Tuesday, May 13, 2008

Eternal Truths About Trading Success

A portfolio manager lent me an interesting small book from the late 1800s written by Dickson G. Watts and reprinted by Traders Press. Entitled "Speculation as a Fine Art and Thoughts on Life", the book begins with a description of the "qualities essential to the equipment of a speculator" (p. 8). Here is the author's perspective, written well over a century ago:

* Self-Reliance - "A man must think for himself, must follow his own convictions...Self-trust is the foundation of successful effort."

* Judgment - "...equipoise, that nice adjustment of the faculties one to the other...is an essential to the speculator."

* Courage - "...confidence to act on the decisions of the mind...be bold, still be bold; always be bold."

* Prudence - "The power of measuring the danger, together with a certain alertness and watchfulness, is very important."

* Pliability - "The ability to change an opinion, the power of revision."

I especially like Watts' formulation: "There should be a balance of the two, Prudence and Courage; Prudence in contemplation, Courage in execution."

This very much fits patterns of success I detect among the most profitable traders. They are prudent in contemplating their ideas--they wait for the odds to be in their favor and conserve their capital when the edge is not there--but they are courageous in executing those ideas.

Equally important, they can be courageous without getting their egos tied to their ideas. If markets are not confirming their views, Pliability ensures that they can revise those views and not hang on to losing trades.

"The qualifications named are necessary to the makeup of the speculator," Watts explains, "but they must be in well-balanced combination. A deficiency or an overplus of one quality will destroy the effectiveness of all" (p. 9).

Too much courageousness and too little prudence leads to impulsive risk-taking. Too much pliability and too little self-reliance leads traders to get chopped up, reacting frantically to the last market movements.

Some trading truths never go out of date.


Four Overlooked Qualities of Successful Traders

Resilience and the Courage of Your Convictions


SSK said...

Hello Brett, excellent article. Those points expressed in a pithy manner drive the point home. Thank you as always. BTW, the article on "Trading like a sniper" has helped me to be more patient, helping to find the balance that this article speaks about. I broke out to new highs after a losing streak, taking a few days off to contemplate, and I believe that I am trading better than ever. Much of my succsess has come from learning how to learn. Thank you agian. Best, Steve

Pete Nordsted said...

Dr Steenbarger,

I have been reading your blog and indeed your material now for around a year. I still trade on the financial markets but have now been studying the sporting markets and specifically the Betfair (Betting exchange) markets. The similarities are amazing and I have found your posts and books to be of great assistance. Over the past year I have studied in depth the price movements in events such as Tennis, NBA, NFL and Soccer looking for any trends which may occur and have now collected enough data to find an edge on the tennis markets and I am now currently working on the NBA markets.

The great thing about these markets is that if you are laying (buying) at a low price say 1.10 your loss is automatically minimised as it can only move ten ticks against you and yet the potential gain far outweighs any loss and also the beauty of these markets is the games are over within a couple of hours and your money can be put back into the markets. Indeed anyone who trades should seriously give these markets some attention.

Once again many thanks your books and articles have certainly improved my expertise in these areas and I always recommend your work to all of my clients.

Pete Nordsted

itrade4real said...

Hi Brett,

Great post today, but especially interesting was the link to another post called "Four Overlooked Qualities of Successful Traders". I visit frequently, and I can say you uncover the truth about trading. That is, it's psychological more than anything else!

VB said...

Today's action on the markets, was another 11AM (ET), timing deal: If you want to make money, you just have to wait until 11AM and then buy,buy...

Nix said...


I just got a copy of your book "Enhancing Trader Performance" and I definitely like it. I must say that I've improved as a trader by reading your posts in this blog. I'm just a small fish trading HK markets but I know I couldn't do 30% on a single trading day from an account of -4% to 7.5% without all your work. I just want to express all my appreciation for this blog.

I really really am thankful and I agree with your line...

"when u find ur niche, you won't want to be doing anything else."

this is just a thank you to you.

You act as my invisible virtual mentor.

-Nix (from the Philippines)

Ana said...


While I find there is eternal truth from the book "Speculation as a Fine Art and Thoughts on Life", I would not like to be a Speculator.

I would rather be an Investor or a true Trader, be it intraday, swing or position,as the word 'speculation' has a connotation of 'gambling'.

'Speculator' has been defined as one who engages in a venture or transaction of risky nature offering an unusual high return as distinct from an Investor or Trader.

Globetrader said...

Speculator' has been defined as one who engages in a venture or transaction of risky nature offering an unusual high return as distinct from an Investor or Trader.

Ana, I actually know no other business where you can set yourself a daily goal to increase your anccountsize by 3% to 5% and have a reasonable probability to do just that.
Trading futures, stocks or other financial instruments you can do just that, but that potential return involves taking higher than usual risks. Being a true Trader involves taking high risks and I think the description "Speculator" fits.
If you have a problem to apply this term to yourself, you might want to find out why and solve it for you, as otherwise you might unwillingly damage your trading results or limit your returns as unconsciously you might think you are not worthy taking these returns out of the market.
Best regards,


Ana said...


With due respect to any interpretation of the word 'speculator', my interpretation rests on this premise.

I feel the definition would just as well fit "gambler".

It is within this context that I would not consider myself a speculator

A return of 3% per day ROI on a possible 200 trading days would give me a 600% ROI pa. To me this is only possible if one adopts a gambling mentality.

The good traders look for 25%-45% ROI pa. and this is because they trade within a high probability of success and with good money and risk management.

In this context to me, a speculator does not fit a good trader or investor.

Again, it is a question of semantics.

The Financial Philosopher said...

Success, if defined correctly, in any personal endeavor can only be found in self-awareness. In the context of this post, all of the "qualities" mentioned could be summarized into one key ingredient of self-awareness -- emotional intelligence.

While it is notable that the book mentioned was "written well over a century ago," this wisdom goes back more than two millenniums...

"At the center of your being you have the answer; you know who you are and you know what you want." ~ Lau-tzu

"Real knowledge is to know the extent of one's ignorance." ~ Confucius

"The unexamined life is not worth living." ~ Socrates

SSK said...

ana, those high ROI figures, at least in my case come from trading 1 contract per 10K, as the leverage grows so does the ROI, and you can still be as discerning as your mental mindset allows. I checked out your site, nice work. Good trading to you. Steve

SSK said...

itrade4real, I like the way you update your positions. I do the same thing with my daytradingsnippets link. It used to be done by video, but I think it is more usefull to traders when I type it, because I can post the reasons behind the trade more quickly, and it doesnt slow the box down. Good job on your site, Good trading to you. Steve

SSK said...

the financial philosopher, wow, what an interesting archive of wisdom, Great work! I will enjoy your content over the next weeks. Good trading to you! Steve

SSK said...

GLOBETRADER, a while back i posted an email address for you if you were interested in a copy of our trading analyzer, here is a different address that I will be putting on our site soon, the other one i wont be using. Here is the new one, ssk@tamta.net If anyone else is interested in a free copy of the analyzer, just drop me a line. Steve

Marc said...

We're all gamblers here...don't fool yourself by saying you're an "investor" as if it means there's no risk.

You are placing a bet, perhaps a well-informed bet, but unless you are buying a T-bill, you have a bet with risk. This is called gambling. I'm not afraid to say it. For instance, sports betting is called gambling and yet there is much research and analysis done in those ventures. So what's the difference?

That being said, there's nothing wrong with gambling. The higher the risk, the bigger the payoff usually. It's up to you.

If you can absolutely guarantee me 25-40% pa. with no risk, I will write you a check today.

Cheers (or should I say "good luck")

Ana said...


The interpretation of 'speculator' is a question of semantics as I stated earlier.

Having said this, here is what Ayn Rand said:

As Rand said, 'words are capable of precise meanings' and 'when rational men disagree, check their assumptions'.

* Marc seems to define as 'gambling' as any activity that involves risk.
* Steve defines 'speculator' as activity involving risk with abnormal rates of return - rates that I view as involving a high probability of risk of ruin.
* I define 'speculation' as a return involving high risk of ruin and 'trading' as activity providing a return above that produced by 'safe' interest rate products and where risk of ruin is minimised.

In trading science, we are taught that we analyse our markets in a scientific way to reach a statistically set of methodologies that will give us a high probability of success.

However, sad to say, only those who persevere and adhere strictly to such methodologies are in the lower 10% going by the statistics that this percentile makes the most highly successful traders.

In this context, I maintain 'speculator' does not fit a good trader or investor.

Marc said...

Ana wrote: "However, sad to say, only those who persevere and adhere strictly to such methodologies are in the lower 10% going by the statistics that this percentile makes the most highly successful traders."

This is why we read Brett's fabulous articles. The market and it's participants are made up of people who are emotional, irrational and illogical at times. Investigation into psychology adds clarity to market moves. I too think gambling psychology is pervasive in the stock market. Failing to take this into account is why some people are always scratching their heads because the market isn't behaving according to their analysis.

I'm sure Dr. Brett could say it better.


Ziad said...


I think you are quite mistaken in your notions of risk of ruin, and also what is truly possible in trading- especially DAY trading of futures and currencies.

In reality, in these types of day trading, returns of several hundred percent are quite possible without any danger of risk of ruin. And the reason for this, is due to what Steve alluded to, namely the leverage that is available.

Let me give you an example to illustrate the point. Say a skilled professional day trader risks 1% of his equity per trade. The risk of ruin in this case if he is disciplined and keeps all of his stops, is virtually zero, as he would need to lose 100 times in a row to be wiped out. If you do the math, even assuming low trading accuracy, the odds are actually much much less than one in a trillion, i.e. a virtual impossibility of ruin. But what kinds of returns can he make risking this much? Well, let us assume that he takes 4 trades a day and that his overall expectancy per trade is 0.25. At this rate, He would make 1% a day (4*0.25*1%). In turn, averaging 1% a day, and compounding it daily as the account grows, his yearly return would be 1.01 to the power of 250 = 12.03. That is he would multiply his capital by 12 times, or make a 1200% return.

Now are such returns outrageous and impossible? Not at all. The caveat here is that the *percentage* returns will naturally diminish as the account grows. A $50,000 account in the hands of a very skilled trader could grow to $600,000 in one year, but after it reaches larger balances, the % returns possible decrease rapidly because intraday trading is not very scalable due to lack of liquidity and slippage associated with trading huge size, and thus effectively the leverage available that produced the huge returns when the account was small can now no longer be used at the same rate.

Eventually, when the account reaches the millions, then the 25%-45% ROI that you alluded is all that can be targeted. And that is why you hear that the pros target this. It's because we are usually referring to the large portfolio managers who are managing huge money and who cannot take advantage of large leverage.

In the end, the mistaken notion is that large leverage = risk of ruin. That is simply not true. Like I've shown in my example, a trader can use large intraday leverage while having virtually no risk of ruin if they use strict stops and only risk a small % per trade. In fact, this isn't just theory, as I have personally made much more than the yearly ROI you alluded to, and have done so in less than half a year. Was I gambling irresponsibly? Absolutely not. My largest loss never exceeded 1.5% of my equity. I would hardly call that gambling.

So I just thought I would clarify all of this in case someone read the comments and got a mistaken conclusion.

Ana said...

Brett, first: your Eternal Truths is getting eternal comments, I see....a good moot!

Now to Ziad:

First off, I base my premise on Assumptions as spelt out for myself and any commentator/s on their comments.

