Article

Trading on Borrowed Time – Part 2

This is the second part of Jea’s article entitled Trading on Borrowed Time. The first part is available here.

Most day traders are going to blow out their accounts, they just don’t know it yet. The same applies to almost every new trader entering the game. They are all on borrowed time, a disaster waiting to happen. It’s a gloomy picture, unless they take the right steps to prevent the impending disaster. The initial goal of trading is to diffuse the bomb before it explodes. It’s not about making money. This is what traders don’t realize until it’s too late.

The only way to diffuse the time bomb is by slowly building a foundation of knowledge and experience so that you will be properly equipped to handle all situations. I see newbie traders all the time that get lucky starting out in the game. They over leveraged and made some quick profits. Instead of using that money to properly buy time and set forth to learn the methods, they jump right back in for more fast money. When they eventually get tagged with some big losses, they have no real foundation. The only thing that worked for them was taking large over leveraged bets (which put them in the hole in the first place). From here, they will either put on the brakes and set forth to learn, or go even heavier to recover losses and end up blowing out their account.

It’s no wonder day trading is often considered gambling. Most traders are gambling. That’s what happened during the internet bubble. With the popularity of poker, the world now knows what the pros have known all along. Gambling is not gambling in the long run. There’s something very real and tangible that separates the pros from the fish (everyone else). The same applies in trading. Gambling is a 50/50 proposition with no edge. Speculation implies at least 60/40 leaning towards an edge. The latter is what consistently profitable traders have embraced.

Every trader at some point ends up in the abyss. They violated their own rules of trade management, setup filtering and size allocation. In full desperation, they leverage heavily into a Hail Mary trade. Against all odds, the miracle trade plays out and the account recovers. While the trader may consider this a gift, he will eventually find out that it is a curse.

What to do when you get that miracle trade:

1) Acknowledge you got lucky, admit it was a gift (like a Trojan horse)

a. the market doesn’t give you money for no reason, it expects that money back and MUCH more

2) Put yourself on probation by taking a self imposed hiatus for at least one trading day to get your mindset back to normal

3) Start back up trading smaller size with tighter filters, revert back to your foundation. The goal here is not to make money, but to replenish confidence levels steadily. If the overwhelming need to ‘make back’ losses causes you to over trade and make large size trades again, then go right back to step 2.

4) End the trading day early and on a small profitable trade if possible

Be aware of anytime you step over the ‘line’ and control yourself by simply walk away before you fall into the abyss

Negative Reinforcement
If you want to lose weight, what would motive you more…staring at a picture of an obese guy or a champion bodybuilder?

Chances are you chose the fat guy because that’s how you don’t want to end up. The same applies to trading. Negative reinforcement uses fear to prevent you from the worst-case scenario.

It’s an effective constant reminder of what you shouldn’t do. It’s also very easy to apply. Print out the trade blotter and profit/loss statement for one of your worst trading days (everyone has them). Tape that piece of evil right under your monitors so that you see it every trading day. That is the abyss. Take a good look at it every morning as you reboot your computers. Identify with it. Feel the sting… ouch. That’s what you don’t want to repeat today!

Band Aid or a Cure?
Taking a break from the action is only a temporary band-aid. If you haven’t built your foundation of knowledge, it’s just a stay of execution. You are still on borrowed time. All you did was just add a little more time to the clock. If you don’t take the time and make the effort to build a foundation, you will once again find yourself in the abyss. Remember, the faster you make it, the faster you lose it. Slow, boring, steady progress is the key.

Gauging the Market Trading Conditions
Please note that I am referring to the trading conditions, not the market index gains or losses. A strong or weak market is irrelevant to a trader. A tradeable environment is composed of follow through, trading channels and liquidity. Don’t mistake a market being up huge or down huge as a tradeable market. Sometimes they do overlap but not always. The best litmus test is to take your best setups and see if they play out. If they fail back to back to back, then it tells you the market environment is not fertile. Don’t punish yourself for this. It’s not your fault. The only actions you need to take are to preserve your capital and your confidence levels which means quit for the day.

