Can you beat the market? Many academics will tell you no. The markets are just too efficient in the long run. Those who appear to be winning are simply lucky fools who will get their comeuppance eventually. Are the efficient theory proponents right? I really don’t know. Certainly the challenges are daunting. In any given year only 10-20% of all market participants manage to beat the averages. Still, regardless of whether the professors are correct, traders will continue to trade for the very same reason that climbers continue to climb Mount Everest – the human spirit will always try to master a challenge.
So if you are going to try to play the game here are my rules that I call the Tao of Trading.
1. Have an edge.
There are only two types of edges available to most traders in the market – informational and behavioral. (For now let’s forget all about execution edge because most retail traders will never have it) Informational edge is simply what we call fundamental analysis – and most retail traders ignore it at their own risk. Fundamentals are the primary drivers of price action. To trade without knowledge of fundamentals is like driving blindfolded by “feeling the curves” of the road. Chances of a crash are almost assured. The second edge is behavioral which is simply another way of saying know your technicals. Technical analysis despite its fancy geometry and mathematical indicators is nothing more than an attempt to handicap human behavior. I believe that technicals work better on ultra short term time frames when price action is not subject to ever changing news flow, but that’s a matter for debate. What’s incontrovertible is that techs are an important compliment to fundamentals. At BK we always trade in alignment with both and that approach provides us with our edge.
Recognize that ALL edges will disappear over time as more and more traders attempt to exploit them. That why the search for edge is a never ending process.
2. Don’t be greedy
I know that the standard trading advice is: make your winners bigger than your losers, but I have never had success with that approach. Markets are generally not that generous. The standard refrain is that you need to be correct 50% of the time on a 2-1 reward/risk trade to make money in the long run, but in my experience the market produces strict 2 to 1 payoffs only 30% of the time making that strategy a loser. Floating profits are just that - floating. They can hit an iceberg anytime. That’s why I’ve never found a better way to manage risk than to take partial profits early and try to ride the rest to glory. When it comes to trading a bird in the hand IS worth two in the bush
3. Be Humble
It is incredibly seductive to pound your chest when you are winning and proclaim you are the Greaaatest, but Mr. Market will bitch slap you mercilessly just when you think you have it all figure out. K and I are blazing hot right now, but we spend most of our time ruthlessly challenging each other’s assumptions and come up with many more reasons to rule OUT trades rather than to rule them IN. Having done this for a long time we are the biggest skeptics of our own hype. We know just how tough this game really is. This brings me to my final point.
4. Trade One Pip at a Time
The best way to make a millions in trading is to never try. Novice traders always approach trading with a hidden desire of hitting it big. The marketing literature of our business is littered with take “$10,000 to $1 Million in Just one year” pitches. That’s not trading – that’s the lottery. The real business, as many of you who have been with us for several years know, is remarkably prosaic. Two steps forward, one step back. Every basis point of return is a cold calculated battle with the market. In the end wealth, like all things in life, is built one brick at a time. Perhaps the reason why so few people make money from trading is because most simply don’t have the patience or the equanimity to withstand Mr. Market’s inevitable blows. But if you really like the game, the intellectual and financial rewards are well worth the challenge.