Handling complexity

In his book “The Checklist Manifesto” Atul Gawande shows how very costly mistakes are avoided using simple paper checklists. He provides a very detailed account that we can learn a lot from.

The truth about modern life is that it became way too complex for most people to handle by keeping information in their heads. We cannot account for all the variables of the modern life. The doctor is not able to concentrate on everything anymore, the modern operations are way too complex. The pilot cannot control a modern airplane and keep all the details in his head, no matter how good he is at remembering things.

It is not by accident that all modern pilots are required to go through simple paper checklists. In the midst of all technical complexity of their cockpit, they have to take a simple paper checklist and go through it for virtually every single procedure they are doing. Similarly, a nurse can stop the surgeon before the operation and remind him that some simple check has been missed in a checklist that nowadays is a requirement in most modern hospitals. No matter how good the surgeon is, a simple piece of paper has proven times and times again to be better in avoiding crucial mistakes that cost lives.

In trading we can exercise the power of checklists like never before.

I was always a big proponent of simplicity of trading. I was always defending the position that a mid to long term trader can simply spend an hour a day checking the entry conditions, taking the trades and then calling it a day. To be fair, the analysis and placement of the orders really does take a couple hours but somehow I was never able to make it to consistency by doing just that. The answer is that I was never a trader and I certainly never managed a trading business. I was an analyst at best, a market hobbyist at worst.

Analyzing the market and then trading your plan are two very important parts that we already discussed before but they are only that – two parts of the whole, only two elements of your trading business. A surgeon who learned the anatomy of human body and how to use the scalpel and stopped right there will never be allowed to work in any hospital. He must understand the management, the paper work, preparing reports, planning the operation, have critical thinking to decide the best course of action.

Whether you make money in trading or lose depends on how you manage your trading business as a whole. That consists of your monthly accounting and review, weekly goals and limits as well as review, daily plan, analysis schedule, trade management, recording all your trades in a diary, gathering statistics for different types of entries, timeframes, pairs, etc. As you can see, the problem is not in the complexity of a particular trading method but in the amount of work that has to be conducted regularly to maintain trading as a successful business.

More importantly, besides regular daily life of a trader, there is another crucial part to it. Just like in any other business you must advance in order to stay on top. You cannot start an endeavor in any competitive segment of the market and hope to make it, if your knowledge base always stays the same, if you never learn and never improve. Trading, being extremely competitive, is where one must advance every single day.

Do you know the problem areas of your trading business? If you lose money, do you have a clear picture HOW exactly you lose it? Is it a certain mistake you repeat times and times again or a trading timeframe you can never get right? If you are making money with a certain degree of consistency how do you know it will stay the same tomorrow? What can you improve to stay on top of the market even better?

There are stages to development of a trader: you are first oblivious to these questions, then you ask them and then you try to answer. After you find some answers all you’ve really done is built a theory on how to improve a certain aspect of your trading. The next step is to put that theory to practice and see how well it works in real life.

The real simplicity of trading

When you created a system of accountability for yourself in form of trading diary, log and various process checklists, you have made a big step towards consistently. If we have no clear idea what to do in our business we can still work hard and stay busy every single day, spending countless hours, but in the end we can only reach consistency by being extremely lucky.

Here is why creating an accountability system is so powerful: it lets you know clearly if you are doing your job or not. In the end of the day you look back and see your diary entries, trading log, start of the day checklist, daily summary checklist and you know what you accomplished today and where you fell short of ideal.

When you have a trading system with clear rules and accountability system with clear rules, all that is left is to follow them every single day. At this point, the trading is still not easy because of the amount of work you have to do, but now it became simple – in a sense that you clearly know every step that needs to be done every trading day. When you are not satisfied with the results of your trading, you can always look back and analyze what can be improved. You can make a couple changes and then see how well they work after another couple weeks.