If you can’t tell me your best up, then you shouldn’t be trading with cash in the markets. In order to measure anything, you need a measuring tool. As a trader, you should first set out to learn the most effective patterns and trading method. From here, you need to be able to assess what is a high probability setup and everything else. With my methods, the highest probability set up is called the perfect storm. If I see back to back perfect storm set ups fail, then it tells me this market is just not tradeable. We’ll either call it a day or trim our risk with much lighter size with the intention to call it quits on any further stop losses. It’s not our fault. The market just isn’t in the mood and we can’t fight it. Having the ability to realize this and the discipline to stop trading is the markings of a solid trader.

The only way to recover is by having a foundation to fall back on. Losing traders never took the time to build the foundation so they are constantly on borrowed time.

Building the Foundation
You might ask, what about the medium probability and the slightly high probability set up just before the low probability set up? That’s like being exposed to pink, yellow, purple and green when setting out to identify what black and white is. Anything less than the highest probability set up simply doesn’t matter. This is called tight filtering. This is what new traders need to do from day one. Filter only the best set ups. This is how you slowly build the foundation that you will need so that you don’t blow out your account. This foundation is what you fall back on any time you face a disaster or a slump. You start with the tightest filters first and based on market conditions, you may loosen them up to allow for more opportunities. The problem with new traders is they start with loose filters to begin with. When disaster strikes, they have no foundation of knowledge or experience to fall back on, they are in that proverbial minefield. This is where they cover their eyes and nervously walk straight forward…

This foundation is the only safety net that will keep you from plunging into the abyss. Therefore, the first thing a trader needs to do is learn some working methods to make them work, not make money. Failing to do this may result in some lucky wins in the beginning, but the market takes it all back and much more in the end.

Some will blow out their accounts much quicker than others.

Preservation of Confidence Levels
It’s kind of ironic how traders concern themselves with levels all day (support and resistance, profit and loss, margin, etc) but overlook the most significant level that affects their trading success, confidence. Confidence levels fluctuate with each trade. The degree of your gains or losses will naturally determine extent of the effect.

Trading is similar to Texas Hold’em poker in that most set ups are like most poker hands, they need to be thrown away. You should only be playing the best set ups and premium hands while actively throwing away the rest. As in poker and even at the casinos, the more you play (poker hands), the more you will lose. The more you trade, the more stop losses you will take. Every stop loss you take will subconsciously and consciously erode your confidence levels.

Confidence is having full trust in your own abilities. This trust must be earned slowly with steady small victories. These small victories add up. Small low risk trades allow you to be objective once again. With each small winning trade, you make a little money and simultaneously rebuild your confidence. Confidence is the key to this game. The world looks so much nicer through the eyes of confidence.

Don’t cross that subtle line between confidence and over confidence. This is called arrogance. Don’t mistake confidence with arrogance. Arrogance lets your guards down but makes you mentally rigid. Arrogance can RAPIDLY transform itself into desperation with just a series of losing trades and baboom… blow out. It happens very quickly! Afterwards, you will wonder how the hell you lost so much money so quickly after being profitable. It’s called arrogance, not the silent but the loud killer (as in loud screams and fists through the walls when all is said and done, doh).

How did it happen? You started off with profits on some high probability set ups. You managed the trades very well selling into the climax buyers. Your confidence levels were great and you were satisfied with your gains on the day. That’s the last thing you remember before the decapitation. What the hell happened? You fell victim to the silent assassin… boredom.

Boredom: The Silent Assassin
Effective profitable trading is boring. Why? Implementing tight filters for the best setups, by its very own nature will give you less (but the best) opportunities. You will spend the majority of the day in wait. If you are properly pacing, then you also know the first and last hour is where the best volume and action is. Therefore, you will most likely be doing nothing for 2/3rds of the day. Boredom will naturally set in. If you are profitable, the next enemy you will face is boredom. Trust me, this is a MAJOR enemy. Boredom slowly seeps in and takes over your trading.

