This is one blog post that I hope you never have to read.
Why? Because it’s all about failure.
The word “failure” has tons of connotations. Shame. Guilt. Disappointment. Anger.
These are things that we try to avoid at all costs.
If the world were perfect, you would never run into failure in your trading career. I hope that you will never be in a hole that you have to struggle to climb out of. I sincerely wish you a phenomenally successful career where you have a continuously smooth, upward-sloping equity curve and you become superbly wealthy.
As for me, I know all about failure because I have failed—spectacularly, actually. When I started my career, it was in one of the most coveted spots globally—a proprietary trader at a big global bank. Pretty damn good for a 22-year-old. Heck, very few 32-year-olds could ever land a job like that. Indeed, as a trader, I thought that I was hot s*%t and on the quick and direct path to limitless riches. Instead, I dropped the ball. Spectacularly. When it comes to failure, I know it all too well.
Unfortunately for most traders, including myself, our career is not a straight-up path. In the pursuit of profits and excellence, we have experienced our fair share of setbacks and struggles. We have taken our lumps and wallowed in misery, wondering when we would ever get back on track. And we know that, while we will give it our best effort and always strive mightily to improve, we will probably meet with failure and setbacks at some time in the future.
In fact to trade well, we need to tolerate failure. We will have some trades that lose, even if we are running well. We will have some losing weeks or months, even if we have a good year. We will do some stupid things from time-to-time, even if we end up profitable in that timeframe. In fact, given that we are taking calculated financial risks, it is inevitable that we will experience losses and setbacks. To paraphrase Van K Tharp, taking risks without experiencing the occasional loss or setback is like breathing in without breathing out. This reinforces the need to prepare for losses and failure in our trading.
Obviously, this humbling conclusion begs certain questions:
- When faced with failure, how do we bounce back?
- How do we come back from failure and learn from it, in order to be better than ever before?
- What lessons can we draw from the past?
Because I have failed badly as a trader and come back, I hope that have something to share with the rest of you. If you can draw some lesson that helps you avoid failure, or to come back faster and more powerfully, then this post will have fulfilled its mission.
Obviously, before we can go any further, we need to define failure. In a markets context, the first answer would be that failure is “losses”. Yes, P&L is a critical barometer of success. I’m just saying that there is a lot more nuance to this answer than “Were you profitable or not?”.
Imagine that you were up 20% per year on average for five years and then you are up 1% in the most recent year. Profitable, yes, but you would be content with those results? Probably not. Perhaps you had a good year in terms of profits but should have made two or three times as much because the market conditions were perfect for your trading style. Lastly, you could be down 2% in a year, but if market conditions were terrible for your style and your last drawdown in similar conditions was 10%, then you could even consider yourself to have succeeded, despite having lost money.
We need a definition of failure that accounts not just for profits but for how you are making decisions overall, relative to your expectations. As I love to bang on about, trading is all about making good decisions. Profits don’t magically appear out of thin air—rather, they flow naturally as a result of making sound risk/reward and process-driven decisions.
What we are really talking about is your performance relative to your expectations, in all aspects. The most obvious level is profits. One excellent trader can expect to make $10 million in a year and berate himself for failure if he makes only $6 million; another could be hoping to make $200,000 and feel that he succeeded if he made a $210,000 profit. We can also benchmark our performance according to other metrics, like win/loss ratio; average winner vs. average loser; etc. By way of example, one trader could strive for a 60% win rate and fail by only getting to 58%; another would be a success shooting for 40% and getting to a 43% win rate.
Similarly, you need to have a broad conception of how your trading style should perform under various market conditions—and use that knowledge to determine position sizing and other risk parameters so that you never threaten your account size in adverse market conditions. Thus, failure comes when our results are out of whack with realistic expectations for our trading style in market conditions.
If you are a long-biased equity investor and don’t make tons of money in an up 50% bull market, then even if you are up 15%, you have failed. If you are a day trader and want to go from making an average $1000/week to $2000 /week over the course of the year, and you don’t, then you have failed. If you were expecting to make a few research-driven trades per month and ended up with 100 poorly researched short-term trades per month, then you have failed—regardless of your profitability.
How To Come Back From Failure
Working with this definition of failure, we already have some idea for how to come back. There are a few basic steps, which I will outline below. But the precursor is to have an honest appraisal of how you are doing at that exact moment—and to resolve to do better. If you are unhappy with your trading results, fine, you are unhappy—but you can start right then and there to get better. Wallowing in your unhappiness will do nothing to correct your mistakes, and is likely to worsen your sense of distress. There is absolutely no reason to beat yourself up!
Step #1: Figure Out Your Trading Style
Like I wrote earlier, the key is to have your own style for making decisions. The most important step is here to make sure that you have a defined trading style. This is your way of doing things—how you get in and out of positions, how much risk you take, etc. Ideally, it’s written down with a set of rules or guidelines that you try to follow. Without an understanding of your style, you run the risk of flailing around in the markets with no clear plan, donating money to the market. As the saying goes, “Failing to plan is planning to fail”.
If you don’t have a plan or if it’s not well-formed, then remember this: if trading profitability is a business, then this is your business plan. You need a plan for how you intend to take money out of the market. So, take the time to get it all written down and really define what you are doing. If you are just starting out and don’t have extensive experience with trading, then it’s okay to borrow a trading plan from someone else who’s successful. It can be a book, a course, whatever- just make sure that it works.
While failure can result from not having a plan, it can also stem from not having a plan that’s suited to your personality. If you are a research economist by training, then you should stop trying to be a day trader. If you are star athlete who excels at making in-the-moment decisions, then long-term trend following is not for you. If you are an experienced execution trader for a bank and start trading your personal account by swing trading in highly liquid stocks, then that almost certainly does suit your personality. Thus, a key ingredient to success is that have a trading plan which fits your personality.
As Steve and Mike like to point out, someone who doesn’t cut it as a day trader may have a fabulous career ahead of them—it just will be doing a different style of trading that’s more suited to their personality.
Step #2: Set Realistic Expectations
Once you have defined a plan, then you need to set expectations around it. The most important of these are the profitability and the drawdowns that you envision. You should know if your plan will be “slow and steady” or a rollercoaster ride. That way, you can benchmark your future profitability against some kind of measuring stick. If you are trying to make 20% a year plus, then you should know that in advance of looking at your P&L statistics. You should also judge it against the risk being taken, otherwise defined as the potential drawdowns. If you expect only 6% maximum drawdowns, you should also have some idea of that in advance—and be happy with 4% drawdowns and extremely unhappy with 10% losses!
If you are coming back from a perceived failure, you need to have an idea of how you think you *should* be doing, and then evaluate in comparison to that—and ignore other comparisons. For instance, if your neighbor is up 40% one year while you are up “only” 20%, then it’s natural to be a bit envious—but if your style is lower volatility and you know that a 20% return is at the top end of what your trading style can produce, then you can rest easy and ignore the comparison. Focus on your results and how you are doing things, not on something that you can’t control.
Most people fail because they haven’t calibrated their expectations for different market conditions. After all, markets can change and you need to prepare for it in advance. You also need to understand how your trading style will perform in different markets. Obviously each trading style has market types that are more or less favorable—and you need to have a good idea of what P&L and drawdowns to expect in those different market types. As an example, if you are using William J O’Neill’s CANSLIM system, then you would expect a small- to medium-sized drawdown during bear markets for stocks and up to 100% annual returns in big bull markets. Market type doesn’t always mean bull versus bear. If you are trading forex, then think about how you would do in choppy and rangebound markets versus trending markets.
Failure usually derives from not paying attention to how you were making decisions. Thus, the next set of expectations should relate to how you go about making decisions. You want to make sure that you are checking each trade against your trading plan, so that you are following your rules. When you enter a trade into your record-keeping system, there should be a rationale that explains why you put it on—and how it’s consistent with your overall trading approach. That way, if you are long-term trend follower but put on a trade that was a just a short-term punt, then you need to realize that you slipped up in how you make decisions. In this department, set your expectations high – make a commitment to have each trade in line with your system’s approach, consistent with your trading rules and well-documented.
