On Why making money on your first few trades may not be the best outcome

 

“The potential for temporary success by pure luck beguiles people into thinking that trading is a lot easier than it is. The potential for even temporary success doesn’t exist in any other profession.

 If you have never trained as a surgeon, the probability of your performing successful brain surgery is zero.

 If you have never picked up a violin, your chances of playing successful solo violin in front of the New York Philharmonic is zero.

It is just that trading has this quirk that allows some people to be successful temporarily without true skill or an edge—and that fools people into mistaking luck for skill”

- Quote from "What I Learned Losing a Million Dollars" by Jim Paul and Brendan Moynihan

Luck or skill?

The quote above, which is from the true story of the rise and fall of Jim Paul, sums up trading. It’s an occupation that you don’t need any specific qualifications to pursue.

However, unlike most “unskilled“ roles, the potential rewards in trading are substantial. In fact, they are open-ended or without limit if you prefer.

Of course, the key word in that sentence is potential because until they are realised those rewards will remain out of reach, tantalisingly close but just beyond our grasp.

Realising those rewards and doing so regularly will usually require hours of dedicated study and application, combined with the ability to follow a set of rules and the discipline to apply them every time you trade.

There is an old saying among traders and gamblers that they “would rather be lucky than good”, but this is wrong because as Messrs. Paul and Moynihan point out, people are very quick to mistake luck for skill.

Falling into a trap

To do that is to fall into the trap of outcome bias that is judging the success of an event or action purely on the results generated, rather than the journey taken to get to that endpoint.

Annie Duke, the famed poker player and author of “Thinking in Bets” calls this “Resulting”.

Yes, trading is about making money, but more importantly, it’s about making money without taking on excessive risk. It's all well and good picking up nickels and dimes you find in the street, but you wouldn't (or shouldn't) want to do this in front of a steamroller.

The ability to recognise, measure and quantify risk is a key skill for any would-be trader. Unfortunately, it’s a skill that must be learned the hard way, which in trading means losing money.

Harsh lessons

Losses are a fact of life in trading. They are part and parcel of the job description, and the trader must come to terms with that, and the sooner the better.

Here's the thing. In an ideal world, those new to trading should experience several consecutive losing trades. They should feel the pain and disappointment of seeing their money disappear and their ideas going up in smoke, however, by learning from their experiences, they should go on to be a better trader.

This may sound harsh, but there is no substitute for having skin in the game and losing money. It focuses the mind like very little else.

If we have correctly approached the markets from the outset (that is, conservatively), we should be risking only a small portion of our capital on any one trade, and only having a limited number of trades open any one time. Then these losses will be akin to scratches and scrapes and not mortal wounds.

A biased picture

Therein lies the crux of the dilemma we face as traders. If you are lucky and you make money straight away from your first few trades, you can develop a false sense of security.

You will overestimate your own abilities and fall victim to another bias, that of anchoring.

When our mind tricks us into anchoring, we carry an incorrect assumption or set of assumptions forward into future decision making. In turn, this can lead to availability bias where you make decisions and form opinions, based solely on the information in front of you, rather than considering the bigger picture.

To put this into context, let's imagine that you start trading in the live markets and you are fortunate to have US$ 10,000 in your account.

For your first trade, you take a “flyer” by going long two lots of an FX pair (that's US$200,000 of underlying notional value) You trade without a stop loss and then you head off for nine holes on the golf course.

By the time you return to your desk, the markets have shifted after a key central bank announcement.

By complete chance, because that's what it is, the markets have moved in your favour and you close out your position for a tidy profit.

That might sound like a good day's work, but it’s a disaster or at least a disaster in the making simply because you broke so many rules around money and risk management.

You didn't consider the leverage involved in the trade, the relative size of the position to your account balance and by not having a stop loss on the trade, you put all your trading capital at risk.

Finally, you didn’t check the calendar to see if any key data was due out and you left your position unattended while you played golf.

Make money but in the right way

We are not saying that we want you to lose money, on the contrary as your broker we would like your account to grow and for you to recommend us to your friends and family.

Ideally, as your partner in the markets, we want you to make money in a sustainable, systematic and thoughtful fashion, one that rewards best practice and encourages good habits, not bad. A trader placing small trades across ten years is worth far more than an easy-come easy-go trader who treats it like a visit to a casino.

A little discomfort in your first few trades can go a long way to achieving just that.