A Formula for Disciplined Trading

Dear Reader,

It’s easy to feel like a genius when the market climbs almost every month, gaining nearly 30%, like it did last year – but then came the January woes, and more woes afterwards.

In less than a month the S&P 500 dropped 10%, and if that wasn’t enough to get you riled, it did nothing but erase all of the 2021 gains by mid-October.

The market has always had patterns of rising and falling, but it’s clearly much harder to cope with our emotions in the down turns.

I’m going to say this, and it might surprise you – I don’t get excited about winning trades.

Nope, and do you know what else I don’t get riled about? – losing trades.

That’s right. I try to be like a robot when it comes to trading.

If you’re question is how can I do this… Well, I’ll tell you…

For one thing, emotions can lead to arrogance when you’re on a winning streak – which inevitably leads to poor decision making, followed by losing money, but it’s losing on a trade that can really test us.

When we see a weakening economy, or falling market, our fears can overpower us if we let them – which can cause you to freeze in your tracks, which can then lead to portfolio AND opportunity losses.

One thing I’ve witnessed too much of, is traders overcome with emotions so much that they simply give up – and this can lead to missing out on the winning trading opportunities, which often come right after a string of bad trades.

I don’t mind telling every trader to memorize the following statement: “There Will Be Losses!”

I think you’ll agree that trading decisions can be influenced by emotions.

Let me give you some tips to help you stay calm and directed throughout your trading journey.

And in the end, you’ll be capable of making more money trading by rules than you can by trading off emotions.

Professionals use well-recognized techniques to keep calm and make decisions based on logic, not emotions, and in today’s trading world there are computer algorithms that do the work – I know that the algorithms I use do not show one whit of emotion.

So, the best way to compete with non-emotional software is to create a set of rules to follow.

Let’s talk about ways to remove emotions from your trading, follow rules and compete like professionals. After all, making money is your goal, and if you treat trading like a business it can lead to profits like a business.

I’ve got a handful of tips I think can help lead the way to trading systematically, not emotionally:

  • Don’t act on anger. After a losing trade, anger can kick in and a “revenge” trade is apt to happen. It’s easy to chase a trade by jumping back in to recoup losses, but this can easily lead to more losses.
  • Don’t be married to any of your positions. For short-term trading, we should not feel any obligation to the stock. If you’ve got rules regarding holding times, follow them. Some investments may be intended to last for years, but otherwise get comfortable letting things go. Once a bad trade is shut down – move on.
  • Follow each trade with a break. As you’re getting started with any trading system, don’t feel the need to take on every trade. Take some time off after your trades to deliberate. Get focused and then move on to the next trade.
  • Set exits with stop losses. I use stop loss orders because it’s a great way to limit losses. Additionally, stops can save you from emotionally hanging on to losing trades. It’s one of the hardest habits to overcome.
  • Don’t focus on single trade profits or losses. Concentrate on the trading strategy. It’s growth over time that counts, not the single trade.
  • Stay the course. Stick with the trading plans that have proven track records. Don’t let the results of one, and sometimes a few, bad trades discourage you. It happens with all trading systems – sometimes you’ll have a string of good AND bad trades.
  • Beware of greed. Greed can make you stay in a trade when you had planned to exit, which is why my trading plans call for exiting partial positions and then letting them run afterwards. Successful trades can end up losing money if greed is not managed properly.

On any trade, once it has doubled in value, half of the position can be taken off, and the rest of the trade is essentially what I like to call “playing with house money.”

  • Don’t give up. I saved this for last because I want you to memorize it. If your trading plan has a proven, back-tested track record, it becomes a matter of trading the numbers from thereon – which is the best way to avoid emotional trading.

The formula for success

Once you’ve discovered the trading strategy that complements your style, you can simply plug numbers in the formula below to determine if it’s worth it.

Here’s the formula: (# of Winning Trades X Total Gained Dollars) – (# of Losing Trades X Total Dollars Lost) = Success or Failure.

And here’s an example.

Suppose your trading strategy produced 15 winners and 10 losers, and when you added up the winners, you netted $10,000, and the losing trades totaled $4,000.

Let’s plug the numbers in the formula: (15 x $10,000) – (10 x $4,000) = $6,000. The result must be a positive and an acceptable number for you. If so, you have a winning, systematic trading approach that will allow you to be successful without all the emotions.

Take note that even my example had 40% losing trades. If that becomes the focus, you won’t feel good about any strategy. In the end, the system that can produce positive results over time is worth keeping – you’ll have your profits and your sanity.

Until next time,

Tom Gentile
America’s #1 Pattern Trader

Join Tom each Monday through Wednesday at 12:00 p.m. ET as he discusses a range of strategies to make money in a strained market environment.

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