Creating Standardization to Improve Your Trading Process
Jan 3, 2020 Trading Blog
I hope everyone had a great Christmas break. I know I definitely needed some time off to recharge, review and get ready for another year of the grind. I wrote down some things that I thought some might find useful to improve their trading process, and I hope it helps someone out there trying to find their way in this game. I’m also putting together a list of trading tips that I wish I’d found on my journey, which I’ll hopefully get posted this weekend.
When I started trading, I would trade anything, whatever was popular that day. I’d watch the market, find some hot stock and just jump in with absolutely no real plan. I had no process and nothing that I could repeat day to day, each day was different. I couldn’t improve myself because I basically had no process to fix or improve. I had no starting point from which to build. I was always just hoping that I was going to get lucky each day and hit the next random trade. I had no repeatable setups, no standardized way of evaluating the overall market strength, no set risk or position sizing. I gave my brain absolutely no structure to work with, and of course you know what a brain without structure will do in these markets. I did this for a long time, simply because I didn’t know any better, and I’m guessing there are many traders still doing this. Trading without standardization DOES NOT work.
Probably the most important thing for me in trading was to create a standardized trading process. Standardization creates Repetition, which creates Intuition, which creates Expertise. If you never standardize the way you trade then you can’t repeat it, you can’t fix it when it’s broken and you can’t improve it if you aren’t really even sure what you did in the first place. Everything must be defined and have a label. Each piece of a system is its own entity with its own rules and specifications.
The beginning for me was to just start reviewing my mistakes. It always seemed like I was making a million mistakes every day, but at some point I started keeping a journal and writing them down and why I made them. To my surprise, I found that I really only had about 10-12 mistakes which caused all my losses. And those 10-12 mistakes were mostly caused by 3-4 psychological weaknesses that I had to fix. It just seemed like I made a million mistakes because I never labeled them or explored them. I eventually started assigning a number/label to each mistake and would record it every time it occurred. Everyone will have different mistakes, but a few of mine go something like this:
1 = Not defining my risk/reward (R) before entering.
2 = Not accepting the actual risk of the trade.
3 = Micromanaging a trade after it’s entered.
I’ve currently got a list of about 10 things that I know that I commonly do wrong. Each one has a page in my book. Some I’ve dropped off the list because I just don’t make them anymore now that I’ve created structure to avoid them. With a list of labeled mistakes, I find it easier to focus on staying on plan. I’ve standardized all the places where I know that I commonly go wrong. Most traders know they are making mistakes, but they never really know AHEAD of time what those mistakes are so they can avoid them and they also never really try to address or fix them AFTER they happen. When I make one, I simply write the number of the mistake down in my journal to review after the market closes.
And when I say write them down, I don’t mean just jot them on a sticky note and put it on the computer screen. The guys that do this just drive me crazy. Stopping at that shallow level is a total waste. You will ignore that sticky note a week from now as your brain gets used to it being there. What I mean is devote a page or two in your journal to each mistake. When you make it, write out what happened. Write why it hurt, what it did your your mood, how much money you lost and how you felt. Write out how to avoid it and what signals usually appear when the mistake situation is about to develop. Dig deeper and keep adding to each page so it sticks in your brain and reinforces WHY you have these standardized rules. A sticky note just doesn’t cut it, it’s lazy and a useless quick fix to a problem that needs more attention.
When I first had someone tell me to do this, I was skeptical, but it really does work. If you know yourself so well that you can assign a number to the mistakes you are likely to make, it becomes much easier to avoid them. Simply knowing where you usually go wrong is half the battle of correcting it.
On the technical side of things, every trade setup I use also has a number/label designated to it. When I make a trade, I write it down as a number. In the journal it’s something like this: “Trade #3 at PDH”, which stands for a buildup breakout trade at the previous day’s high. I’ve got six basic daytrades that I describe by number:
1 = Spring/Stop Hunt/False Breakout
2 = Impulse/Pullback
3 = Buildup Breakout
4 = Breakout Retest
5 = Overextension/Climax
6 = Climax Retest
Each of these trades has its own description, and much like the sticky note situation above, each requires a fairly deep dive in detail. I’ve got a list of conditions/context where each is ideal. I’ve detailed the entry and exit methods of each, the profit potential of each, the volume I want to see, the volatility, etc. Everything is optimized beforehand. If I’m watching the market and I see a trade setup that isn’t on my list, then I know NOT to take it. If I can’t assign a number to it, it doesn’t exist for me. Many traders don’t really know what they are looking for during the day and they are simply trading impulsively. Labeling the trades you are looking for focuses you to create a plan and stick to your plan.
