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Thursday, March 31, 2016

Lessons from a Social Trading Program

“I realised that the best way to free myself from worries about uncertain outcomes, is to make sure a negative outcome of a specific trade will not affect me.” - Christiaan van der Meer

I recently came across a popular social trading program that enables signals providers to go through various career levels. This social trading program appeals to me because it doesn’t honor those who achieve most profits over the shortest period of the time without considering risk control methods and survivability of trading strategies used over a long period. The organizers of the social trading programs know what it takes to be a winning trader – unlike most competition organizers who flaunt lucky gamblers as market wizards.

There are 5 categories of traders in the program, namely: street traders, advanced traders, professional traders, risk-adjusted traders and institutional traders. Street trader is the lowest level and institutional trader is the highest levels and that is the level that most followers want to follow. You go through each level one after the other, and gradually.

Traders going through each level must not suffer more than 25% at each level.

1.      A street trader must spend 30 days at that level and must make at least 0.5% profits before becoming an advanced trader.
2.      An advanced trader must spend 90 days and must make at least 1.5% profits before becoming a professional trader.
3.      A professional trader must spend 180 days and must make at least 3.0% profits before becoming a risk-adjusted trader.
4.      A risk-adjusted trader must spend 360 days and must make at least 6.0% profits, before becoming an institutional trader, who must spend at least 365 days to get to that level.

Institutional traders are what people want to follow. Honestly, anyone who reaches the institutional trader level really has a proven strategy and safe risk control techniques. One sensible trader follows one institutional trader and he’s happy to have gained 2.1% in a recent month (not 20% or 200% per month that irrational people aspire to).

If trading contests and social trading programs were structured like this, all temporarily lucky suicide traders and gamblers would be prevented from reaching the top: the highest level. Can traders, brokerage firms, trading education websites, and other financial institutions learn anything from this?

A Baptism of Fire
When you buy or develop a new trading methodology, you’re in high spirits, thinking that you’ll soon be soaked in money and you’ll be rich enough to serve your landlord a quit notice. However, your newly-found speculation methodology will sooner or later go through a baptism of fire.

There are merits and demerits of wide stops, tight stops, wide targets and tight targets.

When a take profit level is tight, profits are taken quickly and the hit rate increases. But it’s the disadvantage of missing on larger movements for each trade, therefore making us to miss out on greater profits.

When a take profit level is wide, the hit rate is reduced but few trades that hit the target levels would recover numerous losses. Wide take profit levels are rarely hit in consolidating markets.

When a stop loss level is tight, we’re quickly taken out of the markets in case adverse movements occur and we keep our losses small as well. But it’s the disadvantage of too frequent stop-outs, plus too many small and accumulated losses can become something big with time. We’re also frequently, prematurely stopped out of trades that could end up being profitable.

When a stop loss is wide, we give our open positions enough leeway so that in some cases, we aren’t prematurely stopped out of positions that could end up being winners. This has the potential of increasing our hit rate, but there is a disadvantage of being stopped out eventually, which makes the loss per stop loss trigger a considerable thing because of its width.

If you don’t use stop loss, then you’re a suicide trader and a gambler. This means your risk is unlimited. You may look smart in most cases and for a long time, provided that market are choppy and consolidating, but rare adverse movements will soon occur and your account will go kaput.

If you don’t use take profit levels, then you need patience and discipline to catch rare trending markets which would recover all your past losses and move you ahead. This means your reward is potentially unlimited, though you’re better off using take profit levels.  

To sum it up, someone called “loyek590” on Elitetrader.com wrote: “I've traded the chop and I've traded the trend. The chop is nice because you make money every day. Until that one day that wipes out the whole months profits. Now I trade the trend and lose money almost everyday, until I catch that one rare trend and hopefully it wipes out all those small losses.

This is really a baptism of fire which all traders will face. If your trading methodology can come out victoriously in spite of the advantages and disadvantages mentioned above, then you’ve found a pearl of inestimable value.

Conclusion: There are no perfect trading methods or perfect risk control methods. We simply need to find optimal parameters for our strategies and adapt to the ongoing market conditions. I’m so grateful and happy now that I allow my stops to always protect my capital.  I know a trader who’s never had a negative year in his career – this is possible for all us to attain.

This piece is ended by the quote below:

“Accept drawdowns as part of this business and learn how to deal with them. When you think about increasing your position-size, be aware that more profits usually mean more risk. Get to know your drawdowns and backtest to get an idea of what to expect so that you’re not surprised when it happens.” - Marco Mayer





What Super Traders Don’t Want You To Know: Super Traders

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