Saturday, July 14, 2007

Three Good Questions to Ask About Your Trading

There's an interesting interview with Apple co-founder Steve Wozniak in the book Founders at Work by Jessica Livingston that illuminates an important aspect of trading. Wozniak advises tech entrepreneurs:

If you can just quickly whip something out and it's done, maybe it's time, once in a while, to think and think and think, "Can I make it better than it is, a little superior?" What it does is not necessarily make the product better in the end, but it brings you closer to the product and your own head understands it better. Your neurons have gone through the code you wrote, or the circuits you designed, have gone through it more times, and it's just a little more solidly in your head, and once in a while you'll wake up and say, "Oh my god, I just realized a bug that's in there, something I hadn't thought of."...Or, if you have to modify something, or add something new, you can do it very quickly when it's all in your head...You don't make as many mistakes (p. 55).

There are times when trading is going well and we can simply "whip out" the profits. The majority of traders, I find, relax their efforts to understand their markets and improve their trading at these times. Wozniak's insight is that it's work when things are going well that turns good results into superior ones.

Under peaceful conditions, Nietzsche wrote, the warlike man turns upon himself. When there isn't a worthy adversary to fight "out there", the competitive individual finds noble challenges within.

Here are three questions that might assist traders' development under peaceful conditions:

1) How many distinct setups do you trade? - When you look day to day, week to week, how well correlated are your trading results from these setups? If they're quite positively correlated, are they really distinct and do you really need them all? If they're not well correlated, are you allocating your capital to them ideally to diversify your risk?

2) What are the outcomes of your largest vs. smallest trades? - Do you really have a good sense for when there is opportunity and do your largest trades take advantage of this awareness? If your largest trades don't have a distinctly better track record of success than your smaller ones, should you be raising your risk when you don't have an expanded edge in your favor? If your largest trades are less successful than the others, might size be adding to your stress and performance problems?

3) Is the distribution of your long and short trades consistent with the market's direction at the next largest timeframe? - Are you making more long trades (and holding long trades longer) when there is an established uptrend (and vice versa)? Are you trading with a directional bias when the market is rangebound? Do you have an edge in your trading when you trade with the trend? When you trade countertrend?

My latest entry to the Trader Performance page of my personal site elaborates some of these evaluation criteria. That page includes 45 posts that reflect my own thinking about the improvement of trading, much of which is based on my recent trading experience. You may find material in some of these posts to be relevant to your own work on yourself, especially at times when things are going well.