This article on Trading Discipline is the opinion of Optimus Futures.
Imagine, if you will, two traders. One trader holds a superior trading strategy and ample capital resources to make it work. But he lacks discipline. The other trader has a mediocre system, fewer capital resources, but superior trading discipline. The non-disciplined trader has everything going for him, except for himself; whereas the disciplined trader has a few things working against him, but his ability to remain disciplined serves as his core strength.
Who might end up becoming the more successful trader? The answer is that it all depends on a few other things: the ability to adapt to situations, the smarts to assess what’s working and what’s not, and the “discipline” to pull it off.
When a system stops performing well according to its historical metrics, when faced with the inevitable losing streak, or when the overall market dynamics have changed, having the perspective to see the big picture, the smarts (or know-how) to find a solution, and the discipline to adjust one’s trading strategy makes the biggest difference.
- Without perspective, your know-how and discipline might compensate for it (if only by telling you that you need to widen your scope of understanding).
- Without know-how, your perspective may clue you in as to what you need to know, while your capacity to stay disciplined might acquire the knowledge and skills you need.
- Without discipline, however, your perspective and knowledge are rendered ineffective. How so? You become your own biggest risk factor; you may end up defeating yourself.
Discipline may not be everything you need, but it is the one thing you need to make all of the other components in your craft work.
Without it, your actions are unreliable, and so too is every bit of knowledge and skill you possess.
How Lack of Trading Discipline is Killing Your Performance
Trading Discipline – Do you have it?
What would your trading account look like if you hadn’t taken all those trades you knew you shouldn’t have taken in the first place? Most traders are often much closer to finding their market edge than they think. But they’re missing something. And the missing piece is not a lack of knowledge, but the inability to follow a disciplined approach.
The good news is that developing discipline is usually much easier than developing a better market edge. But you need to develop discipline first before finding your edge.
This article will show you exactly what is needed to take your trading to the next level.
Knowing what to do and doing it.
In trading, like in most other professions, it comes down to knowing what to do and then doing it. This statement consists of two parts: “knowing what to do” describes your trading system and how you define your trading edge. The “doing it” part is the actual execution of your system, following the rules and applying risk management principles.
The average trader spends the majority of his time trying to develop his trading edge, namely looking for “better” indicators, or trying to find other ways to improve his win-rate. Trading failure is usually not caused by inferior trading systems, but by the inability to follow the rules. Just think about all those trades where you entered too early, broke your rules, chased trades, took too much risk, exited too early, were too greedy and gave back profits or did not close a losing position and ended up with a much greater loss.
Honest self-reflection, meaning assessing your trading performance objectively will often reveal that it ‘s not your trading methodology that’s the problem, but you: your ability to execute rules that are clearly laid out for you to follow.
Discipline and hidden trading performance.
There’s a point beyond which you can no longer optimize a trading system. Forget the 100% win-rate (it’s impossible) or the magic formula to predict absolute tops and bottoms; trying to achieve such extremes often leads to the opposite results: failure instead of improvement, let alone excellence.
You do, however, have room to improve your discipline. Its impact on your trading performance will be much greater than any effort you take in trying to squeeze out a few more points from your trades. As we mentioned earlier, trading mistakes stemming from a lack of discipline are among the most common problems for traders and the greatest performance killers:
- Taking exits to early – leaving money on the table
- Taking exits too late – giving back profits
- Entering trades prematurely – taking trades without an edge
- Chasing trades – trades with a reduced expectancy
- Revenge trading – entering trades without an edge
- Risking too much – Losers have a significant impact on trading equity
We will say it one more time: Imagine how your trading equity would look like if you would have avoided all the trades wherein you violated one of the principles. You will see that it’s not a “bad” trading strategy that’s causing losses, but your undisciplined trading.