Boredom can turn confidence into arrogance/over confidence. The trader will just trade a few ‘small’ trades here and there out of boredom. Just to ‘play’ around and keep it interesting. The first few stops don’t bother him too much, but, as these stops start to add it, he starts to notice his profits on the day eroding significantly. His ego kicks in. He wasn’t ‘supposed to lose’, so now he will add some more size just to make up the losses. When his losses start to grow, he adds more and more size on gamble trades. If he’s luck he’ll make back the losses but likely end up with the same profits as earlier when commission costs are taken into consideration. If he’s not lucky, then he will lose a big chunk of the account and set off the timer on the bomb.

Combat boredom by doing something active, other than trading. This is why having a ‘day job’ fits right into trading. The best way to combat boredom is to walk away. Cut the hard-wired connection between you and the markets. Get up and walk away from the computer screens. Take breaks!

End Your Day with a Green Trade or a Small Stop Loss
A trader with control has the ability to get up and leave the screens at any moment. He can call it quits abruptly. Emotionally, it can be tough to do, but your actions are all that matter. Remember that your action is required first, the emotions will adapt and follow. This is why you may feel crappy calling it a early day with a loss, but feel great for doing so the next day.

How may times have you stuck around a boring choppy day looking for just one more trade to bring your balance back to it’s highs and ended up losing all you profits by the end of the day?

You should always try to end your day on a positive note. Try to end your trading day with a small positive trade or a small stop loss. This will keep your confidence levels fresh and ready for the next day. I believe replenishing confidence levels comes from victories regardless of the size. This is an area where quantity matters more than quality. The more string of winners you collect, the stronger your confidence will be. Feed your confidence with small victories.

Good Enough
These are two words you should repeat daily. My scalp was ‘good enough’. My green on the day is ‘good enough’. My profits are ‘good enough’. These two words have an effect of diffusing pressure and loosening the grip. Pressure can easily build throughout the day and this train of thought can take the pressure off.

Bottom line, expect less and be pleasantly rewarded with more.

In a nutshell, to take yourself off ‘borrowed time’ and diffuse the ticking time bomb within, you must:
1) Never trade with desperate money

2) Expect less, get more- don’t set yourself up for failure with unreachable goals

3) Build a proper foundation based on solid methods – SLOWLY

4) Play only the fertile market environments

5) Stop trading for most of the day, stick to the first and last hour initially

6) Combat boredom by taking breaks away from the screens and do other things

7) Replenish confidence levels with small victories

8) Resist the urge to keep trading to make up losses if environment is infertile

9) Impose trading hiatus when you find yourself falling into the abyss

10) Be loose, not tight

As Sun Tzu put it “A skilled fighter puts himself in a position where defeat is impossible, yet never misses the opportunity to defeat the enemy”. As a trader, this is called being in cash. Embrace that beautiful defensive position whenever you are in doubt about a trade, the trading environment or your confidence levels. Take it slow and grind your way to the top. Good trading gang!

Please send any feedback or questions to jay@undergroundtrader.com

Jea Yu is a co-founder of http://www.Undergroundtrader.com , an interactive active trader chatroom and training site that has served over 8,000 traders, fund managers and investors worldwide since 1998. His brainchild was voted Forbes Best of the Web for four consecutive years under the active trader category. Mr. Yu has published two best sellers through McGraw Hill "Undergroundtrader.com Guide to Electronic Trading" ,2001 and "Secrets of the Undergroundtrader",2003 as well as two popular trading videos titled "Level 2 Warfare" and "Beating the Bear" published through Traders Library. He has been a featured speaker all over the country at various expos and seminars who enjoys a standing-room-only reception in the largest convention halls. Jay’s energetic presentation style, along with his obvious mastery of the materials being covered makes him an audience favorite. He has been quoted in USA Today, WallStreet Journal, and the Financial Times. Mr. Yu is an active contributing writer for http://www.TradingMarkets.com

new_trader

Well-known member
Jan 1, 2006
6,163
1,252
223
#2
It’s not about making money. This is what traders don’t realize until it’s too late.

The only way to diffuse the time bomb is by slowly building a foundation of knowledge and experience so that you will be properly equipped to handle all situations.