Risk of Ruin is a big factor in why so many especially newbies fall on the way as they trade, believing it is very easy to make money , due mainly to hype in the ads that it is very easy to make hundreds of percentage on one's equity margin.

If Risk of Ruin were a myth, then every one would give up their full time jobs and be a full time trader since it is a given that this is not true and making money can be so easy.

Hence, whatever statements we make must be based on ASSUMPTIONS to be valid and to avoid giving wrong impressions of how easy it is to trade and make money , big money especially.

With due respect to you, Ziad, you may be an exceptional good day-trader as you have been making big percentage returns on your equity , but I would not encourage the man in the street to trade without learning the ropes ie with good money and risk management techniques , which takes years or trading experience to succeed as witness statistics of the low 10 percentile of traders , and they are the top pros who aspire to 25 - 45 % pa returns on their trading.

What more for newbies who join the 90% of traders who usually blow up their accounts or can barely keep their bottom line in black.

Again, theoretically 1,200% pa is possible and easy but
• You assume that trading a 1% loss (not risk but actual loss taken) will always be possible.
• But as Taleb has shown, Black Swans are more prevalent that most give credit for. When you are aiming for a hit win rate, low return, such events cause devastation to the bottom line. As Tom Baldwin (famed pit Bond trader) once remarked: I give back 25% of what I earn in a month when a trend day happens. Tom was one of the largest and best pit traders around.
• Most importantly, you assume that a 25% expectancy is a realistic return in this sort of environment. We would have to see a large sample of returns to accept this.
• Finally even assuming your calculations are right, only exceptional traders maintain the discipline necessary to maintain the high win rate necessary to produce the returns you speak of, allowing some exceptional traders who may achieve triple digit returns.
• But that sort of return is not available to us mere mortals - the fact that so few traders achieve ie 1,200% is proof of this statement.

Please learn the ropes of good trading with good money and risk management and with discipline you and I will be happy to achieve ROI close to what the Pros do ie 40% or more.

Ziad said...


I don't want to keep these comments going forever (although they are interesting) but I'll just quickly comment and say that:

1) It certainly is not easy and I've been working my ass off studying every aspect of the market and myself for the last 2 years. Newbies should never think it's easy. I was addressing what was possible for professionals who have already put in the time to learn the ropes.

2) I don't have a high win rate at all. In fact it is less than 50% as I am an intraday Trend trader primarily. I really dont care about accuracy and it has nothing to do with it. I care about large reward to risk ratios by identifying trades where I can enter with a tight stop and hold for a big move. As such, Taleb's black swan doesn't really apply as I am not trading in the style of the LTCM arbitragers and thereby assuming some mathematical model will hold and thus leveraging myself to the teeth with no stops. I'm in an out usually in a matter of minutes when I'm wrong as my tight stops get hit. The only possibly disaster would be if the exchange went down, but for that I can quickly hedge with the DAX.

3) I never implied risk of ruin is a myth. It is definitely real. But to assume that it is tied to leverage only is wrong. It is actually tied to position size AT RISK. i.e. the contract size you trade plus the size of your stops. As such, you can indeed remove risk of ruin with some discipline and good risk management.

4) An expectancy of 0.25 is actually on the low side. I know day traders with an expectancy of 0.80. Of course their frequency of trading is lower so in the end the overall returns are about the same.

In the end my intention is certainly not to argue with you. But we create results based on our beliefs. If you believe that such high returns are equal to gambling, you artificially limit yourself subconsciously in what you will be able to achieve. And it's really not about having some incredibly special talent. If you train your skills relentlessly, you can achieve a decent expectancy, and then you leverage that intraday and you get great results. But only after relentless hard work.

Brett Steenbarger, Ph.D. said...

Thanks for the excellent comments and perspectives. The term "speculator" was more common and popular earlier in stock market history and had a positive connotation, as someone willing to risk money on a venture with favorable odds of success. I wholeheartedly agree that controlling position size and amount risked per trade and per day is key to avoiding risk of ruin.