Email of the day (1)
Comment of the Day

January 24 2012

Commentary by David Fuller

Email of the day (1)

On discipline in trading:
"First of all, thank you for an excellent service! Here around the New Year I have been reflecting on 2011 and my investment and trading results in general. I enthusiastically started investing and trading in 2007. I invested in the fullermoney themes: resources, India and China and gold bullion. I was quickly exposed to the meltdown in 2008, and thanks to your service stayed calm and even took the opportunity to add a little when markets started to recover. Obviously gold bullion has done the best.

"However, during the 2008 melt down, I lost quiet a lot trading futures - I considered it tuition fees. And the next couple of years I had a very good income trading. However, this has all been wiped out (and more) during 2011 by shorting the Yen and US treasuries and finally going long gold at the wrong time. Obviously the 2008 tuition fees weren't sufficient in my case.

"When I try to analyze it, I reach the conclusion that it all comes down to lack of discipline. I have gone in without clear trends having been established, and I have let them run the wrong way far too long, instead of cutting my losses (which may be ok when investing, but not when trading futures).

"I have read in one of your articles that when you were a young man, the accountant in the company you were working for exposed you to how important discipline is to achieving success in especially trading, but obviously also investing. I would highly appreciate if you could elaborate on what this discipline consists of and how it is implemented in practice. I think this topic is so important for achieving success, and it could be great if also others in the collective would contribute to this discussion with their practical experience implementing discipline in trading. Thank you very much!"

David Fuller's view Thank you for your enthusiastic comments, for sharing your experiences, and raising points of interest to all subscribers. You will appreciate that this is a huge subject which cannot be fully addressed in one response to an email. However, both trading and investment disciplines are features of The Chart Seminar and they are periodically referred to in Comment of the Day and Audios.

My first point concerns the often different disciplines required for investing as opposed to trading. At the beginning of our financial careers many of us are drawn to leveraged trading because we lack the capital for longer-term unleveraged investing. Leveraged trading can be very profitable but the risks are correspondingly high. The learning curve in trading is steep and this can be emotionally exhausting. For these reasons I never encourage investors to take up trading if they have no need to do so.

Additionally, we can only deal with the realities that markets provide and a volatile, choppy environment is inevitably more difficult than markets which trend over the medium term. Due to volatility, 2011 was one of the most difficult trading and investing environments that I can recall. I think this is confirmed by the performance statistics for most funds which invest or trade in stock markets, commodities or currencies. The best performances last year appear to have been achieved by credit market specialists.

That said, there were opportunities last year, including precious metals during 1H 2011. Also, the corporate Autonomies often mentioned and reviewed by Fullermoney - the big, successful multi-national companies - had a generally good year. Nevertheless, the prevailing choppy volatility, plus Eurozone woes, resulted in very low consensus expectations at yearend 2011.

One of the most important disciplines for investors and traders is to study market history over the last few decades. The best way to do this is not by reading market histories. They can be interesting but tend to concentrate on a few specific events, often involving bubbles and slumps. To understand how markets move most of the time, one learns a great deal by reviewing historic charts seen on semi-logarithmic scales.

Markets move in cycles, as most of you already know, and these are heavily influence by monetary policy. Human nature causes crowds of investors to extrapolate trends, so they are inclined to be too fearful following a down year and too optimistic following a really good up year. For this reason most investors figure out what they should have done in the last cycle and then apply those tactics in the next cycle which is more than likely to be different. For instance, following a choppy year such as 2011, people feel that they should trade more actively and this may cause them to jump off the next medium-term trending moves which often follow ranging phases.

Here are some specific trading disciplines which I have mentioned before and generally have cause to regret when I do not adhere to them: 1) trade less and in smaller units if markets are choppy; 2) look for patterns which indicate potential for trending moves, including breakouts from bases or top formations, or from smaller pauses within consistent trends; 3) for risk control purposes, build positions incrementally within trends so that you are only adding to winning moves; 4) raise stops to in-the-money on successful trades before adding to a position, using technical stops if possible and trying not to crowd positions unless you are feeling apprehensive; 5) lighten positions or tighten stops when they appear overextended.

When successful, siphon off most of the accumulated profits in your trading account and invest that money somewhere else. Given the ongoing risk in trading it is important to diversify when in a position to do so. By leaving too much money in a trading account we can easily become careless. Or the environment may become more difficult and we find that we have given back too much profit. Our future trading decisions are likely to be sharper if we have to build up from a comparatively small stake.

No doubt every trader reading this will have their own set of appropriate rules or guidelines. The important point is to develop simple strategies which increase your money control discipline and make sense to you.

We tend to be our own worst enemy when trading as the email above implies. Risky strategies include impulsive plunging, having too many positions when things are going well, and worst of all, running losses when the pattern is clearly not doing what we had hoped for. The best way to avoid this expensive trap is to decide where you will come out if the trade is not working - before you even open the trade - and stick to it! I have said this for decades and if I had always followed it, my net worth would be considerably higher today.

I also think it is very important to take charge of one's own decision making process. We look at charts, read, discuss and listen to others for perspective. However, if our strategy is to wait to see what someone else is going to do, and then follow them, we are not really thinking. With a losing trade, it is also a mistake to overstay because someone who you may respect has the same position.

I also think it is important to withdraw from the trading fray from time to time, if only to recharge one's batteries. I lost money in 2H 2011, mainly because I ignored too many of my own trading guidelines. Trading can be stressful, unlike research which I generally find therapeutic. I look forward to resuming my own trading before long, in what I suspect will be a reasonably benign market environment.

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