Basic Rules for Building a High-Performance Trading System
I was introduced to the commodity futures markets by a master trader. He was a co-worker and friend, who had a unique set of skills that brought him success. Patience was his forte, and the reason he realized what most investors fail to achieve. Thirty-five years ago he and I worked together on the top of a mountain in Pennsylvania. It was the height of the cold war. As contractors of GE, we wrote computer code to process azimuth and spherical information on electromagnetic, optical and seismic signals. Our objective was to triangulate the likely point of a nuclear attack against the U.S.
In addition to our regular work on that classified military project, my friend patiently waited for opportunities in the futures markets. One day he took a small long position in sugar. His reasoning was that the price of World Sugar Futures was "impossibly low," at less than one and one-half (1.5) cents per pound. He felt he couldn't go wrong because the price was significantly below the cost of production. Along came the Cuban Missile Crisis and the Bay of Pigs invasion, resulting in a surge in the price of sugar by nearly 1000% to over 13.5 cents per pound! My friend used pyramiding to skillfully parlay a couple of sugar contracts that were margined for perhaps $800 into over a million dollars. This spectacular success in the world sugar market involved a rare moment in history, but similar opportunities can and do surface from other commodities over time. Patience paid off for my friend in this trade and many others. He continues to invest using the same strategy, and consistently does quite well.
Like a lion on the prowl, this trader waited for a suitable opportunity to present itself. Then he acted decisively. When the position exploded into a remarkable windfall, he kept his wits about him to play out the scene and reap a fantastic bounty. It takes patient watching and waiting to know when a market suggests the right opportunity. It takes honesty and good relationships to continue the journey begun with that first successful trade - to trade for a living. Today we humbly offer some basic insights into how one might hold on to the gains that may fall your way, allowing you to not only earn profits, but to also, perhaps, earn a living through your investments.
The accumulation of wealth requires honestly knowing who you are and knowing that rewards come only when you are not fooling yourself or others. When setting out to make a living off the markets, you must ask yourself if you have what it takes to be an exceptionally successful trader. Measure your prospects carefully, because the bigger the package of benefits you seek, the bigger the risks required to achieve it. Honesty and patience are more than virtues. They are prerequisites.
Making Money With Money
Most people make a living by selling their services. They earn a wage for performing a task for which others are willing to pay. Trading is a different, more difficult way to make a living. Based on the idea of making money with money, it is the art of capitalizing on price fluctuations.
I have had the experience of trading for a living, albeit somewhat vicariously. I sold my services as a registered Commodity Trading Advisor (CTA), staking my reputation and future employment on my market successes. For the bulk of the trades I have booked, the at-risk capital and profits were not my own. My first client was a New York executive who hired me to trade his commodity account while he was out of the country. Profits rolled in and soon I was asked to move my family to Florida so I could work exclusively for him near his winter residence. My original client unexpectedly passed away, whereupon I bought the computers and transformed CSI into a data-vending firm. Although I successfully managed several accounts in the ensuing years, data vending and software design eventually replaced the advisory business entirely. This line of work rests more easily on my shoulders.
Making money with money may appear to be easy when the stakes are low and the rewards are moderate, but the difficulty factor increases exponentially with investment dollars. At lower levels, the emotional attachment to positions is relatively minor, and decision-making is easy to control. Add a couple of zeros on to both the investment risks and the reward, and things materially change for the worse.
Trading for a living involves assuming the perils of an uncooperative market. Losses are likely to occur even under the best of circumstances. You must know in advance how much account value attrition you can afford before you will exit from the market. In order to attain a viable risk-reward ratio, it is crucial that you know in advance what will be the expected value or outcome of your trading experience. The Trading System Performance Evaluator, a product within CSI's Unfair Advantage® system, can show you the probability of returning a profit with your investment capital. This is important because even a highly profitable system can turn into a loser if your goal is statistically unreachable. Balancing investment funds with a reachable level of achievement is a mandatory requirement.
As you move forward in your trading success (or failures), your goals will change. In a series of successful trade experiences, your goal should increase, provided the ratio of your goal to investment capital does not increase. Just as statistical confidence is derived from a large sample, frequent profitable experiences will add to your confidence in trading.
When long-term goals are realized, spend some time becoming accustomed to your newly found wealth by taking a vacation from trading. Relax. Pay taxes on your gains and set a new future goal. In the event of a large loss, it is time to change your focus and scale back your investments.
If you are in any way unfamiliar with the terms, risks, conditions, procedures, etc. in trading, I highly recommend opening a traditional account with a full-service broker. An online Internet-based alternative would likely offer lower fees, immediate trade confirmations and other automated services, but they won't make up for the disadvantage of being on your own. A full-service broker offers procedural market knowledge and a possible assessment of situational conditions that can be useful to anyone - even an expert trader.
When dealing with a broker, make sure everyone involved recognizes that the money in your account is yours. It does not belong to the broker, and he or she does not have to know your objectives. You should be in control. Open an account with the expectation of making one or two trades. No broker should expect continued business from you. Keep a minimum of resources available for trading, and don't feel guilty about withdrawing your money; you are not required to keep your broker solvent. If you are happy with your broker and the way your account is being handled, keep it funded and use it to your best advantage. A good relationship with a trusted broker is a valuable asset.
Be wary of tips and unsolicited advice from your broker recommending the liquidation of existing positions or entry into new ones. Brokers are not necessarily qualified advisers, so check the track record and reputation of your broker before taking any action. If you have your own trading plan, don't let the broker lead you astray. If you don't want advice, say so. A good broker, however, will point out delivery risk notices for futures, margin requirements, limit-move risks, and perhaps relevant news and relationships between products, etc. Your broker should routinely offer procedural information that may be useful, but you should do your homework so that minimal assistance becomes necessary.
Your relationships with peers, and especially with your broker, can impact your decisions, and not always for the good. Avoid the temptation to share stories about trading experiences with your broker and friends. Such publicity tends to elicit feedback that is not conducive to uninhibited trading. If you must talk about your trading adventures, balance stories of triumph equally with stories of humbling failures. Each success story will bolster your courage to take on more risk, perhaps more than you can afford. There is no advantage in adopting a behavior that can lead you to shed assets. Great traders don't boast of their successes because they know that losses are always on the horizon.
If you honestly evaluate your ability to sustain a trading life, it is likely that you'll find yourself better suited to selling your services than to making money with money. There's no shame in that. In fact, it is the best course for most of us. Even if you don't earn a living from trading the markets, you can still benefit from investing disposable income. We hope these suggestions will help you along the way. Focus on patience, honesty and relationships. These are the intangibles that separate the master traders from the rest.
I wish you great success. Article written by Bob Pelletier of CSIdata.com