Six Keys for Trading Success

From Traderfeed and Brett Steenbarger:
In my last post, I mentioned that a generous blog reader shared his intraday trading approach with me last week. His ideas seemed sound, so I suggested that he contact Henry Carstens, an experienced systems developer. Henry, I told him, could test his trading ideas and perhaps suggest improvements, while avoiding the problem of curve-fitting. The reader, trusting that Henry and I would not divulge the particulars of his method, patiently explained his setups with numerous examples. Within a matter of hours, Henry had backtested the ideas over the past five years of trading. What Henry's report revealed tells us quite a bit about what it takes to be successful as an intraday trader. My subsequent conversations with the trader revealed yet more. Here are six lessons from our experience with a successful short-term trader:

1) The successful trader is selective. The trader's approach took about 1300 trades in a five-year period, or about one a day. It spent more time out of the market than in the market. As a result, it did not rack up huge commission overhead. Instead, it only took very high percentage trades. Without any optimization whatsoever on Henry's part, the system had almost 80% of trades as winners. This selectivity makes for very high risk-adjusted returns. Most of the time, the trader's capital was not at risk. He only entered the market when he could make money consistently. He had clear ideas regarding execution that enabled him to get into the market at favorable prices, minimizing losses when the trade didn't work out and maximizing gains when he got the moves to his target.

2) The successful trader has made the approach his or her own. When I talked with the trader by phone, I sometimes had trouble following his thinking. He spoke quickly about hitting the red line or the brown line on his charts and casually mentioned important trading ranges and levels. It was clear that this way of trading had become part of him. The way he set up his charts is the way he thinks. No doubt this internalization helps him see when the market is acting normally and when it is not, enabling him to quickly act upon opportunity or threat. Only considerable experience, watching markets day after day and studying charts upon charts, makes it possible to internalize a method to that degree.

3) The successful trader has found a niche. The trader did not just send me one or two charts illustrating his method; he sent dozens. On the phone, when he talked about his approach, there was real enthusiasm in his voice. It was clear that this kind of trading had captured his interests, skills, and talents. That creates a virtuous cycle in which success leads to more excitement which leads to more learning, which creates further success. He didn't try to trade instruments or time frames for which his approach--and his skills--were not suited. He focused on his strengths.

4) The successful trader is creative. I think it's fair to say that his approach is a short-term trend-following method. His way of evaluating the market trend, however, is unique. He is definitely not just looking at the same old 14-period oscillator that comes pre-programmed in most charting applications. Similarly, he has clear stop points and price targets, but these are defined in a unique way, based upon the market conditions he's observing. This "out-of-the-box" thinking style is common to successful traders, I've found. They look at markets in unique ways that help them capture shifts in supply and demand.

5) The successful trader is always seeking improvement. If our trader is already successful, why does he need to talk with Henry? He knew that, by sharing his ideas, he would learn a great deal about the strengths and weaknesses of his trading. Sure enough, Henry found that the average size of the trader's losers was larger than it needed to be. A simple modification of stop-loss rules improved the system's performance meaningfully. Similarly, by putting a filter on the system--only taking trades if certain conditions were met--the average profit per trade went up significantly. That could aid position sizing. The trader knew he had something good, but good wasn't good enough. He wanted better.

6) The successful trader is persistent. One thing I want to stress: the trader's methods were very sound--and Henry found ways to make them better--but they were not perfect. Out of about sixty months analyzed, fourteen were losers. The drawdowns were not hellacious, but there were periods of flat performance and drawdown. What that means is that a successful trader needs to have the confidence to ride out these periods of poorer performance to get to the periods of success. That is one reason why it's so important to find a way of trading that you can make your own. You're more likely to stick with a method that fits with how you think (and that fits with your skills) than if it's something you've blindly copied from others. Our trader believes in his method, and that gives him the brass ones to hang in there during relatively lean periods.

Note that our trader is not a mechanical systems trader. What Henry did was test out his major ideas and identify their strengths and weaknesses if they were traded consistently, with discipline, as if they were a system. If you are a successful trader, this is a valuable exercise. It will break your trading into components and show you how each component is contributing to profitability. It very often shows how the components can be slightly modified to produce even better results. By looking under the hood, so to speak, and making a couple of adjustments, we can meaningfully improve upon our success. There are very few trading strategies that cannot be programmed and tested, including complex chart and indicator patterns. The results can be most enlightening.