Trading Strategy: Stay Composed

Buenos Dias, it’s been a week of travel and culture.

I went to a see the National Symphony Orchestra of Colombia this week. It was incredible watching 50+ professional musicians warming up. Despite their individual expertise, the practice session sounded like a train crash!

The composer arrived to begin the performance, and I watched in admiration as she brought everyone together to deliver harmoniously without error. Her direction, rhythm, tempo, timing, and presence turned the musicians into a robustly organised team. I’d always wondered why composers take so much glory, and it finally made sense.

It inspired me to think about trading as a meticulous artform with so many moving parts and the importance of being composed. Clearly, we must always be growing our informational edge and skillset. Yet without a trading strategy and system to manage ourselves, the end result will always be a train crash to our account balances.

A lesson re-learned by me this week, and so today we’ll cover the importance of strategy.

"Repetition is Mastery!"

Random Fun Fact: The Ancient Romans used to drop a piece of toast into their wine for good health - hence why we 'raise a toast'.

The Problem:

It’s not that you’re a bad trader and can’t predict the future. Its not simply that you fell short on your research. It’s not that you can’t handle risk or just can’t seem to make effective decisions.

The problem is that most people trade on gut feelings and make hasty decisions. They act without a clearly defined strategy and system in place leaving them reliant on how they feel.

"It's not what we don't know that gets us in trouble. It's what we know for sure that just ain't so”.

Don’t let this be you!

Strategies and systems can be tested and built upon. Trading is a journey and not a get rich quick scheme.

The unsuccessful trade on information and emotion alone or experience paralysis from the sea of information that can overwhelm. They allow themselves to stop trading when facing a setback or loss that hurts.

Having a strategy and system will move us through these problems and keep us moving towards profitability in a sustainable and scalable manner.

The Opportunity:

Financial markets of all kinds shall always be unpredictable in the short run. The more unpredictable, the more volatile, and ultimately the more opportunities to make money. Being wrong at times is an essential part of the business, and so our business demands a strategic approach.

We can plan for it, learn from it, and use our learnings to propel us to the next level. Even loss-making trades give us more information to help make more profitable strategies as long as we can stay in business.

Let’s delve into the significance of creating such frameworks to ensure longevity and prosperity in the trading business:

1. Building a Solid Foundation

Just as a building requires a strong foundation to withstand external pressures, a trading business necessitates a well-crafted strategy as its core. A trading strategy sets the guidelines, principles, and rules that govern trading decisions. This structure helps traders avoid aimless wanderings and instead work toward consistent growth.

2. Navigating the Turbulent Waters

In the absence of a well-defined trading system, traders are left vulnerable to being tossed about by waves of market emotions and external influences. By having a trading system in place, traders gain the ability to navigate through turbulent waters with calculated precision, enhancing their chances of survival.

3. Embracing Discipline and Objectivity

In the absence of a trading strategy, impulsive decisions can lead to a series of detrimental actions. A robust trading system enforces discipline and objectivity, ensuring that trades are executed based on predetermined criteria and not on spur-of-the-moment emotions. This approach allows traders to stay focused on their long-term goals and avoid succumbing to short-term temptations.

4. Adapting to Changing Tides

A well-crafted trading system is flexible and adaptive, enabling traders to adjust their strategies in response to changing market conditions. Staying in business requires the ability to remain agile and embrace new opportunities while managing risks effectively.

5. Managing Risk and Preserving Capital

Trading involves inherent risks, but a systematic approach can mitigate potential losses. A trading system incorporates risk management techniques, such as position sizing, setting stop-loss levels, and diversification, which help preserve capital during adverse market movements. By prioritizing capital preservation, traders increase their chances of staying afloat in the trading business.

6. Reducing Emotional Influence

Emotions can be a trader's greatest enemy. Fear and greed often cloud judgment, leading to irrational decision-making. An established trading strategy acts as a buffer against emotional interference, ensuring that trades are executed based on logic and analysis rather than impulsive feelings.

7. Measuring Progress and Growth

A well-defined trading system allows traders to measure their performance over time. By analysing past trades and evaluating their effectiveness, traders can identify strengths and weaknesses in their strategy. This evaluation process paves the way for continuous improvement and growth.

A structured approach provides traders with a sense of direction, discipline, and resilience, ensuring their ability to stay in business and weather the storms of the market. By embracing strategic planning and systemization, traders position themselves on the path to sustained profitability.

A Call to Action:

I’ll start with a painful learning. I lost -20% of my trading account this week with a single pair trade that would now be profitable. Right idea, wrong timing you might think. But no, it highlighted that I’m taking too much risk. I’ve now put a system in place to ensure no single trade can result in such a large drawdown for the account. Going forward any losses shall be limited.

Here is a list of trading rules that I check before I put on any single trade:

1. Daily rituals: Do not trade until these are completed. Examples are market readings (headlines), refresh on market view, check major asset moves overnight, and check existing positioning. Ask the question, "Would I put that trade on right now?". If not, then cut it.

2. Purpose check: I get clear on purpose before I trade. I’m here to make money. I’m not here to waste time, play games, or do silly trades that hurt my psychology.

3. Plan the trade, and trade the plan: I document trade rationale, target, and stop loss on every trade before it is executed so I fully understand my goals and risk.

4. Evaluate risk against view: I reconcile whether my risk reflects my broader view of the market. If not, I cut positions and start again.

5. Do not fight trending markets: I make sure I am not going against trends for extended periods. It’s a losing strategy, markets trend and I want to trade with the market, not against it. If I'm trading against a trend for more than 1 day, then I cut it.

6. Adequate risk size: I don’t risk more that 10% of trading capital on a single trade. Conviction: 2% risk = low, 5% risk = medium, 10% risk = high.

7. Liquidity check: I check whether my risk is in liquid or illiquid assets. As a general rule, I want to be trading liquid assets most of the time and notably in volatile markets. This means tight bid-offer spreads and transparent pricing.

8. Put a conviction level on every trade: From 1-5, 5 being strongest. This way I have clarity on my approach to risk and can evaluate the success of the trade, view, and strategy when its completed.

On trading accounts I have basic macro driven strategies. That means I make trading decisions based on current and ongoing macro themes and express risk views in liquid asset classes. All positions are short-term, less than 1 week in duration. I use hard targets and stop-losses on every trade to manage risk, preserve capital, and avoid emotional interference. I measure trades and P/L daily, weekly, and monthly. This allows me to evaluate progress and make strategy/system changes periodically.

Lastly, everyday in order to avoid paralysis, I immediately put on the smallest trade size possible in a benchmark asset to be involved in the market (eg SPX 500 or EUR/USD). You have to be in it to win it! As strategies and systems grow in sophistication, I find it's important to have a handle on the market. Whilst we should trade our risk first, and not our PL, I find that nothing keeps me more focussed on asset prices then how my positions are performing. Moreover I see a common mistake that people talk to much and then realise they have no risk on. They have given all their energy to opinions and not action - my systems do not allow for that.

Despite this weeks losses, year to date trading PL stands at +83%. Onwards and upwards!

"A good writer writes!"

"A good singer sings!"

"A good trader trades!"

Random SPX 500 fact: The top 10 companies account for over 30% of the index value, with Apple (7.48%), Microsoft (6.74%), and Amazon (3.06%) the largest weightings.

What strategies and/or systems are making you money right now?

The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of financial advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.