Sunday, January 05, 2020

The Fatal Mistake Traders Make

The fatal mistake traders make is that they define themselves narrowly, and this artificially constrains their opportunity set.

For instance, a trader might define himself or herself as a "breakout trader", a "trend trader", or a "bear market trader".  All ensure that the trader will underperform when markets are not breaking out, trending, or moving lower.  The frequent justification for such limitation is that the trader is adapting trading to his or her personality.  But would that work in other performance fields?  Would a quarterback in football last long if he defined himself only as a running QB?  Would a baseball pitcher succeed if he declared himself to be a fastball pitcher?  How about an actress who only played one kind of character?  In every performance field, ongoing and elite levels of success require the ability to adapt to the opportunity set, not expect the game to adapt to the performer.

The trader who does one thing consistently in all situations is not a disciplined trader.  He is a one-trick pony.

Let's  take a practical example:

During 2019, the SPY ETF moved a total of nearly 73 points.  During the NYSE day session, total movement up and down was about 303 points.  Total movement overnight was about 272 points.  During all the day sessions, SPY gained about 39 points.  During all overnight sessions, SPY gained about 34 points.  In short, declaring oneself to be a daytrader effectively cut the opportunity set in half.  

Many daytraders work hard at improving their trading.  Less often do they work at broadening their trading.  As I mentioned in a recent post, there are many markets in which a demonstrated edge *is* present, but not on the day time frame.  Similarly, there are markets in which a demonstrated edge is present, but not directionally.  (For example, volatility may be in a very tradeable declining trend, but the market may not move a lot directionally during that period.  One part of the market may be moving higher, such as large caps, while another is moving lower, such as small caps.  A good long/short trade is present, but perhaps not an overall market trade.)

I consistently find that traders who develop multiple ways to win show the greatest career longevity.  As in the business world, long term success requires flexibility and innovation, not a stubborn insistence that the market adapt to our preferred edge.  In a coming post, I will share how I have been expanding my trading through the integration of quantified models and discretionary pattern recognition.

Further Reading: