Five Fatal Flaws of Trading - Jeffrey Kennedy

That's an age-old question. While there is no magic formula, one of Elliott Wave International's senior instructors Jeffrey Kennedy has identified five fundamental flaws that, in his opinion, stop most traders from being consistently successful. We don't claim to have found The Holy Grail of trading here, but sometimes a single idea can change a person's life. Maybe you'll find one in Jeffrey's take on trading? We sincerely hope so.
(Editor's Note: The following is an excerpt from Jeffrey Kennedy’s highly popular Trader’s Classroom section of his Monthly Futures Junctures. Learn more about Futures Junctures.)

Why Do Traders Lose?
If you’ve been trading for a long time, you no doubt have felt that a monstrous, invisible hand sometimes reaches into your trading account and takes out money. It doesn’t seem to matter how many books you buy, how many seminars you attend or how many hours you spend analyzing price charts, you just can’t seem to prevent that invisible hand from depleting your trading account funds.
Which brings us to the question: Why do traders lose? Or maybe we should ask, 'How do you stop the Hand?' Whether you are a seasoned professional or just thinking about opening your first trading account, the ability to stop the Hand is proportional to how well you understand and overcome the Five Fatal Flaws of trading. For each fatal flaw represents a finger on the invisible hand that wreaks havoc with your trading account.

Fatal Flaw No. 1 – Lack of Methodology
If you aim to be a consistently successful trader, then you must have a defined trading methodology, which is simply a clear and concise way of looking at markets. Guessing or going by gut instinct won’t work over the long run. If you don’t have a defined trading methodology, then you don’t have a way to know what constitutes a buy or sell signal. Moreover, you can’t even consistently correctly identify the trend.
How to overcome this fatal flaw? Answer: Write down your methodology. Define in writing what your analytical tools are and, more importantly, how you use them. It doesn’t matter whether you use the Wave Principle, Point and Figure charts, Stochastics, RSI or a combination of all of the above. What does matter is that you actually take the effort to define it (i.e., what constitutes a buy, a sell, your trailing stop and instructions on exiting a position). And the best hint I can give you regarding developing a defined trading methodology is this: If you can’t fit it on the back of a business card, it’s probably too complicated.
  
Fatal Flaw No. 2 – Lack of Discipline
When you have clearly outlined and identified your trading methodology, then you must have the discipline to follow your system. A Lack of Discipline in this regard is the second fatal flaw. If the way you view a price chart or evaluate a potential trade setup is different from how you did it a month ago, then you have either not identified your methodology or you lack the discipline to follow the methodology you have identified. The formula for success is to consistently apply a proven methodology. So the best advice I can give you to overcome a lack of discipline is to define a trading methodology that works best for you and follow it religiously.
Fatal Flaw No. 3 – Unrealistic Expectations
Between you and me, nothing makes me angrier than those commercials that say something like, "...$5,000 properly positioned in Natural Gas can give you returns of over $40,000..." Advertisements like this are a disservice to the financial industry as a whole and end up costing uneducated investors a lot more than $5,000. In addition, they help to create the third fatal flaw: Unrealistic Expectations.
Yes, it is possible to experience above-average returns trading your own account. However, it’s difficult to do it without taking on above-average risk. So what is a realistic return to shoot for in your first year as a trader – 50%, 100%, 200%? Whoa, let’s rein in those unrealistic expectations. In my opinion, the goal for every trader their first year out should be not to lose money. In other words, shoot for a 0% return your first year. If you can manage that, then in year two, try to beat the Dow or the S&P. These goals may not be flashy but they are realistic, and if you can learn to live with them – and achieve them – you will fend off the Hand.

Fatal Flaw No. 4 – Lack of Patience
The fourth finger of the invisible hand that robs your trading account is Lack of Patience. I forget where, but I once read that markets trend only 20% of the time, and, from my experience, I would say that this is an accurate statement. So think about it, the other 80% of the time the markets are not trending in one clear direction.
That may explain why I believe that for any given time frame, there are only two or three really good trading opportunities. For example, if you’re a long-term trader, there are typically only two or three compelling tradable moves in a market during any given year. Similarly, if you are a short-term trader, there are only two or three high-quality trade setups in a given week.
All too often, because trading is inherently exciting (and anything involving money usually is exciting), it’s easy to feel like you’re missing the party if you don’t trade a lot. As a result, you start taking trade setups of lesser and lesser quality and begin to over-trade.
How do you overcome this lack of patience? The advice I have found to be most valuable is to remind yourself that every week, there is another trade-of-the-year. In other words, don’t worry about missing an opportunity today, because there will be another one tomorrow, next week and next month ... I promise.
I remember a line from a movie (either Sergeant York with Gary Cooper or The Patriot with Mel Gibson) in which one character gives advice to another on how to shoot a rifle: 'Aim small, miss small.' I offer the same advice in this new context. To aim small requires patience. So be patient, and you’ll miss small."

Fatal Flaw No. 5 – Lack of Money Management
The final fatal flaw to overcome as a trader is a Lack of Money Management, and this topic deserves more than just a few paragraphs, because money management encompasses risk/reward analysis, probability of success and failure, protective stops and so much more. Even so, I would like to address the subject of money management with a focus on risk as a function of portfolio size.
Now the big boys (i.e., the professional traders) tend to limit their risk on any given position to 1% - 3% of their portfolio. If we apply this rule to ourselves, then for every $5,000 we have in our trading account, we can risk only $50-$150 on any given trade. Stocks might be a little different, but a $50 stop in Corn, which is one point, is simply too tight a stop, especially when the 10-day average trading range in Corn recently has been more than 10 points. A more plausible stop might be five points or 10, in which case, depending on what percentage of your total portfolio you want to risk, you would need an account size between $15,000 and $50,000.
Simply put, I believe that many traders begin to trade either under-funded or without sufficient capital in their trading account to trade the markets they choose to trade. And that doesn’t even address the size that they trade (i.e., multiple contracts).
To overcome this fatal flaw, let me expand on the logic from the 'aim small, miss small' movie line. If you have a small trading account, then trade small. You can accomplish this by trading fewer contracts, or trading e-mini contracts or even stocks. Bottom line, on your way to becoming a consistently successful trader, you must realize that one key is longevity. If your risk on any given position is relatively small, then you can weather the rough spots. Conversely, if you risk 25% of your portfolio on each trade, after four consecutive losers, you’re out all together.

Break the Hand’s Grip
Trading successfully is not easy. It’s hard work ... damn hard. And if anyone leads you to believe otherwise, run the other way, and fast. But this hard work can be rewarding, above-average gains are possible and the sense of satisfaction one feels after a few nice trades is absolutely priceless. To get to that point, though, you must first break the fingers of the Hand that is holding you back and stealing money from your trading account. I can guarantee that if you attend to the five fatal flaws I’ve outlined, you won’t be caught red-handed stealing from your own account.

43 Lessons from 43 Years - J.D.Roth

1. Be impeccable with your word. Be honest — with yourself and others. If you promise to do something, do it. When somebody asks you a question, tell the truth. Don’t gossip. Practice what you preach.


2. Don’t take anything personally. When people criticize you and your actions, it’s not about you — it’s about them. They can’t know what it’s like to be you and to be living your life. When you take things personally, you’re allowing others to control your life and your happiness. “The dogs bark, but the caravan moves on.” — Arab proverb


3. Don’t make assumptions. The flip side of not taking anything personally is to not assume you know what’s going on in other people’s heads, to not assume you know the motivations for their actions. Just as their reality doesn’t reflect your reality, your life is not theirs. Give people the benefit of the doubt.


4. Always do your best. Your best will vary from moment to moment. Some days in the gym, for instance, I’m able to lift heavier weights than on other days. That’s okay. I do the best I can every time. This is one of the keys to success and to happiness: No matter what you do, do it as well as you can.


5. Be skeptical — but learn to listen. In other words, don’t believe everything you hear, not just from others, but also from your own internal self-talk. Keep an open mind, but analyze the things you see and hear to see if they actually make sense.


6. Be encouraging. There are a lot of people out there who want to tell others what’s wrong with their actions, why the things they want to do can’t be done. Don’t be that way. Instead, do what you can (in big ways and subtle ways) to help others achieve their goals.
 
7. People who are happy with their own lives almost never criticize others, to paraphrase Steven Pressfield from The War of Art. “If they speak at all,” says Pressfield, “it’s to offer encouragement.”


8. Have the courage to pursue your dreams. If you want something, go after it. Don’t allow yourself to be trapped in a life filled with shoulds. Don’t do things just because others expect you to do them. Choose what you want. “The minute you choose to do what you really want to do, it’s a different kind of life.” — R. Buckminster Fuller


9. Fear is the mind-killer. If you can build confidence and overcome fear, you’ll be happier and more successful. This isn’t easy, but it’s worth it. “You gain strength, courage, and confidence by every experience in which you really stop to look fear in the face…You must do the thing you think you cannot do.” — Eleanor Roosevelt


10. “No hay mal que por bien no venga.” — Spanish proverb. That is, there is no bad from which some good does not come. (Or, “every cloud has a silver lining”.) Sometimes life sucks. Bad things happen. But in nearly every instance, the bad brings good too, usually in the opportunity to change, to transform yourself into something new.


11. Change is good. For some reason, our society is skeptical of people who transform themselves. A politician who changes her mind because she gains a deeper understanding of something is said to have “flip-flopped” on an issue. But personal growth can be amazing. By doing and trying and learning new things, you experience more of life, and you become a better person. Don’t be afraid to change and grow.


12. Spirituality is personal. The desire for one person (or group) to impose her (or their) beliefs on others is the source of much of this world’s strife. Believe what you want, and let others do the same. “There is no need for temples, no need for complicated philosophies. My brain and heart are my temples; my philosophy is kindness.” — Dalai Lama


13. Self-care comes first. Eat right. Exercise. Take time to relax. Do your personal chores. Be well groomed. Treat yourself like a princess (or a prince). When you take care of yourself, it’s easier to be of service to others.


14. You can’t predict what the Future You will like. It’s pointless to even try. Instead, focus on creating the best life for the Present You. Make decisions based on what you need today instead of what might happen tomorrow. (But note this isn’t permission to simply ignore the future. You still need to save for retirement, for instance, but you also need to make decisions based on who you are at this moment.)


15. Be present in the moment. When you do something, do that thing. When you’re with somebody, be with them. Don’t multitask. Put away the smartphone or the computer or the book. Be all there. When you do this, you’ll do better work, you’ll show respect to others, and you’ll enjoy yourself more.


16. Don’t try to change others. “Attempts to change others are rarely successful, and even then are probably not completely satisfying,” Harry Browne wrote in How I Found Freedom in an Unfree World. “To accept others as they are doesn’t mean you have to give into them or put up with them. You are sovereign. You own your own world. You can choose…There are millions of people out there in the world; you have a lot more to choose from than just what you see in front of you now.”


17. Don’t allow others to try to change you. Again from How I Found Freedom in an Unfree World: “You are free to live your life as you want…The demands and wishes of others don’t control your life. You do. You make the decisions…There are thousands of people who wouldn’t demand that you bend yourself out of shape to please them. There are people who will want you to be yourself, people who see things as you do, people who want the same things you want. Why should you have to waste your life in a futile effort to please those with whom you aren’t compatible?”


18. It’s okay to say, “I don’t know.” Admitting ignorance isn’t the same as admitting defeat. It doesn’t make you look bad. You know what does make you look bad? Saying or doing something with confidence but being completely wrong. If you don’t know, say so.


19. Don’t yuck someone else’s yum. Just because you don’t like something doesn’t mean it’s bad. Pursue your passions, and let others pursue theirs. If you don’t like something, fine. There’s no need to make a big deal about it. (Note: This is a tough one for me to actually practice in daily life.)


20. There’s seldom one right way to do something. Most of the time, there are multiple paths to success. For instance, as I’ve said many times here at Get Rich Slowly, there’s no one right way to get out of debt. Don’t believe anyone who tells you there is.


21. Quality tools can make life better. For years, I equated low cost with smart spending. Now I know that’s not always the case. Now, I’m willing to spend to buy high-quality things when I know I’ll use them all the time. I have high-quality boots, for instance, and an expensive computer. I’m okay with that. I walk everywhere I go, so the boots are worth it. And my computer is my livelihood. The expense is worth it because it makes working a joy. For items used daily, buy the best. If you don’t use it often, of if it’s not important to you, buy the cheapest possible.


22. Happiness is mostly internal. While external forces do affect well-being, most of your happiness comes from one place: You. Research has shown that about 50% of happiness is biological; 40% of happiness comes from intentional activity, the things you choose to do; and only 10% of your happiness is based on external factors beyond your control. If you’re not happy, change who you are and what you do.


23. Small passions give life flavor. I love bacon and comic books and Scotch whisky and cats and maracuyá (a passionfruit from Perú). I enjoy walking through the city, reading the news in Spanish, taking the laundry out of the dryer, and ordering the same tea every day from the same barrista. These small pleasures provide texture to life. Savor them.


24. There’s no such thing as natural talent. If you want to be good at something, you have to spend the time to become good at that thing. Only American superheroes don’t have to work for the abilities they have. And how strange is that? They’re just given their powers. That’s not how it works in the real world. As Malcolm Gladwell notes in Outliers, in the real world, people become experts by putting in thousands of hours.


25. Be adventurous. Try new things. Eat new food. Learn a new skill. Travel. Watch foreign films. Change your hairstyle. You might not enjoy everything you try, but then you might find something you really love. (From Action Girl’s Guide to Living.)


26. Be open-minded. Read books and magazines and newspapers and web sites. (And not just the ones you already agree with or like.) Listen to other people’s opinions. You don’t have to welcome every new idea with open arms; just be willing to change and grow. (From Action Girl’s Guide to Living.)


27. Be positive. Life is short. Don’t waste time complaining. If you can do something about a problem, do it. Otherwise, get on with life and forget it. Route your negative energy in a positive direction. If you hate something, fine, but don’t make it your career. (From Action Girl’s Guide to Living.)


28. Don’t sweat the small stuff. Who cares if your shirt isn’t ironed? If you forgot to mail the phone bill? If you can’t remember someone’s name? Take it easy. It’s not that important.


29. Ask for it. You’ll never get it if you don’t ask. And you might be surprised at what you can get just by being bold.


30. Slow and steady wins the race. The most successful folks are those who work longest and hardest at things they love to do. So try to find ways to make frugality fun, and recognize that you’re in this for the long haul. You’re making a lifestyle change, not looking for a quick fix.


31. The perfect is the enemy of the good. Too many people never get started toward their goals because they don’t know that the “best” first step is. Don’t worry about getting things exactly right — just choose a good option and do something to get started.


32. Failure is okay. Everyone makes mistakes. Don’t let one slip-up drag you down. One key difference between those who succeed and those who don’t is the ability to recover from a setback and keep marching toward a goal. Use failures to learn what not to do next time. “Fall down seven times, get up eight.” — Japanese proverb


33. You can have (or do) anything you want — but you can’t have (or do) everything you want. Being smart with money — or with time — isn’t about giving up your plasma TV or your daily latte. It’s about setting priorities and managing expectations, about conscious living. Focus on the things that matter most to you and ignore everything else.


34. You don’t need permission. When we’re young, we wait for our parents and our teachers to say it’s okay to do the things we want to do. As an adult, you don’t need permission from anyone else. Do you want to quit your job and travel the world? Do it. Do you want to learn how to ride a motorcycle? Do it. Don’t wait for somebody to give you the go-ahead. You are the only one who needs to give yourself permission to do these things.
 
35. Action beats inaction. It’s easy to put things off, but the sooner you start moving toward your goals, the easier they’ll be to reach. It’s better to start with small steps today than to wait for that someday when you’ll be able to make great strides. Get moving.


36. Along similar lines, it’s not what you say that matters; it’s what you do. Live a life of action, not words. “Action is character.” — F. Scott Fitzgerald.


37. Look for connections. Share your interests and experiences with people you meet. You don’t need to force your story on others. But learn to strike up conversations with people you meet. Ask them about their lives. They’ll ask you about yours. In Never Eat Alone, Keith Ferrazzi notes this is a great way to form connections you might otherwise miss. In this way, you may sometimes turn a random encounter into a possible “lucky break”. (Occasionally you will be a source of luck for the people you meet, just as they will sometimes be a source of luck for you.)


38. Keep your options open. Goals are good. But single-minded devotion to a goal can often blind a person to other opportunities. And it’s a mistake to cling to one path out of a sense of obligation. If you enter law school and discover you hate it, quit. Don’t endure years of misery because you feel it’s expected of you. You have more options than you think, but you may need to open your eyes to see them.


39. Be empathetic — think like the other person. Remember that people are all the same. We each have the same fears and the same desires. Underneath, most folks are pretty nice. Instead of fighting with others are hating them because they’re different, try to get a feel for their story, their point of view. “You never really know a man until you stand in his shoes and walk around in them.” — Harper Lee, To Kill a Mockingbird.


40. Do the right thing. If you do what’s right, and you do it well, what do you care what other people think? Successful people will always have critics. Learn from the critics or to ignore them, but don’t let them bring you down. Do the right thing, and confidently own the consequences.


41. Don’t compare yourself to others. I’ll tell you a secret. There are a lot of personal finance blogs out there. I don’t get to read them as often as I used to, but I do try to make the rounds once every week. Sometimes when I do this, I feel like giving up. I feel like quitting. I lose confidence. “I can’t write that well,” I think. “I can’t cover retirement investing as well as Jim did.” Comparing myself to others is counter-productive. It only makes me feel inadequate. Who cares what other people write, or how well? What’s important is simply producing the best work I can. All I can be is myself.


42. Be yourself. This is by far the most important thing I’ve learned about life. For so long, I tried to please other people, tried to be and do the things I thought they wanted me to be and do. That just made me unhappy. And most of the time, it didn’t please anyone. I’ve had enough of that. Instead of trying to be somebody else, I’m just me. I’m honest about who I am and what I want. Sure, that means some of my old friends don’t like who I’ve become. That’s okay. I’ve made new friends who do like who I am. But the best part is that I like who I am.


43. “Everybody is talented, original and has something important to say.” — Barbara Ueland, If You Want to Write.