Traders Must Bend But Not Break

 

Today I would like to explore three concepts in trading that many traders have never thought about. Fragility, robustness, and anti-fragility are concepts that describe a trader’s psychology, risk management, and method.

Here are some general definitions:

Fragility is a word used to describe something that is easily broken, shattered, or damaged. It means very delicate or brittle.

Robustness is a system’s ability to operate without failure under a variety of conditions. Being robust means a system can handle variability and remain effective in challenging environments.

Anti-Fragility can be described as high-impact events or shocks that can be beneficial to certain kinds of investment methodologies. It is a concept invented by professor, millionaire trader, bestselling author, and former hedge fund manager Nassim Nicholas Taleb. He invented the term “anti-fragility” because the existing words used to describe the opposite of “fragility,” such as “unbreakable” and “robustness,” were not really accurate. Anti-fragility goes beyond these concepts; it means that something does not merely withstand a shock, but actually benefits from an outlying Black Swan event.
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Fragile Traders are new traders that struggle to survive the first year. Their psychology is fragile; they don’t make it through the learning curve because they expect to immediately make money. Learning to trade takes time, just like any other professional pursuit. Fragile traders lack the mental strength and perseverance to stick with trading until they are successful. They make decisions based on their pride, fear, and greed which eventually break their accounts.

A fragile trader has poor risk management. They risk a lot to make a little. Big position sizing leads to fragility because all it takes in one big adverse move to seriously damage an account.

A fragile trading methodology is one based purely on opinion that really has no edge. It is counter-trend, where a trader thinks the logical thing to do is to short uptrends, and go long downtrends, instead of going with the flow. Shorting bull markets and catching falling knives is a fragile trading methodology.

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Robust Traders are usually, but not always, trend following traders. There are many different types of robust trading methodologies that put the odds on their side.

Part of what makes traders successful is that they don’t put too much weight on any one trade. The most successful traders limit their total account risk on any one trade to 1%-2% of total trading capital. They carefully look at a market’s volatility and logical support levels to position size effectively and set appropriate stop losses.

Their risk management principles make every trade just one of the next 50-100 trades. This brings down their stress level, and turns down the volume on their emotions. They risk a little over and over again for the chance to make many times their risk.

A Robust Trader has completed the homework on their methodology, system, and principles. They know why their system works, and they understand their edge. They keep the faith in their systems, even during losing streaks, because they understand the realities of changing market environments. They know what kind of trader they are, so there is little internal dialogue of doubt or confusion; they just trade.

Because robust systems are generally trend trading systems, they can profit in both bull and bear markets. These traders need trends to make money, and don’t do well in choppy, trend-free markets or range bound markets. Their systems are robust because the trends come back around eventually, and the profitability of those periods, make up for the  smaller losses in trend-free markets.

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The Anti-Fragile Trader is someone that puts on very small position sizes in low probability trades, but shifts huge amounts of risk to the trader on the other side of the trade. The methodology of the anti-fragile trader is to bet on the eventual blowup of the traders making high risk trades for a small premium.

The favorite tool of the Anti-Fragile Trader is the out-of-the-money option contract. For pennies on the dollar, they can control huge amounts of assets. While they expire worthless the majority of the time, when a random Black Swan event hits the market affecting the option contract, they can return thousands of percent on capital at risk, and makeup for all the past losses.

The creator of the anti-fragile concept, Nassim Nicholas Taleb, traded long option strangles, betting on both directions to capture any huge trend event up or down. A company being purchased and rocketing up, or a disaster and a company stock sent crashing, was hugely profitable for Taleb. He also bought option contracts on futures markets. The key is very tiny bets on these trades versus total account equity. Tiny losses and tremendous wins was what made the system profitable.

Anti-fragile traders grow stronger through losing trades by learning instead of quitting. Rough market environments don’t break them; it educates them on what to do different in the future. A trader who is mentally anti-fragile has no doubt that they will be a successful trader, and that only time separates them from their goal.

The anti-fragile trader wins in volatile markets and random Black Swan events, outside the bell curve of normal price movements. Taleb made a fortune in the Black Monday crash of 1987, and many other instances over the past 25 years.

What kind of trader do you want to be?

35 Top Destroyers of Trading Capital

 

When I asked my Facebook trading group what was the cause of their biggest trading losses, no one had any trouble remembering those painful and valuable lessons. These top 30 insightful answers will benefit new traders and provide a nice reminder for those with more experience.

“What was the cause of the biggest draw downs in your trading accounts?”

