Sunday, June 24, 2007

The Rarest of Trading Virtues

Having had the privilege of interacting with many independent traders, prop traders, and traders at funds, I've come to the conclusion that most of them are overleveraged. In the pressure to generate profits, they trade size that is too large relative to the losses they or their firms are willing or able to sustain. One result is undue performance pressure on the trader, but another is the inability to take heat. Raising leverage leads to a shortening of time frame in an effort to contain drawdowns. This, in turn, leads to an inability to ride winning trade ideas.

The rarest of trading virtues is simply the ability to persevere with positions when winning.

If many traders are overleveraged, there is a potential edge to an expansion of holding periods. When others are shaken out, you can ride a longer-term move.

In the latest update to the trader performance page, I illustrate how returns are improved simply by basing trading strategy on the number of stocks making fresh 65-day lows. It's a trading dynamic worth checking out. But the strategy requires the ability to hold the resulting position for many weeks, not days or hours.

Many traders simply can't do that. Maybe they need the action of in-and-out trading. Maybe they're trading so large that the drawdowns associated with longer holding periods shake them out. Or maybe they just can't muster sufficient confidence in their market views.

It's so rare to see traders fully milk their trades.

Perhaps it takes a unique independence of mind to tune out others and stick with your convictions. This evening I was looking at returns after the S&P 500 Index (SPY) makes a 50-day high vs. a 50-day low. Going back to 2004 (N = 824), we've had 31 occasions in which we've had 50-day lows. Twenty days later, SPY was up by an average of 1.98% (24 up, 7 down)--not bad odds.

Conversely, when SPY has made a 50-day high (N = 124), SPY has averaged a 20-day gain of .04% (76 up, 48 down).

There are so many reasons to avoid the market when we've made 50-day lows; so many reasons to jump aboard a trend when we've registered 50-day highs. Even in this persistent bull market, it's taken independence of mind to make a winning trade--and then it takes fortitude to ride it to its potential.

Now that I think about it, those sound like the same rare virtues found among successful entrepreneurs. It makes sense: every trader truly is an entrepreneur, aggressively pursuing niches of opportunity unseen by the established business giants, while keeping a close eye on the bottom line.

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10 comments:

Trader Musings said...

Brett,

Good observation.

After many years of watching the S&P 500 Futures go up and down, and after many losing trades, I have learned to do several things to improve my trading resutls:

1. I now start looking for selling opportunities as the market moves up above a moving average and toward the upper Bollinger Band (Standard Deviation Band) on the daily chart, and look for buying opportunities as the market moves below a moving average and toward the lower Bollinger Band.

2. I have learned that I can make as much profit and sometimes more with a smaller position size and longer holding period than I could with a larger position size and smaller holding period. The net result has been less stress on my trading psychological health.

You would think that a longer holding period should increase stress, but the smaller position size has a larger effect on reducing stress. This strategy also has given me more time to properly analyze the market moves and improve my timing techniques by focusing on the bigger picture rather than focusing on every single tick in the market.

Scalp trading can be fun and adventurous, and quite frankly, it makes you feel as though you are really working hard for your returns. As one gets older, you find that the longer term and smaller position size position trading can be just as rewarding, while maintaining your psychological health. And, you find more time to do other things.

Charles

AnaTrader said...

Brett

I concur with trader musings about scalping and swing or position trading.

Sometimes, I feel that by focusing on intra day trading rather than on swing or position trading, I could become a trading junkie.

I am beginning to switch to swing or position trades especially for forex and intra day trades for ES to find a good balance and to compare results as well as to cut down stress.

Less trades could mean more in returns, as well as to avoid over leverage.

My strategies change with time and learning.

Kathy said...

I also find that my position holding periods become longer as I am getting older. I now often held positions more than a year or two. Although the reason for this is that I have learned to pick up boring issues that would likely to have 10 to 15% returns.
I still love day trading. I do it every time I am on vacation at home.

Scott Teresi said...

How does your two statistics look if you take more historical data into account, say by going back through the last bear market to 2000?

* S&P performance after 50-day high/low since 2000
* S&P performance after stocks making fresh 65-day highs/lows

For instance, if we're entering a bear market, maybe increasing 65-day lows would indicate LOWER returns.

Scott Teresi said...

Do you happen to know if there's any way a trader with no special software can find out the number of stocks making new 65-day highs or lows?

ecologie-umana said...

I think this idea is wrong. But you are the boss!

Brett Steenbarger, Ph.D. said...

Hi Charles,

This is one of the most insightful comments I've seen on the blog in quite a while; thanks much for the perspective. Your observation re: the enhanced potential of smaller positions held longer mirrors my own experience with traders.

Brett

Brett Steenbarger, Ph.D. said...

Hi AnaTrader,

Great point; the goal is to make money, not to be a junkie and trade!

Brett

Brett Steenbarger, Ph.D. said...

Hi Kathy,

It's sometimes a difficult tension: what we enjoy as traders and what can make us the most money.

Brett

Brett Steenbarger, Ph.D. said...

Hi Scott,

I use the Barchart.com site (subscription) to track 65 day highs. I do find that the patterns for new highs/lows shift with major market regimes, but that, overall, there is an edge to buying periods of greatly expanded new lows.

Brett