
- In probability theory and Chaos theory
- In technology – that allows us to receive ‘instant info’ in terms of charts and quotes, and allows us to place orders in micro seconds rather than having to place orders on the phone. Etc, etc
Yet, despite all those advances, the success rate for traders remains much the same as it was when I first started trading in the late 1960’s – a lifetime ago.
Why? And what separates those who make it and those who don’t?
Why?….Because trading is unlike any other profession in that our hardwiring predisposes us to losing. As humans we are most uncomfortable with uncertainty; we have an inbuilt need to be right. I have seen, too often, whole accounts wiped out because a trader refused to exit a losing position. And, it doesn’t just happen to retail traders; the annals of trading are full of stories of ‘professional’ traders who did the same thing and suffered the same consequences (e.g. LTCM)
For those unfamiliar with LTCM’s story: LTCM hosted the who’s who of the world of economic theory – two Nobel Prize winners in Myron Scholes and Robert Merton; it hosted a former vice-chairman and head of bond trading at Salomon Brothers, John Merriwether; it boasted of one of the best initial track records(after fees): first year +21%, second year +43%, third year+41%. These are remarkable returns!
Only problem is in its fourth year (1998), it lost so much money that the FED intervened to prevent contagion. Overleveraging (i.e no money management) and refusal to take losses until forced (i.e. no risk management) led to LTCM’s demise.
So, to succeed we need to re-wire our hardwiring.
- Rather than seek refuge in the certainty of a high win rate, we need to accept the discomfort of an unknowable future;
- depending on our trader’s timeframe, we may need to accept win rates of 30% and 40%, choosing instead to focus on the Expectancy Return so that our dollar loss is low enough (relative to our dollar gain) for us to make a profit given our win rate.
- We need to accept that we will cut a position and find that subsequently, and most times, we could have had a better exit.
- We need to accept that there will be times when we will exit a position only to then have it go in our favour without giving us a chance to re-enter. And,
- We need to accept that there will be times when everything we do leads to a loss; and, there will be times when everything we do leads to a profit – our job is to remember that ‘this to will pass’ and to adopt strategies that will preserve our capital and allow it to grow.
Easier said than done.
If trading is so difficult, why pursue it as a profession? Speaking just for me……trading is a zero-sum game. For every dollar lost, there is a corresponding dollar gain. So, if 90% of the trading population looses money, this means, as a winner, you have 90% of the population giving you their hard-earned. In short, rather than competing against you, 90% are working in your favour. In what other profession can you say that?
…to be continued……