Four Essential Ingredients Of Trading Success

One of the great experiences I've had as a trading coach at a variety of trading firms is the opportunity to witness, first hand, what goes into sustained success. Here are the four success ingredients I've noticed among top performers across different markets, time frames, and types of trading:

1) A big picture perspective that indicates opportunity - I refer to this as "the idea". It could be one asset mispriced relative to another one; an asset mispriced relative to changing fundamental information; a shift in momentum and market flows; etc. Very often, this idea has been backtested or at least has objectively demonstrated its value in real time trading.

2) A near-term perspective that provides a bet with superior risk/reward - I refer to this as "the trade". The trader sees an opportunity to act upon the idea in a way that has limited downside (risk) and greater upside (opportunity). Very often the trade reflects the lining up of short-term (market flow) information with the longer-term perspective.

3) A methodology for sizing and managing positions, providing risk management and the management of opportunity - This amounts to bet sizing so that the trader is taking proper advantage of an opportunity without courting undue losses and risk of ruin. Very often, the successful trader will update bigger picture opportunity and near-term risk-reward during the life of the trade to size up positions and/or scale out of them. This allows them to lose less when ideas and trades are wrong and make more when they play out. The successful trader very often displays average win sizes larger than average losses.  

4) A framework for adapting trading to changing market conditions - The successful trader views the opportunity set as dynamic and will typically run periods of higher and lower risk-taking as a result. There is a regular process of taking in new information and feeding that into both ideas and potential trades. This requires an openness to new data and the capacity to make changes in trading approaches in real time. For example, a trader may emphasize directional, momentum opportunities in one type of market and relative value or "mean reverting" opportunities at other times.

Very often, trading problems result from overemphasizing one or two of these elements at the expense of others. For instance, a trader may place great emphasis on big-picture fundamentals and longer-term market opportunities, but lack an awareness of near-term flows to obtain good risk/reward trading opportunities. Or a trader may focus on short-term "setups", but lack coherent ideas regarding why the asset should move as expected. Or the trader will see good opportunities but will fail to adequately capitalize on them through proper sizing and position management. And, of course, many traders keep doing what has worked well after market conditions change, failing to adapt to shifts in the opportunity set.

When traders don't have an adequate grounding in all four areas, their performance is impaired and this can create psychological frustrations that further interfere with decision making. In such cases, traders often look to psychology for answers to their trading woes, when in fact they need to make process improvements in one or more of the four areas above. This is why mentoring is so powerful: you can see, first hand, how the successful trader blends these success ingredients.

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