Early on in our trading we’re not endowed with the vision and insights to know what successful trading entails.  We have some idea, but without first hand experiences or a really involved mentor to steer and guide us, we largely learn by trial and error.

Here I’m going to reflect back on my early days as a trader to share the first three lessons I learned, so that they may help guide you in your trading.

THE LIMITED VALUE OF TESTING ON PAST DATA

I’m a mathematics person from a career as a Chartered Accountant.  I lived in a world of analysis.

Coming from that background I was drawn to the idea of testing systems on past data.  This was a way to cut through the myriad of choices to develop a system that would improve my fortunes based on sound testing techniques.

Yay, the road ahead looked clear.  Or so it seemed until I discovered some traps.

There are so many ways to make a system look good.  Here are just a few of the many to look out for.

  • Too many user-defined variables for technical indicators are a recipe for over-optimization. 
  • The start time of the testing and relative location of the system drawdown play a large part in how good results look.  
  • A small number of trades in the testing can give a false sense of security when the testing sample size is statistically too small.

What I’m constantly reminded of is that the past is not the future.  The results tested on past data are not going to play out the same in the future.  It’s not poor luck on my part but the reality of the intersection between back testing and the financial markets.

IMPORTANCE OF YOUR RISK COMFORT ZONE

When I first started trading I had my trading system in hand.  Well tested, ironed out and ready to conquer the world.

I’d tested the system using a specific trading capital size and it had spit out results based on an individual trade size.  It all looked good and I was ready to go. The individual trade size was worked out as a percentage of the trading capital size and was influenced by the profit I wanted to get out of the system. With that in mind I got started trading at the tested trade sizes, which were actually quite large and especially for a beginner.

I wanted to hit the ground running and reach the kinds of profits shown in my testing quickly, but I hadn’t really internalized how it would feel to trade the sizes of the tested risk per trade.  Nor had I fully appreciated how many trades I’d have open at a time and whether I was ready to handle those combined amounts at risk on my portfolio as a whole.

With that lesson on board I used a risk per trade I was comfortable to start with, regardless of what I had available in my trading account.  I then had a process for increasing the trading amounts to more appropriate levels to achieve my goals as my skills, expertise and risk comfort zone increased.

VALUE OF A MARKET FILTER IN A TRADING SYSTEM

When I first started trading it couldn’t have come at a much worse time.  Firing on all cylinders I traded as a well-tested beginner into the force of the 2007-2008 global financial crisis.  Boy, what a ride that was!  Not one I cherish with fond memories.

All was not lost.  I did learn that as a beginning trader I’d done one thing absolutely right and it proved to be my lifeboat.

The system I started with was a trend following system.  It was designed to catch markets that were trending.  Since I started trading shares, I could only buy and go long.

Apart from the entry and exit rules, I had a filter that checked that the market conditions were suitable for the system before it put me in a trade.  It was looking to see if the market was trending long.

Having a filter can increase the relative number of trades in times when the market suits your system, reduce it when it’s incompatible and temporarily turn it off when it’s a match headed for divorce.

LESSONS SHARED CAN BE LESSONS LEARNED

Trading lessons can be learnt the hard way or we can benefit from the lessons of others.  These three lessons came at me like a freight train very early on in my trading and I’ve lived by them ever since.

As Eleanor Roosevelt once said, “Learn from the mistakes of others.  You can’t live long enough to make them all yourself.”

Will you use these nuggets of learning by employing them in your own trading?  Your trading experience is in your own hands.

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Related Reading:

Doing Due Diligence on Trading Systems