What it Takes to Succeed

Regrettably, I do not recall the provenance of this excellent essay. I do recall, however, its quality. Despite the inability to attribute the source, I will share it with you in its entirety. Take the time to read it, and if you know its publication provenance, please share that information via a comment. For that matter, let us know what you think on this or any topic.

David
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What it Takes to Succeed
By Jay Kaeppel

Many different individuals have enjoyed investment and trading success over the years, and the variety of trading strategies used by these individuals covers a very wide spectrum. Yet despite this diversity of personalities and methods, there are a few common elements which virtually all successful traders and investors share. In the broadest stroke possible these elements can be categorized as Mindset, Technique and Discipline. Any one or two of these elements alone does not assure success. It is only through the painstaking implementation of all three of these three critical elements that long-term success is achieved. So let's explore just what is involved in these three key elements of trading success.

MINDSET

As with most everything else in life, success or failure in trading comes down primarily to what goes on between the ears. What you think about certain things, how you interpret them, how you react to them, and how much past experience empowers or hinders you in the future all play a part. Anyone who trades long enough will eventually experience the entire spectrum of trading related emotions. There will be the thrill of a great winning trade. And that trade will instill great confidence. And for many people, that great wining trade will instill too much confidence and that will lead to trouble down the road. There will be winning trades that we feel badly about ("I should have stayed in longer," or "I should have gotten out sooner."). There will be losing trades that we feel good about ("Thank goodness I was smart enough to cut my loss when I did!"). And of course there will be those losing trades that cut to the very bone and make us wonder why we got into this racket in the first place ("I can't believe that 15 minutes after I bought it the stock gapped down 30%!").

All of our past experiences simmer somewhere under the surface and can exert a great deal of influence over our future. This influence can be positive or negative. This is especially true for trading, where we have our hard-earned money on the line. The big profit that we let slip away can cause us to take the next 10 profits far too soon and ultimately cause us to leave a lot of money on the table. Or we might strengthen our resolve to follow our preferred trading method and say to heck with that one bad memory. The choice is ours. Obviously, the unexpected big loss can throw us for a loop also. We may become "gun shy" and find ourselves talking ourselves out of a lot of trades that we should be taking. Or, once again, we can write that bad experience off as "the cost of doing business" and stay on the straight and narrow in terms of following our trading method.

It seems that the most successful traders are the ones who can most easily put yesterday behind them.

And in something of an irony, while a short memory appears to be a positive, ultimately, in order to be successful you must have a long-term mindset. This is not the same as saying that you have to hold positions for a long time. What this means is that in order to successfully utilize any technique you must feel as though you are committed to using it for a long time. Too many traders make the mistake of jumping from system to system, invariably jumping ship at exactly the wrong time – after a string of losses and right before the next run of good trades. As a result, it is imperative to develop the utmost confidence in whatever trading method or methods you employ, so that you will have the courage to stick with them when things get rough (as they invariably do from time to time). There are many aspects involved in getting to that point. The real key is to determine the type of trading you are most comfortable with. There are those who trade using monthly bar charts, and adjust their portfolios once a month or even less often, and seem to do pretty well. At the far end of the spectrum there are traders who work off of one-minute bar charts day in and day out. And then of course there is everything else in between.

Choosing the type of trading that works best for you is a critical step towards success. To fully understand this, consider what would likely happen if the "once a month portfolio adjuster" suddenly started trading using one minute bar charts. This person would likely be overwhelmed by the amount of information coming at him and would quickly lose whatever edge he held from carefully and deliberately analyzing monthly bar charts. Likewise, consider the poor "one minute bar chart day trader" who attempted to trade only once a month. There are few things more painful to watch than a hyperactive trader trying not to trade. It's kind of like watching an alcoholic trying not to drink, or the office coffee hound trying to remain calm when the coffee machine breaks. In any case, a person who is predisposed to be a longer-term trader will invariably enjoy greater success pursuing that approach than if he tried to reinvent himself as a day trader. Likewise, an active (successful) daytrader who tries to wean himself of his active ways is likely to do himself more harm than good.

Complicating all of this is that for those starting out, it may take some time to determine what type of trading he or she is most comfortable with. So while ideally you want to settle on a trading approach and commit yourself to following it for a long time, the fact is you may have to do the opposite of that until you make the critical determination as to what type of trading style works best for you. Is this fun, or what?

