Lesson 8: Achieving Success
If you wish
to be a successful futures or options investor, you must learn to
control your losses. No talent that you develop as a trader will
ever be as important to you as this. The formula for success in
futures and options trading is:
X (AP) - Y (AL) = SUCCESS OR
FAILURE
(X) is the
number of profits that you have. (AP) is your average profit per
trade. (Y) is the number of losses that you have. (AL) is your
average loss per trade. You multiply the number of profits you
have times the average of your profits to arrive at your total
profits. You multiply the number of losses that you have times
the average of your losses to arrive at your total losses. X (AP)
equals total profits. Y (AL) equals total losses. Total profits
minus total losses equals success or failure. Of this formula,
the two most important letters to you are (AL).
Why is the
(AL) so important in your effort to achieve success. It is
important because (AL) is the only element of this formula that
you can control. Think about it for a while and you will see what
I mean. What result would be easier for you to manage in your own
account?
-
An
average profit of $800 per trade or,
-
An
average loss of $200 per trade?
It is
obvious that the answer is (2). You have some control over your
losses. You can manage them. You will have very little control
over your profits. Concentrate your attention on that which you
can control rather than on that which you cannot. How would you
answer this next question?
Your honest
answer would have to be "no". There is no one on the face of the
earth who can guarantee themselves or anyone else an average
profit of $800 per futures contract or option traded. No one.
Even if you trade only one contract one time once in your
lifetime, you can never guarantee yourself an average profit of
$800 on that trade. It cannot be done. It is hopeless. There is
no chance of guaranteeing that result. None. Now, what is your
answer to the next question?
Your answer
should be "yes". This you can do. It is achievable. It can be
done. Most traders can do it. The person who has never traded a
futures contract in his or her life can pretty much limit himself
or herself to this $200 average loss (AL) if that person has the
will power and the knowledge of how to do so. Then what is your
answer to the last question?
How did you
answer this question? Should you concentrate upon the achievable
or the non-achievable? History and experience answers this
question by telling us that it is always preferable to
concentrate upon that which can be done. There is a reason for
this. If you develop the skill of achieving the attainable, you
may be able to achieve the attainable.
Trading
in a series: Imagine that you are able to maintain an average
loss of $200 per contract or per trade when you are trading in
futures contracts or options or even stocks. Imagine that you aim
to be correct in your market decisions at least 33% of the time.
If such were the case, in every series of three trades you will
have a $200 loss, another $200 loss, and an unknown profit. What
sort of profit will you need in a 33% success rate program to
break even? You will need a $400 net profit. In order to break
even in this trading series your profit need be only twice your
average loss even though you are wrong 66% of the time.
Remember
that you will never be able to control profits in this game; you
will only be able to control losses. By keeping your average loss
to $200 and by being successful 33% of the time in your trades,
you will only need $400 in average profits to break even in any
series of three trades. Success or failure is directly
related to average losses. The higher your average loss,
the greater the average profit that you will need in order to
break even in a series of three. The lower your average loss, the
lesser the average profit that you will need in order to break
even.
The more you
control your losses by making them lower and lower, the easier it
will be for you to earn a profit from a series of trades.
Everyone wants to make his or her job easier. You make futures
trading easier by controlling average losses. A quick response
might be that "this is easier said than done" and that "no one
can control losses." But of course losses can be controlled. Here
are four really simple ways to do so,
-
Don't
trade. This creates an average loss of "0".
-
Immediately upon entering a position, enter a stop/loss
$100 away from your entry price. In most markets, this
will result in your being stopped out with a loss of less
than $200.
-
Every
time you take a futures position, instruct your broker that
if the market closes against you at the end of the day,
meaning you have a paper loss at closing time, you want to
terminate your position on the close. This will
accomplish two things. First, you will always go to
sleep at night with winning positions. All losing positions
will have been offset at the close. Second, if you are
trading in relatively stable markets your average loss should
be under $200 per contract. It could be higher if you are
trading in markets with wide price swings. If such is the
case, then simply do not trade markets where the daily price
swings are of such a magnitude that your average losses are
greater than $200.
-
Enter
your positions "at the market on the close" only. Once
you know your entry price, enter a stop/loss order $100 away
from that price. By using this method, you will always go to
sleep at night with little or no loss on your open positions.
When the market opens the next morning, it may go up or it
may go down. If it moves against your position by $100, you
should be taken out by your stop/loss order. Only in those
situations of limit moves might this not happen. If the
market moves in your favor, you are on board a winner. You
may remain with winning positions for as long as you like or
for as long as they are profitable.
These
are just four methods you may use to try to keep your losses at
an average of $200 or less per contract. There is no guarantee
that any of them will work for you except the first. But with
time and experience, each method should offer you the opportunity
to keep some reasonable control over your average losses, your
(AL)'s. It is important to control your average losses
because an average loss of $200 requires a profit of only $400
for you to break even in a series of three. This is true
even if the market returns you a profit in only 33% of your
trades. If you let your average loss run to $400 you start to
have problems. You will then have to make an $800 profit just to
break even in the series. And to earn a net profit of $200 from
your three trades, your third trade will have to return a profit
of $1000. In futures trading, it is easier to make $400 than it
is to make $800 or $1000.
So remember
that if your average loss (AL) is great, your profit will have to
be even greater in order to make money on any series. By
concentrating upon that which you can control and keeping that
sum at a reasonable amount, you will make the net profit that you
hope to achieve from any series more likely to be achieved.
Isn't that what you want in your trading, small losses and an
achievable net profit? If this is what your goal is, then
your road to success will be the road of controlling your losses.
You can travel this road using many different methods or
vehicles, such as the four I mentioned above or several others
that you can learn from my Choppy Market
Trading Method or other writings. Whatever method you select,
you should always remember,
-
You will
never be able to control your average profit per trade
no matter how hard you try.
-
You
should always be able to control your average loss per trade,
once you make up your mind to do so.
You must
learn to control your average loss (AL) per contract traded. No
talent that you develop as an investor will ever be as important
to you as this one.