I have always said, that trading consists largely of psychological components. Traders should therefore spend a lot of their time on it, to work on their attitude. The fact is, that most “Super Trader” have worked on their psychological attitude for at least one year, before they started developing their trading plans and trading systems. When mistakes are made when trading, these are often psychological in nature.
Let us therefore take the “Psychology of Trading” from the point of view of “Errors” view from. If you don't follow your own trading rules, then make a mistake. That's simple and if you make this mistake over and over again., then this is called self-sabotage. Self-sabotage is another area in psychology, which offers ample possibilities, Improve your trading results.
But we want to focus on mistakes, related to a specific category of traders. At the beginning I would like to show you a way, how to measure the errors, that influence your trading behaviour. The efficiency of trading comes about through measurement, how effective a trader is, Process error-free trades. If a trader at 100 Trades make five mistakes, then it is too 95% efficient.
Over the past five years, my super traders have neatly documented their mistakes., so that my team and I could take a close look at the efficiency of each trader. I found out, that the value of 95% reflects a very good efficiency in trading.
However, some traders did not achieve any 75%, a terrible value! It means, that these people make a mistake on every fourth trade. This is of the utmost importance for a particular type of trader, the mechanical trader. This guy believes, that he has trading problems, that can be eliminated related to psychology, by trading mechanically. Many people strive to trade mechanically, let the computer make all decisions, because they believe, so that all human errors can be excluded.
One of my best friends once said to me, that psychology doesn't play a role in his way of trading, since its trading is fully automatic. I replied to that: “With the method, however, you could miss a good trade.” 18 Years after this statement from me, he had to close his business. Be “Partner” the computer had decided against a certain trade and this one trade would have given him the financial means for the whole year...
I always said, you can only trade your beliefs about the market. Therefore, let's take a look at typical beliefs, that a mechanical trader usually has.
- With mechanical trading, I can be objective and not make mistakes (except for the psychological errors, change my trading approach).
- Mechanical trading is objective. My system allows me to determine my future results.
- Mechanical trading is precise.
- Human decision-making is too prone to error.
However, I can compensate for this shortcoming with a mechanical system.
But mechanical trading is really objective? I think, that it is not, because there are also a variety of sources of error here, that can even influence an automated trading system. Incorrect data, faulty software, Errors in programming the setups etc.
With erroneous data, the trouble starts. Are your course data always displayed correctly, or does the data flow sometimes stop, and it appears “Error”? What does their trading software do in such a case?? Does this potentially trigger a trade?? In addition, the historical price data may not be correct, for example, if stock splits or dividends have not been taken into account. Mechanical traders constantly have to deal with sources of error of this kind.
Once I wanted to find out, whether I have an effective, Can develop automated stock trading system. So I looked into it “Efficient” Shares around, bought them and secured them with a trailing stop from 25% Off. I was using a dataset of the S&P 500, the course information of the last 40 years included. The data appeared to be well prepared and splits and dividend payments were taken into account.
I was very pleased with the first results, because my system made a small profit. But at that time I was not clear, that the system was trading on the basis of false information, because the data set allowed the system to buy shares at the respective IPO time, however, these only later became part of the S&P 500 Index.
In the back test, my system bought shares of Microsoft, eBay, Intel and many other companies – before anyone knew, that one day in the S&P 500 would be listed. Why? Because my dataset represented the state of today and this data 40 Going back years. The back test was therefore carried out on the basis of incorrect data, the profits were made by shares of companies, that did not even exist on the stock exchange.
The mechanical trader under the magnifying glass
In the first part of this column we have found some sources of error, that can negatively affect the mechanical trading approach, because mechanical trading is not really objective. Because in this approach, erroneous data plays a role, faulty software and errors in the programming of the setups an important role. In the second part, further sources of error of the mechanical traders are illuminated.
What was on 6. May 2010 actually off? The Dow Jones lost 1000 Points in only round 20 Minutes. Blue chips like Procter & Gamble gave over 20 Counter off and accenture's title practically became a penny stock. Certainly, several reasons were decisive, that it came to this mini-crash, but which also had a major impact on automated trading systems. Because a crash happens every now and then, and this is exactly the big challenge for mechanical systems, dealing with such things.
Note: Of course, traders without a mechanical approach were also affected by the price drop on this day.. A client of mine said, he used trailing stops at the height of 25% and was still stopped with every single share. But there were also traders who made big profits. Ken Long, one of our trainers, has in the week of 3. until 7. May reaped a profit of 100R with its trading approach. As always, he was very cautious and conservative in his trades and was very careful about it., to have the risks under control.
There is another category of errors in mechanical trading systems: Setting criteria that are too narrow and strict. Because the criteria of trade setups are often too precisely defined, mechanical systems miss many good or even great trades, which traders can easily identify with a self-determined trading approach.
Sometimes mechanical systems miss an entry into a trade, who would be wonderful, just a dot... a trader with a self-determined trading approach, on the other hand, can decide at any time, when he starts where and even if he should make the decision intuitively. Of course, this applies to the exit from a position. Too strict criteria in determining trade setups can sometimes be poison for the mechanical trader.
There are a lot of sources of error in mechanical trading systems and as seen especially in the choice and setting of criteria. And that's just the point, that matters most. Once you set their rules in a way, sometimes too precise, that a computer can execute their trades, fall into the criteria trap. They give their program too much information, too little relevant information or do not pay attention to necessary information. Or how programmers say to maintain: “When you type in crap, then only crap comes out of it.”
Therefore, their automated trading system also cannot make good or excellent trades due to the strict rules, which were given to him. Through the logic of mechanical trading systems behind it, limit as a trader the actual existing potential or the real existing possibilities for highly profitable trades. In comparison, a trader with a self-determined trading approach, where it can vary, even then, as a rule, achieve better results, as a mechanical system even if both use the same trading approach.
Traders who determine their own trading approach are rare and are among the most successful traders worldwide. Of course, they also have a set of rules. However, these are, in contrast to the mechanical traders, flexible and broader. I can say one thing for sure:
Every graduate of my Super Tra program is either a mechanical trader or a trader with a rules-based, self-determined approach to trade. The latter have adopted rules in their daily trading practices, that support their success.
Thus, only a small selection of stocks is analyzed and their price development is tracked. These people pay attention to strong and noticeable course corrections, also with different indices. You never risk more than 0,5% of their capital per position. You ensure, that the risk-reward ratio is at least 3 to 1 per trade is. You use trailing stops and never trade more than 4 Positions at the same time. And finally,: They rethink and change their rules, if at least one profit of 5R does not jump out at the end of the month.
For reasons of space, I have only listed some of the rules of successful traders. But they can be sure, that successful traders have rules for all areas of trading and these rules allow a maximum of self-determination because they can be adapted to any market situation at any time. An invaluable advantage over a mechanical approach.