Sunday, February 14, 2016

Three Essential Ingredients Of Effective Trading Processes

As the quote from Peter Drucker suggests, efficiency is of limited value if we're not effective.  We not only need to do things right, but ensure that we're doing the right things.

What goes into successful trading processes?  Here are three hallmarks of effectiveness that I've observed across a variety of professional traders:

1)  Original Research - I recently spoke with a trader about the difference between trading ideas that you develop for yourself vs. ideas that you borrow from what your read or hear from others.  The successful traders I know do their own work.  Yes, they discuss ideas with people and, yes, they read research, but where they add value is in how they synthesize that information.  Without digging into ideas on your own, you never truly achieve a sense of discovery and conviction in those ideas.  As a result, it's easy to give up on the trades as soon as they encounter adverse price movement.  The best trading ideas are distinguished by their breadth (combining information across time frames and/or markets); depth (level of detail and understanding); and originality (looking at new things or viewing old things in new ways).  Successful generation of ideas goes beyond consensus thinking.

2)  Planful Expression and Management of Trades - The successful traders I know put considerable time into structuring their trades (finding very good risk/reward) and managing their positions (scaling in or out of trades, managing risk/reward in real time).  One trader recently wanted to benefit from an anticipated decline in stocks, but was concerned about sharp short-covering rallies.  He bought a long dated put spread and limited his dollar exposure to the trade.  That allowed him to ride out market choppiness and take a nice profit on the position when volatility expanded.  The thoughtful use of options enabled him to participate in a move that others missed because of getting stopped out due to market noise.  Yet another trader I know achieved a similar end by holding modestly sized core positions, trading with wider stops, and tactically taking profits when markets became stretched in a favorable direction.  Money management is central to the effectiveness of trading processes.

3)  Detailed Reviews - The best trading processes include an element of quality control.  By periodically reviewing performance and highlighting areas for improvement, traders ensure that they are learning and developing even as they may be drawing down.  As I've emphasized elsewhere, those detailed reviews also include episodes of very positive performance.  Traders who reverse engineer and map out their strengths are in a good position to turn best practices into process-driven habits.  Trading reviews provide the foundation of trading goals, and trading goals provide the template for future trading plans and actions.  Without reviews, goal setting, and further reviews, trading experience will not turn into trading expertise.  We learn, not from experience, but from what we do with our experience.

How effective is your trading?  What are you doing that is special and unique in each of these three areas?  If we don't do great things each day, our experience is unlikely to add up to anything great.

Further Reading:  Productivity and Success