Developing Discipline – Willpower and No Exceptions
We hope that by now you have understood the meaning of disciplined trading and its full impact on trading performance. Now we want to share with you a few techniques, tips, and tools on how you can enhance your discipline. Here are our top 4 tips when it comes to becoming a more disciplined trader:
#1 – Self-Awareness and Trade Review
We are starting with the most important point which will undoubtedly have the greatest impact on your trading: start reviewing your trades. Just think about your current trading routine. What do you do after you close your trades? Most traders will never look back and review their trading sessions. Big mistake. This will not only stop them from making any improvements, they’ll miss all of the trading errors that could have been identified, virtually guaranteeing that they’ll end up making the same mistakes over and over again.
Our first and most important tip is, therefore, to take a few minutes each day to review your trades. Start making notes about your mistakes and you will very quickly see patterns in your trading behavior.
#2 – Have a Checklist
Marty Schwartz is one of the most successful traders of all times and he has also been featured in Jack Schwager’s Market Wizards book. In his own book, Pit Bull, he talks about the importance of having a physical checklist. He writes down his trading rules, laminates them, and keeps the checklist next to his trading desk. When he is about to enter a trade, he reviews his checklist. If all the criteria are met, he enters a trade. If a multi-million dollar trader uses a checklist to enforce discipline in his own personal trading routine, is there any reason why you should be trading without one?
#3 – Know Your Rules
This point ties in with the previous tip. One reason why traders tend to engage in sloppy trading is that they don’t have a solid plan. Therefore, we recommend writing down all the rules that define your trading methodology. It’s also a great way to see potential weaknesses and identify areas where you lack clear direction.
#4 – No Exceptions
We talked about “gut feel” and intuition before. Traders constantly come up with excuses why violating their trading rules is the right thing to do; justifying trades that go against their methodology. How often did you really end up with a winner after breaking your rules? A professional trader is characterized by the fact that he does not come up with excuses. He knows that exceptions have to be avoided at all costs (unless it’s absolutely necessary to tweak or overhaul the rules on a long-term basis).
How to Improve Your Trading Discipline
Developing trading discipline isn’t the easiest of tasks. It can also come in different forms which you may not be aware of. Let’s explore what discipline in trading really means and how you can work toward developing more of it over time by following just a few simple steps.
Knowing What to do vs. Actually Doing it
You know you should be going for a run instead of watching the TV with a bag of chips–after all, your goal, so you say to yourself, is to lose some weight; you know that studying a few more hours instead of meeting your friends at the bar will have a big impact on your grades, and you know that getting up a bit earlier instead of hitting the snooze button 5 times to might help you avoid the anxiety of feeling too rushed in the morning.
The same applies to trading.
>You know that staying out of the market more often will protect your capital if you don’t see a valid trade entry, yet you still execute your trade prematurely and end up with a loss;
>You know that trading with a stop loss and not manipulating it will ensure that your losses don’t get out of hand, but you still widen your stops regularly because you believe that price will turn around eventually;
>And you know that sticking to one trading method and trying to master it would help you become a better trader, but you still can’t stop “system-hopping” and changing systems regularly, hoping to stumble over the Holy Grail.
Everyone usually knows what the ‘right’ thing to do would be, but following through and actually doing it is much harder. Unfortunately, there is no trick that will suddenly turn you into a disciplined person.
There’s no magic pill that will make doing all of those seemingly hard and uncomfortable things easy and fun. However, there are a few things you can do to acquire a more disciplined trading approach step by step:
#1 A Trading Plan
Plan your trades ahead of time. Before you start your trading session, sit down and analyze your instruments, go over specific trade scenarios, and map out your potential trade ideas. You also should go over your trading checklist–things that need to happen in order for you to take a trade.
Then, when the markets open, you simply wait for these things to happen before you execute your trade.
A trading plan will help you build discipline because it helps prevent you from trading impulsively. When your trading plan is in front of you and not all of your criteria are met, you have to deliberately break your rules, actively convincing yourself that violating your trading plan is the right thing to do. When you catch yourself doing this, you know, right then and there, that you have erred.