TECHNIQUE

Some traders adopt an entirely systematic approach to trading. At the other end of the spectrum others traders essentially make it up as they go along. Everybody else falls somewhere in between. Within each of these groups there are winners and losers. For the systematic traders, the likelihood of success rests heavily on the quality of the system or systems that they are using. If they utilize a sound system that is based on sound principles and which has held up well over time, then they stand to reap substantial rewards. However, if a systematic trader jumps from one systematic approach to another every time a particular system suffers a drawdown, he will almost certainly end up a day late and many dollars short. Discretionary traders essentially face much the same situation. Whatever criteria they use to select and manage trades must be based on sound principles or else they will fail in the long run. Whether a trader uses a purely systematic approach, an entirely discretionary approach, or something in between, ultimately there are several key questions that must be asked and answered. Most notable among these are:

How much capital will I risk on each trade?
What criteria will I use to determine when to enter a trade?
What criteria will I use to determine when to exit a trade with a profit?
What criteria will I use to determine when to exit a trade with a loss?

The potential number of answers to these questions are countless. Still, when you boil it all down, any effective trading method must – at a minimum – answer these four questions. Obviously, this is true when starting out, however, it is also true even for those who have been trading for a long time. It is an extremely useful exercise every once in awhile to review your trading method or methods in terms of the questions posed above. If you cannot give specific, clear-cut answers to these questions, you may be slipping off the path to success.

DISCIPLINE

Discipline – as it relates to trading – essentially revolves around developing a successful technique, developing the mindset to apply that technique for a long enough period of time to do you some good, and then following through on the plan. For the purely systematic trader, discipline simply means following the signals generated by his or her system and sticking with it even when things get rough. For the purely discretionary trader, discipline means sticking to one's guiding principles and not allowing a rough patch to cause them to deviate from those principles. In either case, it can all be very tricky. The pain of losing more money than one expected to – whether on a single given trade, or on a series of trades or over a period of weeks or even month – can be extremely debilitating, even to the most seasoned and successful of investors. Generally speaking, big profits tend to accumulate over a period of time. Big losses on the other hand, seem to hit like an air raid out of nowhere. Just as you are admiring your ability and the number of zeroes in your trading account, like a bolt from the blue, a chunk of those hard-earned profits vanish.

Bottom line: it hurts. No one likes pain so the first natural reaction is to try to avoid future pain whenever possible. The easiest way to do that in trading is to "cut back". In other words, after a significant loss or series of losses, a trader may decide to trade smaller size or to start skipping certain trades altogether. Invariably, he ends up missing out on some winners that would have easily earned back what was lost during "the big hit". Then having realized that he has just cost himself a chance to recoup his losses, he may decide to suddenly increase his trading size to compensate. And what do you suppose happens next?

The only way to avoid this vicious little cycle is to employ your chosen trading approach with as much discipline as possible, day in and day out, trade after trade. In a nutshell, when you find yourself saying things to yourself like "well maybe I'll just cut back for a while and see what happens", or "well I guess my approach just doesn't work anymore" (even though you've been doing it for years), or "maybe I'll double up on the next trade to recoup my losses more quickly", and so on and so forth – then it's time to stop and take a good look in the mirror and ask yourself who is fooling whom.

The irony is that it is almost always possible to tell when you are putting aside your discipline in trading, it's just that inside of one's own mind it is extremely easy to rationalize things. One good idea is to find a friend or spouse or whomever to act as a sounding board. Keep them up-to-date about what you are doing and how you are doing it (but be careful not to go into overly great detail, lest they get that glassy-eyed, "Oh God, he's talking about it again" look in their eye). If that person one day say's to you "hmmm, that's different," or "that doesn't sound like what you normally do," or "why did you make that change," or well, you get the idea, chances are good that you need to get back yourself on track.

SUMMARY

The real secret to trading success is to recognize that there really are no secrets. A world-beater system will end up costing you money if you don't have the discipline to follow it. Pursuing a career as a day trader will be a costly mistake if you lack the wherewithal to pull the trigger in rapid-fire succession day after day. The best advice involves a very old adage, that being "treat trading like a business." If you were planning to start a business you would meticulously develop a plan as to what you need to do in order to be successful. You would then carefully assess your likelihood of actually achieving success based on your plan. And then you would execute your plan as closely as possible. Your approach to trading should be no different.

If you are just starting out remember these thoughts. If you have been trading for a while, take the time now and then to review and reflect on your entire approach to your "trading business." I guarantee you that it will be time well spent.