One of the main reason why the traders are so rarely reaching consistent success, in my opinion, is that there is little to none consistency in their approach. Some are inconsistent in their life habits: waking up at the same time to start trading day, analyzing the market at the same time, following healthy sleep regimen to stay alert and concentrated during work hours, eating properly to have enough energy, etc. Others are inconsistent in their trading approach: jumping from one trading system to another, constantly modifying their trading rules, not following the rules in the first place. Finally, I think most traders are not consistent in doing proper accounting of their business: market analysis is not systematically recorded, the trades are not logged and analyzed for mistakes, studying the market may be done sporadically and so on.

Having the discipline in all these areas is extremely important. As I keep stressing, being a trader is, first of all, being a businessman. A business owner is completely accountable for everything he is doing. The problem, however, is that he is accountable only to himself which makes it easy to avoid in the short term, destroying all chances for success in the long term.

Accountability system

There are 2 elements of accountability system that I think most important to trading success: morning checklist and evening checklist. These simple lists will guide you throughout the day, always making sure that you are on the right track.

Next, I suggest setting up 2 separate journals: Market Diary and Trading Log. I use Market Diary to record any interesting trading pairs, trade setups, trading ideas, etc. The Trading Log is used to record each and every trade that was taken. First of all I write all data about the trade: trading pair, direction, size, time, price, etc. Then I describe the trade setup – the signal that I used to open this trade. Finally, the most important part of the trading log, is to record my psychological state upon entering the trade. I write if there was any hesitation to pull the trigger, what was my state of mind, any distracting thoughts, etc. I repeat all the same steps when the trade is closed. A screenshot of the chart is also added upon entering the trade and later showing how the trade has been closed.

Now that the basic setup is done, all is left is to make sure that the work is done properly every day:

1. All market analysis and trade setups are recorded in Market Diary
2. Trading Log keeps every single trade that was opened and closed along with psychological analysis

Next, we make sure that we advance in our understanding of the markets:

1. We spend at least 10 minutes a day reading a market related book;
2. Along with current market analysis, at least one historical setup is reviewed to ensure that we learn something new about the market.

We hold ourselves accountable to do this work consistently by following the checklists. In the morning we check:

1. Wake up at the same hour, before everyone else, to create a productive and distraction-free start of the day;
2. Re-read Market diary from the previous day to get into the right mindset first thing in the morning;
3. Review any trades in Trading Log that were taken yesterday and document any trades that were closed since yesterday.

In my opinion getting into the habit of waking up at the same time every single day (including the weekend) is one of the most powerful things we can do to our success. By waking up before everyone else around, you create a distraction free environment that can become the most productive time of the day. When the day has been started with positive action advancing you in life, it will be much easier to keep going in the same fashion for the whole day.

Next, we follow through our market analysis checklist, which is created specifically for our trading system. The main goal is to look for all trading setups of our system on all trading instruments that we watch and record all this information in Market Diary as a clear trading plan.

Now we are ready to go through the Take Action checklist. This list is designed to help us pull the trigger and open the actual trades. Here we check:

1. What trade setups we have available and clearly described in our Market Diary – if there is no plan put on paper, we don’t trade;
2. Check our risk allocation for today (following the guidelines discussed in the previous issue);
3. Place the trades according to plan, making sure that we use only allocated risk;
4. Document the trade entry in the Trading Log.

Depending on trading timeframe and trading system, it is possible that market analysis will need to be done more than once daily. In this example we use swing trading on Daily charts, allowing us to analyze and place trades only once a day, thanks to the fact that there is only one new Daily candle available.

In the end of the work hours it is very beneficial to use Daily Summary checklist:

1. Check once again that all analyzed signals were taken and everything was documented;
2. Do all necessary paperwork preparations for the next trading day;
3. Clean the workspace, ensuring that the next day can be started without any distractions.

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Of course, we looked only through a very basic example here. It simply provides an idea how one can organize his working day. Every trader should prepare detailed checklists for his particular method of market analysis.

Trading is definitely not easy, but it can and should be made simpler. The checklists help to cut through all the guesswork and instead manage the work each day with absolute clarity, knowing that nothing important is missed.