  1. Having no exit strategy
  2. Being certain of your opinion on the direction of an asset
  3. Arrogance that you know how the trade will turn out
  4. Thinking that you are invincible
  5. Over-trading
  6. Believing that the market must go down based on a guru’s prediction
  7. Letting a guru convince you that you shouldn’t place a hard stop, but to wait for a reversal
  8. Incorrect position sizing
  9. Greed that causes you to trade too big and risk too much
  10. Margin
  11. No Hedges
  12. Not understanding that a Bull Market has ended
  13. Poor risk management
  14. Not knowing that earnings were about to come out on your stock
  15. Your ego takes over your trade
  16. You decide not to take your initial stop loss
  17. Believing a losing trade just has to reverse
  18. Buying a stock because it is a ‘value’ that drops another 50% from your entry
  19. Trading without a positive expectancy model
  20. Trading options without understanding how to place stops or use proper position sizing
  21. Thinking it “Has To Come Back”
  22. Buying and hoping
  23. Trading with no plan
  24. Not having trading rules for your system
  25. Not following your trading rules
  26. Averaging down
  27. Trading without an edge
  28. Keying error on the trade
  29. Not placing a stop
  30. Trying to out-guess the market
  31. Trading illiquid options
  32. Fighting the trend in your time frame
  33. Not fighting the natural impulses of greed and fear
  34. Using emotions for trading signals
  35. Using greed for position sizing

Thanks to all the members of the trading group that shared their wisdom!

These 35 things can cost a trader a lot of money. If you are able to avoid these errors, you will find yourself on the right side of your trades, with the money of less educated traders filling your account. Trade well.

Starting a Trading Business

 

If a new trader wants to be a successful, they will need to treat their trading like they would operate a profitable business. Many traders lose a lot of money by approaching trading like it is a hobby. In trading, making money is the goal, and must be kept at the forefront of a trader’s mind if they are to be successful. Fun and excitement in trading can be expensive entertainment. The reality is that most of the time, trading is boring. A trader must treat the market like they would any other business, utilizing discipline and great care to grow their capital and be successful.

  1. You can’t open your trading business until you have a full business plan.
  2. Your inventory is your current positions; you have to buy them for less than you intend to sell them.
  3. Your customers are who you sell to; they have to be willing to pay more than you bought your positions for.
  4. Your mind is the manager of your business; you can’t let pride, fear, or greed lead to an unprofitable mistake.
  5. Your business must have insurance to manage risk. Stop losses and hedges are your insurance against big losses.
  6. Location is everything. You must conduct your business where there are ample buyers and sellers so you don’t get stuck with positions that no one wants.
  7. Your current positions are your employees. You have to keep the ones that produce gains, and fire the ones that lose. 
  8. Expansion of your business can only happen after your first location is successful. Once you have mastered a system of entries and exits you can add new markets and systems.
  9. Your trading capital and your positions are your inventory. Lose that and you are out of business.
  10. The only reason to be in business is to make money. If you don’t make money, you need a new business plan.

10 Trading Mistakes: Are You Guilty?

 

  1. Are you trading without a plan? Trading without a plan makes you emotional and a gambler.
  2. Do you ever trade too big for your trading account size? Big trades are bad trades for the emotional engagement and risk of ruin that they entail over the long term.
  3. Do you risk losing more if you are wrong than you will make if you are right? The biggest driver of profitability in your trading will be big wins and small losses. Big losses and small wins is a sure path to losing your trading capital.
  4. Have you traded without studying charts to see what has happened historically with similiar price patterns? If you do your homework you can make money understanding possibilities and probabilities from past patterns. Trading your own opinions will usually put you on the wrong side of the market. 
  5. Did you trade a system before you back-tested it?Or are you just trading blindly?
  6. Have you ever exited a trade due to fear instead of due to hitting your stop loss or trailing stop? The right exit is what determines your profitability and whether your win is a big one or your loss is a big one.
  7. Have you ever entered a trade becasue of greed without an entry signal? Chasing a trade after the trend is over is a great way to lose money consistently and quickly.
  8. Have you ever copied someone else’s trade not knowing their time frame or position size? Ultimately you have to trade your own system and your own method that matches your own personality and risk tolerance. Only you can make yourself profitable with faith in yourself and your method.
  9. Are you that person that loves to short during market up trends and miss a whole up move?The easy money is on the side of the trend in your time frame going against the trend is a great way to lose money.
  10. Are you that knife catcher that keeps going long at the worn time in a down trend? When everyone is exiting a market that is the worst time to be getting long as wave after wave of holders are leaving. 

5 Quick Tips For Risk Management

 

Days like today really see who is managing risk and who isn’t. Always remember if you have big winning days and trades that are disproportionally large percentage wise then the odds are that you are also exposed to the downside risk of an equal magnitude. Here are five quick tips for risk management for traders.

For Traders: 5 Quick Tips For Risk Management

  1. Structure your position sizing and stops so that you try to never lose more than 1% on any of your trades.
  2. My maximum risk exposure is a total of three trades on at once risking 1% per trade each for a total possible drawdown of 3% in one day if all three go against me at the same time.
  3. I do not trade individual stocks that are highly volatile. I prefer my alpha to come from leveraged index ETFs or option trades for a smoother equity curve.
  4. I trade in the direction of the trend on the daily chart so my biggest risks and losses come from big whips saw reversal days. (Like today).
  5. I honor my stops when they are hit. I do not hold and hope. I get out and get back in later.