Once you have explicitly and clearly defined your expectations, then you are more empowered to bounce back in your trading.
First of all, you should have realistic expectations, so you are not going to beat yourself up for results that fall short of some lofty, blue skies expectations. Expecting to get every trade right or to make 100% per year is ridiculous.
Secondly, you are much better prepared emotionally to handle drawdowns, because you can realistically forecast how much you will lose in bad market conditions—and try to outperform *that* goal, rather than futilely trying to make money when the odds are stacked against you and your system. You know how to persevere.
Thirdly, by setting high expectations for how you make each trading decision, you are going to fine-tune your decision-making process, giving yourself a better long-term foundation for success. It will also divert your attention from just your P&L, putting even less psychological stress on you.
Step #3: Take One Step To Do Things Better. Then Repeat.
Now that you have a plan and realistic expectations attached to it, the route back from failure is simple. As we have discussed, you need to stay focused on process-driven goals, rather than just P&L ones. The best way to address this is to pick just one small element of your trading and to vow to do it better. Revise your expectations higher and work on it until it’s to a level you’re happy with. Then repeat.
As an example, imagine that you are a swing trader. Your rules suggest selling a stock when it’s up 20% and moving on to the next position. While doing your research, you notice that some stocks continue to perform after they’ve gone up 20% because they have extra institutional buying support that the other winners don’t have. You use this information in the most straightforward way—you revise your trading plan. You vow to devote extra focus to this one aspect—making sure to identify the potential big winners that have strong buying support and hold onto them longer, to capture bigger profits.
Now, while going about your normal trading plan, you are going to put more emphasis on this one particular point. You will still focus on executing One Good Trade at a time—not trying to shoot the lights out all at once, but rather making sure that each trade is individually sound. Now, you will pick entries and exits the same way but go that extra mile to look for extra buying support. It becomes easier to close positions that don’t have that support and also to hold onto the big winners. Thus, by tightening up just one aspect of your approach, you can measure directly how that translates into your overall results.
Moreover, that one aspect of your trading is not in isolation—it has a knock-on effect on all facets of your trading. Continuing this example, in learning to look for institutional buying support, you have become a better tape reader. This in turn enables you to pick better entry points or to start timing better your exits. Another example—you focus on cutting your losers faster. By examining more closely your losers, you notice certain ongoing patterns in those quick losers—and stop entering positions that demonstrate those patterns. Your results improve on the back of this.
Thus, the road back from failure is not a road—it is a series of the most deliberate steps possible, one after the other. By drilling down to one very specific aspect of your trading, you start fixing a small problem or upgrading a minor part of your trading. This ripples out into other aspects and helps you to identify the next step and the next solution.
Once you have done the prerequisite work, the road back from failure is straightforward. Instead of beating yourself, remember—“There is no failure, only feedback”. It actually helps us to know where to change—so we can focus on the process of trading at the smallest, most controllable level.
Put it under a microscope and figure out what you need to do improve it. And then do it, measuring yourself against the benchmarks you set. Once you are happy, repeat.
You can augment this process with other tools. I have discussed elsewhere trading and visualization (Check out Part 1, Part 2, and Part 3). In this case, you should enlist visualization exercises and see yourself executing your trading plan successfully. You should imagine feeling good about sticking to your discipline, about doing the things that you are trying to improve in your trading. This is the basic blueprint for successful visualization in trading.
Furthermore, you should visualize having accomplished certain process-related goals at a point in the future, using the goal-setting techniques found specifically in Part 3. For instance, you can imagine yourself having achieved certain metrics, e.g. a win rate above a certain percentage, or a certain maximum drawdown that you are comfortable with. Associate these metrics with the very same feelings of satisfaction and triumph that you would a certain P&L goal. Imagine the changes that you would have made along the way, both in yourself and in your trading, in order to better accomplish this goal. Rejoice in your coming back from failure, in your overall improvement and the massive changes that have resulted in your profitability.