More importantly, defining and labeling your trades like this takes all of the details out of your head while you are trying to focus on the market. Nobody wants to be sitting there trying to figure out how to enter, how much to bet, what kind of volume they want, how far the trade can go or other details while focusing on the market. The brain just can’t handle that much information, especially when emotions kick in when you see opportunity. All of those technical things should be defined and labeled well before the market opens. Label and standardize, commit it to memory, then all your brainpower is available to evaluate the market.
All parts of the trading system should be standardized and have a label. Parts of a system that must be standardized include:
A – How much are you going to risk on a trade (money management)? For me, I risk about .25% of my account on my daytrades. It’s ALWAYS a standard amount. When the trade sets up, there’s no wondering how much I’m going to wager. I know EXACTLY what the bet amount is and this keeps emotion from taking over and causing bets that are too big (or too small) which can affect psychology. What kind of risk vs. reward situation are you looking for? 1:1? 2:1?
B – Where and how to place the stop. You can preset it or use a mental stop if you know you can depend on yourself to take it. If you have a difficulty taking your stops, then preset because you don’t need that emotion while you are trying to watch the market. What kind of levels or barriers do you want between your entry and your stop?
C – Where and how to exit. Do you want to trail a stop? How much are you willing to give back during a trade? Are you scaling out or taking the entire position? These all need to be standardized so you don’t have to waste precious brainpower on them while you are watching the market.
D – What stats are you going to keep during the day? How are you going to evaluate the market action during the day? I divide my day into 13 periods of 30 minutes each and keep track of volume, range, change, average price, MFE/MAE and VWAP for each period. I’m not sitting there evaluating the market in a million different ways. I’ve standardized how I monitor the market and I do the same thing EVERY day. Standardization creates repetition which creates intuition which creates expertise.
E – What points in the market are you focusing on during the day and where are your prime trade locations? I listed 10 standard points that I’m always watching during the day. I call it my Environmental Framework. Things like previous day hi/lo, previous week hi/lo, VWAP, today’s open, etc. I’m not sitting wasting energy on random action at random points. I’ve standardized what I’m looking for. You just can’t sit and aimlessly watch a market, your brain will cause you to do really strange things. It will lock on to meaningless points of reference and meaningless action because the mind has no structure. Give your brain a structure to follow during the day and let it focus.
F – Where and how to enter? Scale in or all in? Limit order on bid or market order on ask? Waiting for a down move or waiting for the breakout? Information risk or price risk? Wait for confirmation before entry or get a better price without waiting for confirmation? Entry is probably one of the most important things to have standardized because this is where the emotions normally kick in as the excitement and nervousness starts for most people when risking real money hits them.
There are several other system parts, as well as a whole list of psychological attributes, but these are the major tent poles. The basic point is this: STANDARDIZE your entire process so you don’t have to think about it during market hours. The human brain has enough trouble evaluating market action, therefore you can’t burden it with all these other details that can be standardized during non-market hours. It’s a huge task just to keep your psychology straight, and having a thousand technical trade details floating in your head doesn’t help.
Also, something else I always had a problem with was this: Don’t be so exact. Nothing in trading is exact. Everything is an area or a level, never an exact point. Everything is gray, nothing is black and white. Your trading process doesn’t have to be perfect, it simply has to be standardized. There are a million ways to trade, just pick one. In the long run, your chosen method really doesn’t matter, almost any process can work. The real key to trading is to choose your process and then repeat it to the point where you develop intuition using it. Trading has almost ZERO to do with your chosen “method”. Trading has everything to do with using that chosen method to know how and when your method will work, when the market is deviating from your method and when opportunity is available for your method.
Sorry that got kind of long. I’ll cut it here and try to move to a general list of rules and tips in the next post. I’m always around and glad to help if anyone has questions.