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Lesson 8: Achieving Success

 

If you wish to be a successful futures or options investor, you must learn to control your losses. No talent that you develop as a trader will ever be as important to you as this. The formula for success in futures and options trading is:

X (AP) - Y (AL) = SUCCESS OR FAILURE

(X) is the number of profits that you have. (AP) is your average profit per trade. (Y) is the number of losses that you have. (AL) is your average loss per trade. You multiply the number of profits you have times the average of your profits to arrive at your total profits. You multiply the number of losses that you have times the average of your losses to arrive at your total losses. X (AP) equals total profits. Y (AL) equals total losses. Total profits minus total losses equals success or failure. Of this formula, the two most important letters to you are (AL).

Why is the (AL) so important in your effort to achieve success. It is important because (AL) is the only element of this formula that you can control. Think about it for a while and you will see what I mean. What result would be easier for you to manage in your own account?

  1. An average profit of $800 per trade or,

  2. An average loss of $200 per trade?

It is obvious that the answer is (2). You have some control over your losses. You can manage them. You will have very little control over your profits. Concentrate your attention on that which you can control rather than on that which you cannot. How would you answer this next question?

  • Do you feel confident that you can guarantee yourself an average profit (AP) of $800 or more per futures contract traded? (Or per option position held?)

Your honest answer would have to be "no". There is no one on the face of the earth who can guarantee themselves or anyone else an average profit of $800 per futures contract or option traded. No one. Even if you trade only one contract one time once in your lifetime, you can never guarantee yourself an average profit of $800 on that trade. It cannot be done. It is hopeless. There is no chance of guaranteeing that result. None. Now, what is your answer to the next question?

  • Do you feel confident that you can limit yourself to an average loss (AL) of $200 or less per futures contract traded?

Your answer should be "yes". This you can do. It is achievable. It can be done. Most traders can do it. The person who has never traded a futures contract in his or her life can pretty much limit himself or herself to this $200 average loss (AL) if that person has the will power and the knowledge of how to do so. Then what is your answer to the last question?

  • When you are given a choice between concentrating your effort on something that you can do versus something that cannot do - which of these alternatives would you think it more productive to concentrate your attention upon?

How did you answer this question? Should you concentrate upon the achievable or the non-achievable? History and experience answers this question by telling us that it is always preferable to concentrate upon that which can be done. There is a reason for this. If you develop the skill of achieving the attainable, you may be able to achieve the attainable.

Trading in a series: Imagine that you are able to maintain an average loss of $200 per contract or per trade when you are trading in futures contracts or options or even stocks. Imagine that you aim to be correct in your market decisions at least 33% of the time. If such were the case, in every series of three trades you will have a $200 loss, another $200 loss, and an unknown profit. What sort of profit will you need in a 33% success rate program to break even? You will need a $400 net profit. In order to break even in this trading series your profit need be only twice your average loss even though you are wrong 66% of the time.

Remember that you will never be able to control profits in this game; you will only be able to control losses. By keeping your average loss to $200 and by being successful 33% of the time in your trades, you will only need $400 in average profits to break even in any series of three trades. Success or failure is directly related to average losses. The higher your average loss, the greater the average profit that you will need in order to break even in a series of three. The lower your average loss, the lesser the average profit that you will need in order to break even.

The more you control your losses by making them lower and lower, the easier it will be for you to earn a profit from a series of trades. Everyone wants to make his or her job easier. You make futures trading easier by controlling average losses. A quick response might be that "this is easier said than done" and that "no one can control losses." But of course losses can be controlled. Here are four really simple ways to do so,

  1. Don't trade. This creates an average loss of "0".

  2. Immediately upon entering a position, enter a stop/loss $100 away from your entry price. In most markets, this will result in your being stopped out with a loss of less than $200.

  3. Every time you take a futures position, instruct your broker that if the market closes against you at the end of the day, meaning you have a paper loss at closing time, you want to terminate your position on the close. This will accomplish two things. First, you will always go to sleep at night with winning positions. All losing positions will have been offset at the close. Second, if you are trading in relatively stable markets your average loss should be under $200 per contract. It could be higher if you are trading in markets with wide price swings. If such is the case, then simply do not trade markets where the daily price swings are of such a magnitude that your average losses are greater than $200.

  4. Enter your positions "at the market on the close" only. Once you know your entry price, enter a stop/loss order $100 away from that price. By using this method, you will always go to sleep at night with little or no loss on your open positions. When the market opens the next morning, it may go up or it may go down. If it moves against your position by $100, you should be taken out by your stop/loss order. Only in those situations of limit moves might this not happen. If the market moves in your favor, you are on board a winner. You may remain with winning positions for as long as you like or for as long as they are profitable.

 These are just four methods you may use to try to keep your losses at an average of $200 or less per contract. There is no guarantee that any of them will work for you except the first. But with time and experience, each method should offer you the opportunity to keep some reasonable control over your average losses, your (AL)'s. It is important to control your average losses because an average loss of $200 requires a profit of only $400 for you to break even in a series of three. This is true even if the market returns you a profit in only 33% of your trades. If you let your average loss run to $400 you start to have problems. You will then have to make an $800 profit just to break even in the series. And to earn a net profit of $200 from your three trades, your third trade will have to return a profit of $1000. In futures trading, it is easier to make $400 than it is to make $800 or $1000.

So remember that if your average loss (AL) is great, your profit will have to be even greater in order to make money on any series. By concentrating upon that which you can control and keeping that sum at a reasonable amount, you will make the net profit that you hope to achieve from any series more likely to be achieved. Isn't that what you want in your trading, small losses and an achievable net profit? If this is what your goal is, then your road to success will be the road of controlling your losses. You can travel this road using many different methods or vehicles, such as the four I mentioned above or several others that you can learn from my Choppy Market Trading Method or other writings. Whatever method you select, you should always remember,

  • You will never be able to control your average profit per trade no matter how hard you try.

  • You should always be able to control your average loss per trade, once you make up your mind to do so.

You must learn to control your average loss (AL) per contract traded. No talent that you develop as an investor will ever be as important to you as this one.

Bruce Gould

 

Always remember that stock, options, and futures trading may involve substantial risks and that past performance is no guarantee of future performance.