The most important question

Posted by downtowntrader | 10/17/2006 09:04:00 PM | 0 comments »

Michelle B. had a great post today over at TraderMike's site regarding discipline and how a trader can get trapped in a vicious cycle of breaking their own rules and "fall victim to a trap of his own making". It is extremely important to be cognizant of when discipline problems are creeping into any part of our lives, as lack of discipline has a way of breeding itself into the vicious cycle described by Michelle. Whether it's the slice of pie when you're on a diet, or that stop you pulled this morning when the markets gapped lower, it is important to realize that eventually undisciplined actions have a chance of snowballing into wrecking machines.

She also pointed out how rules should be few and simple. Complex and detailed rules can help the beginning trader from making some obvious mistakes, but eventually, a trader needs a little freedom and discretion and an over abundance of rules will hamper the trader. She whittled it down to one rule. "Execute perceived opportunity according to my risk parameters". Pretty simple, but what she is basically saying, is FOLLOW MY TRADING METHODOLOGY!!! Read the post when you get a chance as it shows that Michelle is a seasoned trader writing from experience.

I have a similar rule, that I turn into a question I ask before every trade I make.

Do I have an edge?

Thats it. If it's yes, then I take the trade. No, and I look elsewhere.

So what is an edge? An edge is not that your buddy went to the Apple store and had to wait in line for 30 minutes. Nor is it the rumor you saw on the message board posted by Apple_Insider_2008 saying that a new ipod will be released with a bluetooth surround sound system. An edge is a strategy or method that has been tested to give you a positive expectancy over a large sample of trades. In other words,

  1. you either win more times then you lose
  2. win more money when you win, then lose money when you lose
  3. or both.
The second is easier then the first, and the first comes with experience as a trader becomes more selective with a refined edge. I have non trader friends that are shocked when I explain that you can make a very good living losing 60% of the time. The key is to cut your losses and maximize your gains. While it is important to have guidelines for different phases of a trading methodology, the bottom line is a trader needs to ask just one question before taking a trade. Do I have an edge?

If the answer is I'm not sure, then either the trader doesn't have a clear methodology, or the trade is questionable and should be let go.

The markets finally showed some weakness today, and look like they will have another wave down on the 60 minute charts. I don't think it's time to short yet, but I'm not crazy about going long with Options expiration approaching towards the end of the week. I may just wait till next week before putting on any trades.

Good Luck,