Last New Year’s Eve, I gave one final prediction for 2011 in this post. Here is the text:
“There Will Be Head Fakes”
Accordingly, please use caution headed into the next several weeks. There is nothing wrong with taking a wait-and-see approach to start the year.
HAPPY NEW YEAR
Given my style as a technically-driven trader who is best at reacting to price and momentum, it is tough for me to make bold predictions seriously. I was having a bit of fun in that post above, but my sense was that 2011 would, in fact, be a difficult year for just about all market participants. Your style may very well be different from mine in terms of making bold predictions, and that is fine by me. I just try to stick to what I do best.
We have a little more than a month to go in 2011, and there have indeed been plenty of head fakes in both directions at various points throughout the year. Although it sounds, and can most certainly be, boring to say and do, protecting capital has been the far more important discipline to practice this year than growing it. Usually, that means staying in heavy cash and keeping a tight leash on positions.
And that brings me to my next point: The most important and least discussed aspect of trading is bankroll management.
“How do you pay the bills while in heavy cash?” is a question I often see on the Twitter stream from traders who believe they must trade all day, every single day. First and foremost, if you are an active day trader then you are going to, naturally, be more active than I am as a predominant swing trader. Beyond that, though, if you trade full-time then you should have, at the very least, six-to-nine months of living expenses set aside in the event you are trading lightly or are on a nasty losing streak. To state the obvious, unlike other jobs where you are an employee working for a salary or hourly paycheck, in the market you are risking capital each and every time you try to make money.
If you think about it, anyone can label themselves a full-time stock trader. It is only when you deal with the inevitable losses, especially the ones that come quickly and throw you for a loop, that you find out if you are a true professional. In addition to temperament, i.e. not going on tilt, being properly bankrolled is a must if you are going to trade full-time. Not gambling with the rent money is one of those old axioms that will never become obsolete, given how many will be forced to find religion through the school of hard knocks in the market.
There are plenty of talented traders out there who blow up their accounts not because they got outmaneuvered by the guy (or robot) on the other side of their trade, but because they were simply not bankrolled properly and felt compelled to overtrade in poor market conditions to try to “pay the bills.” Well, I have news for you: If you need to trade to pay your electric bill and utilities, then you are in the wrong profession. Being properly bankrolled also gives you the peace of mind that you do not have to, in fact, trade all day, every day. Trading is gambling, although your definition of gambling may differ from mine. The market owes you nothing, and society has exactly zero sympathy for those who have the capital to trade/invest and lose it all (unless you are a giant bank, in which case you can rely on a bailout from Uncle Sam).
If you do not have those six-to-nine months, at a minimum, of money set aside, then no amount of technical or fundamental analysis will keep your back from soon being up against the wall. In addition, position sizing is an important subset of bankroll management, which I will discuss in another post. In easier, trending markets, mistakes are easily forgiven by Mr. Market. But those markets eventually morph into nastier ones, where there is much more of a premium placed on details and discipline. We all make bad trades and stray from our discipline at times. The key is quickly re-focusing and striving to improve.
However, failing to adhere to bankroll management is worse than a mere blunder in a chess game–It often amounts to leaving your King exposed to get checkmated by the market. And that will ultimately be the take-home lesson for most traders from the market as the year 2011 comes to a close.
Epic and so correct. Just in time for my linkfest, perfect!
Nice post. Seems like you and wood are the only people that ever really talk about this. Too many people use leverage in lieu of an edge to generate returns and everyone who has been around a while knows how that inevitably ends once things go against you, which they always do at some point. I would say that something along the lines of 18-24 months (liquid assets w/ no equity exposure) is more appropriate though for anyone really considering trading full-time and will actually make one a much better trader for it.
You are def right about position sizing!
Great Post Chess-ter! I have learned this all too well this year.
Great post! I think this needs to be said and often. It’s my impression that many don’t understand this.
Buddy, incredible post..
Great post, Chess.
BTW, how do you get onto the elk to ride them? And how do you get them to stop and let you off when you’re done?
After having spent 100s of hours reading your contributions here on this site … and when I say “contributions” … I mean that in the truest sense of the term !
I must confess …
To NOW learn that you also have a penchant for “riding elk” and … well … “playing with gunpowder” is quite schocking to say the least !
YOU … just may be …
The Most Interesting Man In The World !
… okay I … am actually the most interesting man in the world !
… okay … make that my street !
I have (actually) been known to “play with gunpowder” ! fwiw
… uhhh “schocking” = shocking ! fwiw
Great post as usual. The thing is though – this sage advice usually falls on deaf ears. It takes the experience of (almost) blowing up to get it in most cases. Funny how that works huh :-). Hopefully your post will save someone some pain.
U R right about that. We humans usually have to experience peeing on the electric wire ourselves rather than taking others’ advice not to do so.
But for the few exceptions to the rule, reading Chess’s post will be helpful. And then maybe some folks will remember Chess’s post AFTER they have peed on the electric wire through money mismanagement, and think “Oh, that was what he was talking about.” So then maybe they won’t have to pee on it 3 or 4X, but only once or twice, to learn the lesson.
Very good post chess.. as always 🙂
Excellent post as usual! Thx
great post! maybe you could include some of your percentage results,(ytd, like the fly) to show how your method has worked. i’m sure that on a risk adjusted basis you have out manouvered most market participants this year. it would certainly add credence.. (i don’t doubt for a minute that your style is working for you).
The post is not about crushing the market with YTD gains. It is about long-term management of capital as a professional trader. Whether or not I “have credence” is up to the reader to decide.
Thanks for all the responses, guys!
Chess… I was going to do my year-end blog about this but you seem to have hit the nail precisely on the head. Been seeing a lot of blogs by traders talking about their losses this year so I guess we are all feeling some pain. And, you’re exactly right. Trading is a gamble and if you need the money to pay the bills then you can’t trade effectively.
A trader who is properly bankrolled and using the correct risk management will always live to fight another day.
Cheers, my friend.