Practicing flawless execution

In the previous issue we discussed how our Analysis and Entry processes help us to find trading opportunities on the market. However, even when the trade is clearly identified many traders will still hesitate to take it.

Convincing yourself to take the trade

After the trades are clearly identified during the analysis phase, we still have to act on them. These are not trades yet, these are only signals.

It is a big trading problem if we have to convince ourselves to take the trades. In reality we should jump at an opportunity to execute the signal and move towards success. The fact that we are hesitating can mean only that we are not confident enough at what we are doing.

So how do you become more confident at it? By acting on each and every signal, time after time, and seeing progressively better results as you refine your rules and your system. In order to act on each signal, we need a confidence of a different kind – the confidence that we operate from a safe environment where nothing is threatening us and we have nothing to fear.

Easier said than done, but nothing we can’t achieve with help of proper money and risk management.

Risk Management

We will follow a simple MM strategy, as discussed in issue 6.

The very first goal we must become 100% comfortable with, is the fact that we have to pay for our education on the market. You might have taken classes, seminars or self-studied many books, but that’s only part of the price you have to pay – this is the price for the theoretical knowledge of the market. The next phase is to pay for your education by practicing all this theory.

You have to define the amount of money you are absolutely comfortable paying the market each month for your education. It can be anything, but it must be real money.

It does not matter if you can spend $1000 or $10 000 a month practicing trading if you are not psychologically comfortable leaving this money on the market. You have to go down until the amount bears no emotional attachment whatsoever. Let’s say it is a very conservative $100.

Now that you know your monthly tuition fee, you have to make sure that you trade, you practice with it, and you don’t lose it all the next day. Remember, you are setting your monthly limit and you will have to stick to it. The next step, therefore, is to divide that amount by 20, making sure you have something to risk each and every trading day of the month.

In our example it will amount only to $5 a day. Fortunately, there are brokers that will allow you to open so-called cent accounts, where your $100 will be shown as 10 000 cents, and you can risk $5 as if it would be $500, but in reality you are risking just 500 cents. Once again, the amount is not important right now, because we are not trying to make money, but become confident executing the real trades.

It is very important that you are absolutely comfortable with paying the market for your education, so this planning phase is crucial. It is just as important to learn paying with real money. Reduce the risk until you can confidently say that you are happy to pay the market every single day for the opportunity to learn from it. After all, there is no better teacher for our trading than the market itself, and it is the only teacher that allows you to set the daily education fee as low as you wish. Make it $1 a day if you have to, but commit to paying that price without any emotional discomfort.

Now that the risks have been defined and truly accepted, we are ready to enter the practice phase.

Practice

The goal of our practice is very simple: every single day we try to find just one single entry opportunity with our trading system and act on it, paying the market the daily fee we predefined in the previous step. At this point we must have an attitude that will make gladly accept every single opportunity as soon as it is confirmed. We do not think about money anymore, we know our tuition fee for the month.

Of course, there are a couple disciplinary rules we must follow:

  1. The trading opportunity must be defined objectively by the rigid rules of our trading system. It means that any other person should see the same entry if we put the trading rules in front of him.
  2. We are trading only under our risk limit for the day and after a trade is placed that fills that risk allowance completely, no more trades can be opened. Whether we decide to take one trade a day with full risk or divide it between two trades is up to us.
  3. The trading must be documented

The last point is very important and it is worth going into it in more detail. As we discussed in Issue 7, trading organization is just as important to our success as trading system or proper psychology. I call it Trading Accountability, because we must make ourselves accountable (responsible) for all our actions. For the purposes of this exercise let’s define 3 accountability rules we will follow:

  1. Before placing the trade, we make a picture of the chart and annotate it, explaining why this is a good trade opportunity. The picture is placed into our “Analysis Diary”
  2. Right after taking the trade, we write all details into our “Trading Log”: entry price, time, stop and profit target, risk for this trade, expected return ratio, etc. We also write down our psychological state of mind about this trade: do we feel good about it, was there any hesitation before taking the trade, etc.
  3. When the trade is closed we update our “Trading Log” with relevant information and write down a short analysis of the trade and how we feel about it now.

In the end of each week it is crucial to analyze trading results so far. Now we can see how the market developed after our entry and we can analyze our mistakes with a benefit of hindsight. It is the most important phase of this practice.

When this exercise is done for the first time, chances are that performance will not be outstanding. Many traders will think that it is simply a matter of trading rules that we developed so far for this exercise – if the rules are not good enough to show us good entries, then we will not see profitable results. However, after actually doing the exercise, we may see many trades where the rules were not followed.

We need to take each trade and compare it with our original analysis and entry system description:

  1. Did we follow all the rules in our analysis system, meaning that this trading pair had a bias in the direction we traded?
  2. Did we follow the rules of our entry system, clearly seeing a signal before we took the entry?
  3. Did we respect money and risk management?

Question 3 is by far the most important. It is understandable if we miss some sign of changing or weak bias in real time in our analysis system that is obvious to us with hindsight. It will also happen many times in the beginning that the entry is far from ideal, because of the many factors we have to account for. But our Risk Management rules are always simple and straightforward.

We know precisely what position size we must open, we know that there must be a stop loss set immediately with our entry and we know our risk limit for the day. We can only break these rules willingly, talking ourselves into not putting a stop loss order, because we “need to give the market space to breathe” or taking additional trades today, after reaching our limit because “the market is showing a signal that cannot lose”. Such lack of discipline and awareness over our thinking will lead to the greatest losses on the market.

If we find ourselves breaking Risk Management rules during our first series of trades, it is not the end of the world, we still did not waste the time doing the exercise. We have found that there is a serious issue in our psychology that we need to work on and that is a great advancement towards success. After all, most traders are losing money on the market (sometimes losing it all because of such judgment errors) completely unaware of the crucial mindset issues that they have.