The Evolution of a Trader from Entry Level to Pro

The evolution of a trader from entry level to pro. Idealist to a realist, moving away from the abstract black box where profits will cure anything to utilizing systems that only fit your personal style.

Entry level traders often underestimate the emotions and psychological swings involved in trading. Everybody is a tough guy at the beginning. I am the master of my own destiny, I'm a rock! This type of thinking is fine for those with bottomless pockets, yet for those of you who don't like to lose money, and you will lose money, it's part of the game, humility finds it's place in a hurry. If you survive through your initial investments and decide you need to reevaluate your trading strategy, the first thing on your list should be discipline. How do I trade with discipline? Do I rely on a particular method? How about some sort of system? Whichever you choose, the point is to bring discipline into your trading strategy.

"Discipline" is the most frequently used word used by the exceptional trader. There are two basic reasons why discipline is critical. First, it is a prerequisite for maintaining effective risk control. Second, you need discipline to apply your method or system without second-guessing. What we mean by "second guessing" a trade signal is choosing which trades to take. The way it almost works out is that you opt not to take a trade and you are right, thus giving you positive reinforcement. However, I guarantee that you will almost always pick the wrong trades to take after that. Why? Because you will tend to pick the "comfortable" trades. You will only take the trades that feel good and the market does not care how you feel. Everyone who trades is human and is never immune to bad trading habits. The best you can do is to keep a lazy or sloppy temperament latent. Do this by implementing a method, or a system. A finely structured process will clarify your trading strategy, eliminate most of the bad trading habits, and allow you to focus on disciplined trading.

A system is a set or arrangement of things so related as to form a unit or a whole. In reference to trading, a system is an arrangement of indicators into a mechanical trading unit. All entry level traders who use Mechanical Trading Systems (MTS) do so because they have come to the realization that to succeed at this high risk endeavor it takes discipline. In other words they believe they need to control their emotions, control their neurotic tendencies. Control of intense and inappropriate fears regarding a losing situation or missing a winning situation is called trading discipline. They need to control the compulsive need to pursue certain actions or thoughts in order to reduce anxiety. An example would be taking a profit just to make themselves feel better. Traders without discipline also excessively employ defense mechanisms to overcome their own anxiety. Ultimately, lack of discipline and unchecked emotions can sabotage those not willing to identify and address their won shortcomings. If you admit to yourself that you lack a high degree of discipline, using an MTS may be the way to clarify your trading strategy. Discipline comes from within, not from the system, or the method for that matter. You follow a rigid trading process and trade the system as it indicates. If your confident the system generates quality results through your still sustaining negative results as a whole, look for the breakdown in your trading habits.

Method on the other hand, is the regular, orderly, logical, procedure for doing something. For the trader who takes a logical, disciplines, approach, this mode of trading can be very successful. Mode, means customary method, following a methodical process time and again. For the person who sets out his trading strategy, and follows it, trading by method can be very rewarding. Again, the key is discipline and objectivity. You have greater versatility or flexibility in regards to how you enter a trade than you would with a system. Using flair to enter at the best price possible is not available to those using a system. As an example, a system may enter a position once a trend line has been broken. Plain and simple. On the other hand you may wait for a retracement to the new support level and attempt to enter at a better price and avoiding whipsaw. Both trades are entered, one just has a little more finesse. The method trader has to be forever vigilant and aware of any deviation that may occur from his methods. If you have the strength to maintain your discipline, trading by method may produce the same results as MTS.

Most entry level traders who use Mechanical Trading Systems (MTS) do so because they believe that to succeed at futures trading they will need discipline. I believe that to be only a half truth. Yes, I do feel that a MTS helps provide discipline to trading. However, it is not the holy grail of self discipline traders that most novice traders make it out to be. I suspect that anyone whose decision making process is fraught with emotion will almost always lack objectivity. Furthermore, there are other ways to gain "objectivity" besides a MTS. Point is that any "objective" means of reaching a trading decision which includes a Discretionary Trading Method (DTM) will assist the trader with his discipline.

I really feel that this needs to be understood by most beginners. I understand that we all come to the futures trading arena due to our sense of independence. But it is being disciplined to "execute" which must come from the trader. He needs to keep his neurotic tendencies under wrap. Control of intense and inappropriate fears of a losing situation or fears of missing a winning situation. Traders have to control the compulsive need to pursue certain actions or thoughts in order to reduce anxiety. Like taking a profit just to make themselves feel better. Traders without discipline also excessively employ defense mechanisms to overcome their own anxiety. Some trader's even reach the point of losing their sense of reality.

The basis of a trading method is supported by solid theory and observation. In our case we want a method that only trades in the direction of the primary or larger trend. What the "primary or larger trend" is will be defined here in a moment. However, what is key is that trading in the direction of a primary trend is a clear and self evident truth. By definition, to be profitable a position, weather long or short, must catch a trend in the direction of that position. The only real issue which needs to be addressed is the length of the trend; and such definitions have more to do with the style of trading the individual is doing as opposed some other factor like total net profit of a trading system. In the "Closing Bell" chapter of the "New Market Wizards", Jack Schwager put it this way: "It is critical to choose a method that is consistent with your own personality and comfort level. If you can't stand to give back significant profits, then a long-term trend-following approach--even a very good one--will be a disaster, because you will never be able to follow it. If you don't want to watch the quote screen all day (or can't), don't try a day-trading method. The approach you use must be right for you; it must feel comfortable. The importance of this cannot be overemphasized. Remember Randy McKay's assertion: "Virtually every successful trader I know ultimately ended up with a trading style suited to his personality."

All systems must enter on a breakout or a retracement. This is simple enough. Profits and trend are synonymous. The only way a trader makes money is to have a position which is in the direction of the trend. The only difference is how long of a trend is required which is more a factor of trader's style and how the trader enters the trade - on a reaction is the larger trend or on a continuation of a larger trend. The trend is our friend they say. So our system needs to determine the larger trend. We will define the larger trend with a 21 period moving average. If the moving average sloping up, the trend is up and if the moving average is sloping down, the trend is lower.

What we want to do here is find a shorter time frame, a shorter trend, which is counter the larger trend to set up entry. In this case we will use Bollinger Bands. We use this indicator for two reasons actually. One is to delineate a shorter-term counter trend move. The other is to determine when the market is overbought and oversold, plus we want a system which provides a counter trend entry. Overbought and oversold conditions by definition are just that.

There are four types of traders: Event Based

Discretionary

Technical

System Trader

Where this breaks down

• [Draft , Jack to add failure modes and conditions under which this framework breaks down]