Saturday, May 30, 2020

Two Mistakes I See Traders Making

Yeah, mistake number one is getting a haircut at home...damn!

Seriously, though, I see traders making two mistakes that are hampering their profitability:

1)  Setting The Wrong Targets - Traders want to set their reward-to-risk at 3:1 or higher, so they end up doing one of two things that hurt their profitability:  they either set stops too tight and exit the trade on noise or they set the targets too far away and then see positions reverse on them, especially in lower volatility environments.  I find that traders will spend time honing their exits to limit adverse moves, but will put surprisingly little effort into defining targets.  I'm currently working on a project that uses a quant framework to estimate the probability of hitting various targets in given time frames.  It's looking promising, but it clearly shows that if traders will hurt their hit rates and profitability by seeking huge rewards relative to risk.

2)  Sizing Trades Too Aggressively - What happens is that traders have been profitable for a while and then decide that they can make much more if they size trades up considerably and just a couple of losses reverses all the gains they've made.  The reason the trader has been successful is because he or she has operated within a stable regime:  a steady trend, a relatively constant level of volatility, etc.  After that profitability, we see a change of regime and, just as the trader sizes up, the market no longer follows the same patterns.  Sizing up trading is a great goal, but it needs to be done across different market conditions, and it needs to be steady and gradual--not a huge jump in risk-taking that can disrupt profitability and psychology.

The common thread here is that traders can become *so* focused on making money that they no longer take good bets.  If we have a need to make money, our greed will control us.  The more we need something, the more it controls us.  For the developing trader, learning is the top priority.  Once profits become the priority, learning goes out the window--and that derails many a trading career.

Further Reading: