A line from Jackson Browne’s excellent song “The Road” keeps running through my head: “You forget about the losses, you exaggerate the wins.”  While often true in life, I’ve found this to be especially true in trading.  Indeed, I’ve only met a mere handful of traders who excel at record keeping.  The irony, of course, is that it’s literally insane to be a trader and do otherwise; sort of like swatting at an overpriced piñata that they keep on moving out of reach.

More than anything, I’m appalled by the widely held belief that trading is an “art,” as if the entire thing came down to nothing more than intuition and “feel.”  Talk about bullshit!  Let me state for the record that the only effective (i.e. profitable, repeatable, etc.) trading systems are based on applied science and mathematics; with a bit of well-researched social engineering thrown into the mix.  As to the “trader”, himself, he needs to have an obsessive talent for the details!”

In an earlier post (“Squids Don’t Have Lids”) I said “the majority of trading systems, commercial or otherwise, are incomplete, unusable or simply crap.”  I’ll go into the particulars another time, but for the present, I’d like to list a number of things that go into any successful trading system.  It’s important to note that when I refer to a “system,” I mean everything that contributes towards your success; not just the technology and infrastructure and brokerage deals.  To my way of thinking, your (human!) support systems and attitude are just as important, if not more so.  If you want to be a successful trader, then you need to start treating yourself like a top athlete.  Eat right, drink right, get plenty of sleep, tone down the stress, work on your attitude, nurture your relationship(s), train obsessively, get a great coach, listen to the numbers; everything!

For the record, each of the following deserves to be addressed at book length, so this list should merely be looked at as nothing more than the briefest of overviews, in somewhat descending order of importance:

Balls: Trading is not for the faint of heart; most especially automated trading.  You need to do your homework, and then to absolutely unreservedly utterly completely without-exception trust your math.  If your modeling and back-testing tells you that a 30% loss is a rare but acceptable occurrence, then you need to totally go with that.  To put this all in perspective, the worst single-trade loss of my entire career came as a result of ignoring that golden rule.  Our model said that we were OK, that we weren’t even close to the theoretical limits, but for some reason a potential $57,000 loss had us freaked.  Needless to say, as soon as we pulled the plug, the market turned.  If we had simply stayed in then we would have made a modest sum of money; just as planned.

Trade-Planning: None of this stuff should be random.  You should never take a trade because it “looks” good.  Instead, your decisions need to be backed up with well proven math, mediated by proven reliable easy-to-use software.  As to your risk profile, you need to have the financial consequences of each and every trade down cold; and this includes the effects of partial and/or predatory fills.  In terms of the mechanics, you need know in advance how to handle every possible contingency, including: entrances and exits, invests and divests, hedging, profit taking, commission variances, margin issues, disaster recovery, stop-loss and/or limit adjustments, technical problems, adverse latency, human screw-ups, account discrepancies, reconciliation issues, theft mitigation and more.  Anything less than perfection in this area will doom all of your other good efforts.

Liquidity:  The entire “scientific trading” thing breaks down when you can’t get your fills.  That means that you should definitely skip stocks, and you should probably skip futures, too.  A good rule of thumb is that you want to have your orders completely filled in much less than a second.  This needs to be consistently doable during every part of the day, excepting holidays and around big pre-planned news events, as well as the few minutes at the start or end of a trading session.  For my own part, I would judge a $10MM USD top-of-book fill that took more than 100 milliseconds to be nothing less than abysmal.  20ms or less is more my speed.  I like to think of liquidity as air.  You can’t breathe in more of the stuff than you need, but if there’s less, you’ll certainly begin to choke.  By these criteria, the ($2MMM USD daily volume) Spot Forex market is the only trading venue that consistently makes sense.

Account Size: Orwell had it right.  “All animals are equal, although some animals are more equal than others.”  In the trading world, brokers love to tell you that “tiny accounts get treated exactly the same as big ones,” which is complete and utter bullshit.  The truth is that you need a big account to get some respect; both in terms of both liquidity and spread.  On the other end of the spectrum, a $500 “starter” account merely exists to serve as handy vehicle for outright theft; as I’ll explain below. The smallest retail account size I would recommend would be $50K, although you should expect to be frequently screwed with until you have $250K or more to plonk in an institutional-grade ECP account.

Theft Management: There are too many ways to have your money legally “stolen” to enumerate here, so I’ll only give a single verified example that came to me directly from one of the ex-board members of a large Forex house.  Basically, their business plan relies upon the fact that they can reliably “steal” as much as 40% of a typical account-holder’s portfolio before she gives up.  It’s outrageous, but just to be clear, the methods these retails brokers employ are entirely legal.  Indeed, as far as I can tell, your typical retail broker doesn’t even come close to shaving the law, since the barn door is generally left so wide open.

More to the point, there are dozens of well-known ways to liberate you from your money (see “Stop Loss Hunting” and “Types of Stock Broker Misconduct” for an incomplete overview.)  The details are way too involved to go into here, but basically, your broker will have no problem whatsoever in out-trading you if he chooses to do so.  They often do this by utilizing proprietary information, but most of the time they’re simply better at trading against you than you are at trading against them.  It’s been famously said that “engineering is all about exploiting tiny effects to great ends.”  The same can be said about trading.  The only good news is that the bigger your account, the less likely your money will be stolen.  At a minimum, you should only trade through brokers that do pass-through trading and lack a dealing desk.

Risk Management: My favorite form of trading insanity is people who trade without stops.  Basically, their idea of a good time is to expose themselves to excessive risk, for no reason whatsoever.  For my own part, I never trade without at least two stops: a primary stop (the maximum that I’m willing to lose under “normal” circumstances), plus one or more “emergency” stops (to try and handle Black Monday-style gapping markets.)  Now don’t get me wrong.  Stops aren’t a panacea, and I’ve lost count of the number of my stops that were gapped.  Even so, they’re an essential ingredient in a well baked trading strategy.  “Safety” aside, the main reason I use stops is because of trade plans.  I also use limits, and never let trades run, unless I’ve passed a profit target and am willing to do the trailing stop thing.

Inasmuch as I have gone onto a third page, I think I’ll stop here.  In either case, I’ve barely scratched the surface.  Some of the additional topics that I plan to expand in a follow-on to this post will include (in no particular order) Commission Strategy, Ambition Leveling, Hidden Spreads, Slow Speed Trading in a High-Speed World, Trading Mechanics, Personal Attitude, Testing Plans, Signals, Statistics, Transparency vs. Opaqueness, Money Management, Order Management, Out-Of-Band Order Management, Data Accuracy, Data Repeatability, Trading Infrastructure, Hedging Strategies, Trading Corporation Structure, Tax Strategy and Management, Co-Trading and Advisory Accounts, Account Establishment, and Profit Taking Strategies.