#2 A Trading Rules Checklist
A checklist zooms in on the “actionable” criteria components of your trading plan. It’s what you check before you pull the trigger. A checklist states all your entry criteria in a clear and sequential fashion. Every time you are about to enter a trade, you revisit your checklist and check off the things you can see on your charts.
With a checklist, you can immediately see the trades to take and the trades to avoid. Again, if you can visually see that a potential trade violates your rules, you are more likely to avoid it. If you take the trade anyway, then you know that you’ve consciously convinced yourself to throw your own rules out the window.
“If you commit the same mistake more than once, it is no longer considered a mistake. It’s a conscious decision and a bad habit.”
#3 Keeping a Journal and Reviewing Your Trades
Most traders will never look at their trades again after they have closed them. They will just move on to the next trade, forget about what they did before and completely miss any learning opportunities they could have used to improve themselves.
“We do not learn from experience …we learn from reflecting on experience.” – John Dewey
Keeping a trading journal offers two potential benefits. First, it provides a place where you can revisit all your past trades, see what you’ve done (wrong) and how you’ve developed over time. And second, it will keep you from repeating the same mistakes over and over again.
If you know that you have to later enter your trade into your journal and write down that you made the same mistake AGAIN, you might think the better of it.
#4 Physical Reminders
This tip may sound odd, but it is worth your while. Some traders report that by writing down their most common mistakes and putting these physical notes next to their screen, they become more aware of their actions.
The Levels of Trading Discipline
Not all previously discussed tips and tools may seem applicable to every trading system. Especially when it comes to discretionary and automated trading, the differences can be significant.
A discretionary trader may find it difficult to write down a trading checklist or pre-plan his trades because he makes his decisions in the moment and does not have a fixed set of rules. But, discipline is not limited to trade entries.
It encompasses a variety of different principles and tactics. We now take a look at the typical areas in trading where a lack of discipline is most prevalent and how a more disciplined approach can help you:
Even a discretionary trader can usually improve his trading by applying a more disciplined approach to risk management. Being certain about how much to risk on a single trade and not going beyond this threshold may limit losses by helping you avoid trades that may be tempting but are potentially ruinous.
Cutting Losing Trades
This is a consequence of the previous point. Specific rules about how to set a stop-loss order and when to cut losing trades are also possible for discretionary traders. Not letting losses get out of hand and having a fixed plan about how to execute your stop-loss orders is a must for every trader.
When it comes to profit-taking, there are two common problems. First, traders are too fearful and close trades too early, and miss out on potential profits. And second, traders become too greedy and want to generate more profits by not closing winning trades and eventually giving back their profits.
If you find yourself among these groups, creating rules about profit-taking can help you build a more disciplined approach and avoid common mistakes.
Limitations to Trading Discipline – Audit Yourself!
What if Michael Jordan pursued a financial career instead of playing basketball? We might never have heard of him. Or can you picture Warren Buffet as a professional race car driver?
Even in related fields, the difference between particular domains can be huge. For instance, a world-class long-distance runner may be a horrible sprinter. Both entail different physical attributes.
The same is true in trading. The differences between trading styles can be significant. Whereas swing-trading requires more patience before and during trades, a day-trader has to deal with emotions very effectively and move on to the next trade fast, even after realizing losses.
A naturally more impatient and emotionally unstable person may have difficulties following a discretionary trading approach. But that same person might do better by following a set of fixed rules or creating an automated trading strategy.
The point is, no matter how many tips you follow and tools you use for your trading, by building a trading strategy and style around your strengths and weaknesses, you could potentially remove some of the negative impacts that undisciplined trading has.
In other words, your lack of discipline may not be a matter of trading psychology; instead, it might be telling you that you’re in the wrong domain, or that you’re using an approach that’s not in sync with your natural strengths and inclinations. If that’s the case, then you have to find the right trading environment where your strengths will have room to soar.
Trading futures and options involves substantial risk of loss and are not suitable for all investors. Past performance is not necessarily indicative of future results. The risk of loss in trading commodity interests can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.