Trading Success: What It Means to be Process Driven

We often hear that traders, to be successful, should "follow their process."  But what really goes into trading processes?  The recent post described a few common elements of successful trading.  One of those was selectivity.  Faced with an infinite number of possible trades and times to trade, even the active trader must find some way of filtering out the majority of possibilities and focusing on the smaller number that offer distinctive opportunity.

How does such selectivity work?  I would argue that every successful trader and portfolio manager filters trades by three criteria:

1)  An Idea - The trading idea expresses the underlying logic of the trade.  It is what gives the trade a potential positive expected return.  The idea could be that risk assets will rise when the rate of change among a host of macroeconomic indicators is positive; the idea could also be that a company's shares will fall if they experience a parabolic rise because of promotion not grounded in fundamentals.  The trading idea defines the field of opportunity.

2)  An Expression - Any trading idea can be expressed in a variety of ways, and those expressions ultimately determine the risk/reward of the trade.  For example, daytraders might run several scans of stocks in the premarket to identify promising "pump and dump" candidates.  Portfolio managers might express a view in currencies, equities, and/or rates, depending upon the positioning in those assets and how they might fit together in a portfolio.  An expression could be in options, in a relative value trade, or in an outright long or short cash position.  Each brings different risks, different rewards.

3)  An Implementation - To a surprising degree, the way in which a trade expression is implemented impacts its ultimate profitability.  Two traders could have the same trading idea and decide to express it with a long stocks trade.  One trader predicates entry execution on strength, buying when there is upside price confirmation and then adding to the position on strength.  Another predicates entry execution on weakness, buying pullbacks in price and scaling out on strength.  The profitability curves for the two traders over time will look radically different.  Indeed, for the ES futures, the former implementation strategy could have easily led to flat to negative returns even in the recent bull market!  Placement of stops, sizing of trades--all of these greatly impact trading outcomes.

I would propose that a truly process-driven trader has studied each of the three areas above, so that all three contribute to an overall trading edge.  The process-driven trader should be able to justify the trade on all three criteria, and the process-driven trader should be able to review performance across the criteria to determine where improvements can be made.  There is much more to profitable trading than arriving at good ideas, and there is much trading of randomness in the place of good ideas.  Not all who follow routines are process-driven.

There are also psychological processes underlying success across performance domains.  Further Reading:  Feeding Your Head And Developing Your Self
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