Monday Series: Part 3 - Dealing with Uncertainty

"Risk comes from not knowing what you are doing". Thus spoke Warren Buffett in describing the attributes that made him so successful. How can the average trader make use of this simple homily in developing a mindset for consistently successful trading?

Traders constantly strive to be correct in determining both the timing and direction of market moves. Traders like to minimize uncertainty and have comfort that their trades have more of a probability than a possibility of being successful. Experienced traders appreciate that the markets provide a take-no-prisoners arena for competing against the most highly capitalized and best educated traders in the world who have no regrets about beating us on a trade and taking our money. Most successful traders have developed an edge, both perceived and actual, that there is a quantifiable probability that the market will move in one direction or the other, (or will not move significantly at all). Popular edges include technical analysis tools such as moving averages, pivot points and trend lines which seek to identify recurrent patterns in market behavior. These technical analysis and pattern recognition tools used in a methodical and consistent basis can help traders stay focused on current and developing market dynamics. At the same time there are always unknown forces and traders operating in the market with diverse goals and strategies that may not be logical from your perspective, so if you utilize a trading plan that posits anything can happen in the markets then you will always be right. Typically, Murphy's Law will prevail and “anything” will happen most often when you least expect it or when it is most disadvantageous to your market position. "In the Zone" traders have trained their minds to believe in the uniqueness of each moment in order to be open and perceive what the market is offering. These traders have accepted the inherent uncertainty of the market and have developed an almost detached state of mind that treats trading as a probability game. So far, so good, but this is where it gets interesting. Last Monday I mentioned Curtis Faith and THE WAY OF THE TURTLE. One of most interesting things Faith mentioned it that he believed most of the Turtles failed to achieve good results because they could not or would not follow the trading plan which they were provided. Other Turtles exited their positions too soon, missing the big moves that followed. They also avoided the 70% drawdowns (that's not a misprint) that Faith sustained. Anybody out there think you could live with even a 20% drawdown? I couldn't. Which brings up another point. I have a friend who is director of managed futures for a medium size firm. He oversees about 80 CTA's and reports that when many CTAs start to show superior performance they often choose to leave the firm and trade their own money. He further reports than in over 50% of those cases over the next year the CTAs have substandard performance or worse....... much worse. Managing other people's money involves a whole lot less risk than managing your own and although the stated trading plan may be the same, the frame of mind from within which it is executed can be dramatically different......along with the results. A common theme that is repeated by struggling traders is that they freeze at the trigger. They have developed a trading plan, have backtested it, forward tested it, paper traded it, and are confident that it will be profitable, but when it comes to laying real money on the line they are unable to act. Worse yet are the instances when the market moves against your position and you freeze, hoping that the market will turn. This is an example of not having a tactical trading plan......but the good news is......it can be fixed. Consistent traders display rigid adherence to the rules of their trading plan and flexibility in the expectations for how the trade will play out. While the trading plan provides a dynamic road map for navigating market fluctuations, the mindset provides the adaptive perspective to embrace and react to those changing market conditions. Most of the successful traders that I know do not focus on making money; rather, they focus on developing and embracing a unified mindset of technical, tactical and mental skills.

Next week: Improving your odds