Wednesday, June 24, 2009

Five Pitfalls of Developing Traders

I've been working with some new traders at firms; here are five observations about their most common mistakes and developmental pitfalls:

1) Lacking a Development Plan - Traders typically start by trading small size and keeping losses small. Then, as they build their skills and achieve consistent success, they trade more capital and move their loss limits accordingly. Very often they (and their firms) don't have structured plans in place for when they would raise their size, what would have to happen to increase size, how loss limits would be set and monitored, how drawdowns would be dealt with, etc. Without clear benchmarks and guidelines, it's not unusual for new traders to founder.

2) Lacking a Structure for Skill Development - Many traders do not keep records/journals and, if they do, are not consistent in maintaining the journals or the depth/quality of entries. Most commonly, the journals consist of broad observations ("I need to trade more patiently.") without concrete observations of *why* problems are occurring and what, specifically, might be done to address those problems. Without metrics on their trading, it's difficult for traders to truly know what is working and what is not. Is a trader taking more heat on trades than usual? Is a trader setting stops too close, getting stopped out of trades that would have been winners shortly thereafter? Is a trader making more money in trending markets than narrow, range ones? Without some mechanisms for review and assessment, these kinds of questions go unanswered.

3) Lacking Perspective on Trading Days - Many traders are looking for "setups" to get them into trades before they truly understand what is happening in the marketplace. Are we setting up within a range or continuing a trend? Are we accepting value higher or lower? Are we doing more or less business at key price levels? What are the themes operating in the current market? A surprising number of traders can't answer these questions. Instead, they react to higher or lower prices without situating those moves in a broader context.

4) Lacking Explicit Stops and Targets - A corollary of being too "setup" focused is that many traders don't have firm ideas of when and how to get out of trades. Without explicit stops and targets, they tend to exit trades at points of maximum pain or at points of comfortable profit. The problem with such seat-of-the-pants exits is that they frequently leave traders hanging on to losers too long and getting out of winners too quickly. Having more winning trades than losers doesn't help if your winners are significantly smaller than the losers.

5) Lacking Persistence - Many new traders simply aren't emotionally resilient. They lose money on an idea and will quickly abandon the idea, rather than try again with refined timing. They will quit trading and leave the screen after several losing trades or after markets turn a bit slow. Instead of observing markets and maybe paper trading some fresh ideas, they exit the learning process altogether. To be sure, there are risks in being stubborn and revenge trading out of frustration. But many developing traders haven't learned to embrace losses and move on: learn from them, then put them behind.

The goal of the developing trader should be to become a lean, mean learning machine. How well are you mentoring yourself?