What is the thing that I work on the most in my trading?
I get asked this question, or similar, a lot. It’s a bit like the question I got when a very junior pilot (actually, I was between flight training courses) when I had a week standing next to a plastic mock-up of a Hawk trainer on the south coast. That particular question, with little variation, was “how fast does it go (Mister)”. Closely followed by “what does the point on the front do—is it a gun?”
The answer to the trading point, like the pilot question, has a reply that can be simple or in-depth. For the Hawk response (to the beach holiday crowd, bless them) I realised the top speed in a relatable format irrespective of flight conditions—namely altitude—was everything.
I have to admit now, some 40 years after the event, and pre-Top Gun movie, that for the “point on the front” the answer being a pitot-static sensor understandably got blank looks far better that I did not disagree with the gun theory!
For the trading answer, it is context, entry identification, risk (including spread) and, last but not least, exit criteria. Okay, slightly more depth but you’re not the south coast beach holiday crowd.
Let’s consider spread again. I’ve talked about it previously (maybe a few times), but it always deserves a fresh look. I bring it back up now as recently my stop-loss positions have tightened. A stop-loss order ejects a trade automatically. Traditionally, it is a level at which a trader has ‘got it wrong’ and needs to get out.
The amount risked, from entry to stop, needs to be consistent with each trade.
As an aside, the risk is significantly more detailed. Nassim Taleb describes this best in his thought-provoking book ‘fooled by randomness’. Best read on an electronic device as, if like me, you’ll need to make good use of the thesaurus facility.
My ‘stop positions’ nestle well inside the ‘you’ve got it wrong’ level. Why I do this is for another discussion. But what it does reemphasise (because of the tightness) is the importance of working with the spread.
Note: If a trader is thinking of following suit with particularly tight stops without first solving the contextual, and other issues, as mentioned above, you will be throwing your money away rather rapidly.
Spread is similar to holiday money exchange. For example, today, we get 1.26 US dollars for a pound. But, of course, we don’t. Because of the exchange fee, we get nearer one for one. If we exchange £100 the cost is annoying but no big deal. If, however, we’re exchanging £100 dozens of times a week every week, then we can see why this would need careful consideration.
The spread in trading is the brokers’ fee. Investor deals entered with wide-stops, and over immense periods have little concern in this regard. A trader’s success, however—with tight stops and sharp targets—is defined in large part by the spread. (For the short-term trader, I notice that planned profit is adjusted down by a third due to this fee.)
The three things of concern to a trader are risk per trade defined as a percentage of the account, R (meaning reward/risk, or the amount of reward achieved on average over and above the average loss) and the win rate defined as a percentage.
Therefore, a trader’s R may signal a winning formula. But when we factor spread into the equation, the consequential reduction in R reverts the (probable) good results into a losing strategy.
A final point on the matter is that successful retail and professional traders have a method that one way or another follows on the coattails of winning institutions—institutions are not burdened unduly by the spread.
Trading is not a level playing field.
Short term traders that don’t consider all the implications of spread very, very carefully are the same as those who were happy to hear that it is a ‘gun’. Rather than acknowledge the more complicated and crucial truth that it is an essential (if not rather comparatively dull) ‘pitot-static system’.