Precisely, exactly.
 
Feb 13, 2008
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#3
Been trading for about a year and have recently formulated a high probability setup that has a good working ratio. The problem that has still plagued my trading is that I seem to always give back my wins. Over the past week I realised that I enter my setup, make profit , feel untouchable, so I don't realise that the setup is changing, it is no longer my set up but i'm still trading. This article has confirmed everything I was thinking and more. It's helped me realise that my high probability setup has to be enough. Theres no point in trading any other; e.g medium to high setup. If I want to trade more I have to discover another high prob. Setup!
 

PKFFW

Well-known member
Jan 9, 2006
535
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Sydney
#4
Great couple of articles.

The only part I would disagree with is the idea of negative reinforcement. Personally that idea never works for me.

Cheers,
PKFFW
 
Dec 13, 2008
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#6
Completely loved the article! I am a professional psychologist specialising in personality and motivation (apart from trader as well) and psychology I would say is the other half to successful trading (first half being a system). Your article focuses on this elegantly! Positivity and self-awareness are key to battling fear and greed which absolutely cripple many effective strategies, and unfortunately leave capable traders feeling and thinking they are completely hopeless loosers (when it is just 1 element of their personality they need to work on, in order to becoming successful). Excellent article! There should be more articles like this!
 

apo

Member
Jun 25, 2008
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#7
Thank you for this wonderful article. You have articulated many things that I have experienced but could not put into words. Focusing solely on the 'creme de la creme' trades ...not giving in to the boredom and taking 'by the seat of your pants' trades.
 
Jan 4, 2011
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#8
A great article! A must read for any trader who wants to make it and not blow out in the first few months of their trading career. Some sound advice ... we just need to remember to put it into practise.
 

NVP

Well-known member
Jun 21, 2004
35,598
1,710
223
fxcorrelator.com
#10
Been trading for about a year and have recently formulated a high probability setup that has a good working ratio. The problem that has still plagued my trading is that I seem to always give back my wins. Over the past week I realised that I enter my setup, make profit , feel untouchable, so I don't realise that the setup is changing, it is no longer my set up but i'm still trading. This article has confirmed everything I was thinking and more. It's helped me realise that my high probability setup has to be enough. Theres no point in trading any other; e.g medium to high setup. If I want to trade more I have to discover another high prob. Setup!
precisely ....its no where you start its where you finish ;)
 
Mar 15, 2013
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#13
I totally agree with that statement but i do believe anybody claiming 2 b
a succesful trader has to blow out a account or 2.Iv learned more from my failures than my success.I do believe your misjudgements and loss of capital makes u well in my case made me study candle stick patterns harder find more technical indicators that suited my style of trading and be a all round better trader.

ps. blowing out a account is not the end of the world i know it may feel like it but the pain heals take this advice and live by it DO NOT TRADE WITH MONEY YOU CAN NOT AFFORD 2 LOSE.SCARED MONEY IS DEAD MONEY
 
Oct 10, 2012
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#14
Aptly put it ,sir. I've gone through it . I stick to first and last 45 mins of trading day. Most of the time profits with few small losses. Rest of the day, I study to kill off my boredom. If I find good chart patterns in between I take a trade.
 
Dec 9, 2012
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#15
I'd be interested in hearing the authors views on which markets are easiest for a private investor to beat. I have traded pretty much everything over the years and find the major FX markets impossible to beat, no matter how much research I do. I've come to the conclusion that the Gold market is completely rigged by the major Central Banks. The one market in which I have an edge is single stock shares, where value can be found by doing the research.
 
Likes: WR1
Apr 23, 2013
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#16
All points agreed

All your tips are right on the money…..literally! I just don’t get the Boredom comment? I LOVE trading and never get bored, everything about it is interesting and exciting to me. Maybe that’s just me, but I think if you get bored with this then you shouldn’t be doing it. Perhaps that’s why I’ve been doing really good in my trades. The fact that I enjoy it and I’ve got a knowledgeable trader that has taught me the ropes keeps me from getting bored. Anyway thanks for the article.
 
Aug 26, 2014
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#17
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