The Universal Principles of Successful Trading

Essential Knowledge for All Traders in All Markets

Brent Penfold

• Publisher: Wiley
• Year: 2010
• ISBN:
  9780470826171
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

The Universal Principles of Successful Trading clearly and unambiguously articulates trading principles that distinguish the winners from the losers. Though trading can be performed in different markets, across different timeframes, and with different instruments based upon different techniques, there is one common thread that ties all winning traders together: the universal principles of successful trading. All consistently profitable traders adhere to them regardless of the markets, timeframes, and techniques.

In this ground-breaking book from top trader, Brent Penfold, the reader will:

• Learn how to develop a trading plan
• Learn how to identify and create an effective methodology
• Discover successful money management strategies
• Understand trader psychology
• And many more exciting trading and strategies secrets.

Supporting the universal principles are rare interviews from a diverse group of successful traders. Some are the new young guns of trading and others are market legends who are trading just as actively today as they were over 50 years ago. They represent a diverse group of traders from the United Kingdom, America, Singapore, Hong Kong, Italy, and Australia. All of them have generously agreed to offer the reader one singularly powerful piece of advice to help them towards their trading goals. Each piece of advice emphasizes an essential element of the universal principles.

This timely and exciting book from Brent Penfold has already garnered many accolades and looks set to become a modern-day classic.

CHAPTER 1

A Reality Check

Trading’s only real secret is . . .

The best loser is the long-term winner.

—Phantom of the Pits

Believe it or not, this is probably the only real secret behind successful trading. Although it may seem to you to be a cliché, I hope by the end of this book you’ll understand why it’s a core truth behind a sustainable career in trading.

In my opinion, Phantom of the Pits’ quote encapsulates what is required to succeed. Most traders are bad losers. They hate taking losses, moving stops and looking for any excuse to keep a trade alive, finding all sorts of reasons to rationalize their actions. While they have money left in their accounts, poor traders will ignore a losing position until it becomes so large they can no longer ignore it and are forced to stop themselves out at a catastrophic loss. They delay the inevitable while there is still hope that the trade will turn around. While the trade remains open, there is still a chance they can be proved right. While the trade remains open they do not have to acknowledge they’re wrong because they haven’t taken the loss. People hate to acknowledge they’re wrong. Most people are only bad traders because they are bad losers. Learn to take losses as an integral part of trading and you will have taken your first concrete step towards success. Continue as a bad loser and you’ll be off to the poor house. Successful long-term trading will require you to be a good loser.

In my own trading, losing seems to be what I spend most of my time doing. In my short-term trading I only average about 50 percent winners, while my medium-term trend trading sits about 30 percent. So since I don’t win very often, I have to be a good loser to survive in trading, otherwise my account would be empty and I wouldn’t be able to trade. I hope you can become a good loser.

As an exercise, it’s certainly worth going back over all your trades and seeing what your results would have been if you had followed a simple stop rule. A simple stop rule for long trades (and the reverse for short trades) could be to exit on a break of the lowest low within the last three bars. Alternatively, you could use a break of the previous week’s low to stop yourself out. It doesn’t matter which stop you use as long as it’s consistent with the time frame you trade. Now, you may find that it doesn’t turn your losses into profits, but I’m sure it will show that your account would have looked healthier than what it was. Believe me, it pays to be a good loser.

If you’re currently profitable in your trading, you can skip this little discussion. If you’re not, heads up, pens down, and eyes off the market! This discussion is for your immediate benefit. Please cease all trading.

If you’re currently trading without profits and are attempting to battle your way out of a drawdown—that is, attempting to come back from a loss in your trading capital—the best thing you can do right now is to walk away from your trading account. I know it’s hard—especially when walking away feels like an admission of failure. Don’t worry about it. It’s not failure. You’ll only be suspending your trading until you can introduce positive expectancy. Don’t be despondent. Be thrilled that real help is here. There is no shame in losing—it happens to everyone. I’ve been there many times and pride myself on being good at it (remember, the best loser is the long-term winner!).

If you’re a loser I’d like you to listen carefully to what I’m about to say. A huge reason you’re losing is that your trading methodology doesn’t work. It’s not what’s in your head that is holding you back. Despite the overwhelming message many trading educators would have you believe, its not psychology that is your nemesis. It can certainly be a challenge, but it’s not your nemesis.

It’s your methodology. It doesn’t work. Although your trading account is telling you it’s poor, you’re ignoring its message. And I can understand why. You’ve no doubt read numerous books and attended many trading seminars that say your method or ideas can be used for trading but unfortunately they can’t. Take it from your trading account—your method is letting you down. The reason may not be that it’s totally without merit; however, as a whole, the reason your method doesn’t work is that it doesn’t have an edge and its expectancy has not been validated.

You need to validate your methodology’s expectancy. I’m sure what you will find will mirror your trading account. You will find it’s negative. Furthermore, if you had independently validated your methodology before placing a trade, you would have never traded with it. You would have thrown it out and recommenced your search for a trading methodology with an edge that can be correctly validated to offer a positive expectancy.

So take a deep breath and walk away from trading for the time being. You’re about to embark on a quest for real trading knowledge, which, among other things, will show you how to validate a trading idea correctly.

