It is relatively simple to create a profitable system for trading forex, stocks, or commodities on paper, and there are countless trading books filled with strategies that you can adapt.
But it is not so easy to successfully implement the system once it is created. While the primary forces underlying market behaviour may be fear and greed, the primary cause of unprofitable trading is almost always impatience, which may very well be a subset of both fear and greed.
A profitable and successful trading system requires three basic elements and three fundamental characteristics. The basic elements are a strategy for entering positions, a strategy for protecting positions from unacceptably large losses, and a strategy for exiting positions with a profit.
The fundamental characteristics of a profitable trading system are that winning trades are on average larger than losing trades, that the number of winning trades is larger than the number of losing trades, and that the frequency of trading signals is high enough to keep the attention of the trader focused on trading. (Of course, there can be successful variations on these fundamentals: for example, a system that produces 95% winners could have the average win much smaller than the average loss and still be profitable).
Once a profitable trading system is created, the trader’s inability to follow the rules of the system is the primary cause of unprofitable trading, and impatience is one of the driving forces behind a trader’s inability to follow the rules.
Impatience will typically manifest itself in all of the following ways:
- A trader will follow a new trading system to the letter and begin to get good results, but will see ways that each individual trade could have had a better outcome by bending the system rules just a little. So, instead of being satisfied with X amount of income from the system, the trader will decide to try to achieve 2X income by changing the system rules on the fly, which always results in errors in judgment caused by fear and greed (which the system was designed to eliminate by its carefully formulated rules).
- A trader will see an entry signal forming (almost, but not quite – it needs Y action to manifest on the next bar before the signal becomes valid) and decide to enter a position on the supposition that the signal will trigger soon, anyway. Of course, the system was designed with black and white entry triggers, and violating these entry rules results in the arrival of bad behavior ruled by fear and greed.
- A trader will wait for hours (or days or weeks, depending upon the system’s time frame) for a proper signal to form and become frustrated by the lack of action on a slack day (or week or month . . .) and begin to talk herself into believing that a given scenario represents a valid signal, even though all the proper elements are not quite there, and enter positions that are doomed to failure because the market is just not in the correct mode for the system during that time.
- A trader will hold a winning position too long because he expects one trade to make up for the previous losing trade (or trades) in one swift move that is outside the parameters of profitability expected by the system.
- A trader will take a profit too soon because the market is taking longer to reach the system’s profit objective than she is comfortable with.
- A trader will take a position much larger than the system’s risk parameters allow for because he wants to make a big profit quickly (often to try to make up for serious previous losses caused by violating other system rules), but then when the market goes against him he will panic and exit with a loss before the system loss point is hit because the pain of holding the over-sized position is too great to bear. Then, she will scream in frustration as she watches the market turn around and move back to profitability soon after she takes her premature loss.
These just begin to illustrate the danger posed by impatience if a trader cannot keep it under control. Meditation, frequent breaks from the market, a clearly defined trading system and a clear set of profitability goals (‘Financial Freedom Through Electronic Day Trading’, by psychologist Van K Tharp illustrates a step by step strategy for building capital in a rational manner without impatience) can all help to keep the trader relaxed and trading within the rules, resulting in profits instead of losses.