And I should have said not to worry if you are currently losing, because you’re actually in good company. Let me share an unfortunate truth with you. Over 90 percent of all traders lose! Let me share with you my understanding on why this is.

WHY DO 90 PERCENT OF TRADERS LOSE?

The simple answer to why 90 percent of traders lose is ignorance.

While many analysts argue that psychology is the main reason, I maintain that the deeper answers are gullibility and laziness. It’s human laziness that causes traders to look for the line of least resistance. Why work harder when you can work smarter, right? Unfortunately, this can make traders gullible, and they start to believe what they read, what they hear, and what they install on their computers. This is because traders desperately want to believe there is a simple path to trading riches. And it’s this line of least resistance that prevents them from correctly validating what they think may work in the markets.

Even though traders may have read a great many books and attended a lot of seminars, they’re still ignorant. It may come as a surprise, but not many books or seminars reveal what actually works in trading. This is because many authors and educators are ignorant themselves about what actually works; they’re usually failed traders. If you look at the vast bulk of financial literature and various products, most rely on the “greater fool” theory. That is, the customers or purchasers are the “greater fools” but they don’t know it! Remember, just because a trading idea is either written down, or delivered by a PowerPoint presentation, does not make it true.

However, if you have the correct knowledge, and the patience to validate a trading idea, you will not be ignorant—I intend to provide you with this knowledge. While you may not be making money in the early stages, at least you’ll be knowledgeable enough to realize that it’s because you don’t yet know enough to succeed.

Psychology

Psychology is often provided as an excuse for the traders’ failure to succeed. However, while it can be a contributing factor, psychology is not the sole reason, as many commentators suggest. To succeed in trading, you need to cover three important areas:

• methodology

• money management

• psychology.

They’re (almost) equally important and I’ll cover each in greater depth later. At this point, you just need to be aware there are three components to successful trading.

Whenever I make presentations I usually ask the audience which part of trading they believe is the most important:

• methodology—the analysis and trading plan behind why you buy and sell

• money management—the amount of money you commit to trades

• psychology—having the discipline to follow your trading plan.

Interestingly, most people raise their hands at psychology. I’m not surprised by this response because the overriding message from most trading material available is that psychology is the hardest part of trading and the key to success.

The usual message is along the lines of “the only thing that separates the winners from the losers is psychology, nothing else” . . . “the winners have no special trading skills, no special trading secrets, no secret formulas to win in trading” . . . “what sets winners apart from losers is their psychology” . . . “winners think differently than losers.”

I disagree with this. What holds the losers back is their ignorance of knowing and validating what works in their hands. Although psychology is important, I believe money management and methodology rank higher.

I mentioned earlier that ignorance, gullibility, and laziness are the main reasons 90 percent of traders lose. To show you how these three evils manifest themselves in trading behavior, I’ll explore in some depth the common mistakes many traders make during their first three years of trading. I’ll group the common mistakes under the three main building blocks of successful trading: methodology, money management, and trader’s psychology.

As an aside, you already know I don’t claim to be an expert on trading, but I’m certainly well qualified to discuss these common mistakes because I’ve been guilty of making all of them at some point!

COMMON MISTAKES—YEAR ONE

Welcome to your first year of trading. If you ever had any doubt at all about your level of ignorance then rest assured that during your first year of trading you are “King Ignorant!”

Methodology

• Listening to others and following tips

• Reacting to the nightly news

• Asking others for their opinions

• Averaging entry levels

• Failing to use stops

• Failing to have a trade plan

Money management

• What is money management?

Psychology

• Trading for excitement

• Trading for revenge or to get even

Methodology

Listening to others and following tips

When most people start trading, they will invariably listen to others and follow tips. This is a recipe for disappointment. Sometimes the tip may be successful, but over the longer term, it’s a loser’s game. You should only ever trade because of what you think, not because of what others say in the corridor or over a dinner table.

Reacting to the nightly news

Often, inexperienced traders will hear some news, such as that most companies are reporting good earnings or the quarterly GDP growth numbers were ahead of forecast, and the next day they’ll go long only to be stopped out at a loss. It takes a long time to understand that once the news arrives in our living rooms in the evening, the information is already old. The market...

Table of contents

• Praise
• Title Page
• Copyright Page
• Dedication
• Acknowledgements
• PREFACE
• Foreword
• Introduction
• CHAPTER 1 - A Reality Check
• CHAPTER 2 - The Process of Trading
• CHAPTER 3 - Principle One: Preparation
• CHAPTER 4 - Principle Two: Enlightenment
• CHAPTER 5 - Principle Three: Trading Style
• CHAPTER 6 - Principle Four: Markets
• CHAPTER 7 - Principle Five: The Three Pillars
• CHAPTER 8 - Money Management
• CHAPTER 9 - Methodology
• CHAPTER 10 - Psychology
• CHAPTER 11 - Principle Six: Trading
• CHAPTER 12 - Just One Piece of Advice
• CHAPTER 13 - A Final Word
• APPENDIX A - Risk-of-Ruin Simulator
• APPENDIX B - Risk-of-Ruin Simulator
• APPENDIX C - Risk-of-Ruin Simulations
• INDEX
• www.IndexTrader.com.au