So, you’ve just shut down your trading platform after a long day of slugging it out in the markets. You’ve tallied up your gains and losses, wiped the sweat from your forehead, and are ready to relax. But before you get too settled, let me ask you, were your trades any good? Not your trading as a whole, mind you, but your individual trades. How would you answer that question? I bet a lot of beginning traders’ first instincts lead them astray on this one. So, let’s talk about it.
(If you want to play along, stop and decide how you would answer the question before reading on. If you don’t want to play along, I won’t hold it against you. After all, I’m just some text on your screen, surrounded by clever, topical advertising.)
Is a trade good because it made a lot of money? That sure feels good, doesn’t it? But, come on, I wouldn’t be writing an article if it were that easy, would I?
“I get it,” you’re thinking, “You’re one of those R-zealots! So you think a trade is good if it made a large R-multiple.” Actually, I don’t think that’s a good answer, either. What if you got short a stock just before news breaks that the CFO and CEO were found in a bizarre joint suicide, surrounded by shredded financial documents and a baby goat? You’d likely make a lot of money, and a large R multiple. But, that had nothing to do with your knowledge or skill. Unless it was your goat, maybe.
Well, let’s try… is a trade good if the stock did what you expected it to? No way. Unless you think you are trading via psychic powers, don’t grade a single trade on whether the stock acts like you predicted. Stock trading is a probability game. Would you say you did a bad job if a coin comes up tails? Then, never tell yourself you did a bad job because a stock happens to move against you this time.
Hmm… Good fills on the orders? Nope. Got out at the top? Irrelevant. Performance relative to the S&P, or risk-free rate? Now you’re just getting fancy.
The fact is, there are lots of ways to characterize the aggregate performance of a large sample of trades. It’s very important to keep track of your overall expectancy and risk profile, for example. It can be instructive to note if you are often leaving lots of profit behind, or underperforming the indices, or getting lots of sloppy fills, etc. But, all those considerations are meaningless when you just want to judge a trade or two.
What Really Makes a Good Stock Trade
I claim the only meaningful measure of a single trade is how well you followed your plan. That’s it. Many traders today have lots of good information available to them from the outset. So, they start trading the first day with a winning system in hand. But, see Van Tharp’s posts about how often traders take a winning system and lose with it, just by making mistakes in their execution.
How many beginning traders experience a drawdown, and immediately start changing up their systems and strategies? Before you even think about making changes, I urge you to at least prove to yourself that you’ve actually been following the strategy you intended to follow. After all, you are the fallible human in this equation! Execution and judgement errors should always be your first line of inquiry, but you can only do that investigation if you have some data. So, why not take a look at my post about the anatomy of a trade (or Bill Rempel’s post about the aspects of a trading system, if you prefer)? Take those steps, and grade yourself on each trade with them. Based on my article, you might form a checklist like this (or customize one specifically for your trading style):
- Were you trading a stock you were supposed to be watching?
- Did the stock set up according to your rules?
- Did an acceptable entry materialize, after the stock set up?
- Did your position size match your plan?
- Did you manage the trade according to plan?
- Did you do proper post-trade record-keeping?
Try to get to the point where the answer to each question is always a confident “Yes.” Answering the questions will make you own up to the time you traded too big to catch up on your P/L. The time you bought into the high-risk entry because you hadn’t spotted a good trade all day. The time you pulled your stop because you were sure it’d come back. The time you traded a stock you didn’t know, because your friend pointed out it was hot today.
In every one of those mistake cases, you might have made a lot of money. Buckets of it. No matter! You still have to give yourself a bad grade, and try not to do it again. Deviating from your plan means you are trading an unknown system with uncertain expectancy. It’s a sure way to lose in the long run, even if you happened to win big this time. That can be tough to swallow psychologically, but it’s the truth, and if you want to survive as a trader, you had better recognize it.
I’ve never logged questions like the ones above formally, but I wish I had. I do have a Mistakes category in this blog, where I try to tag trades where I feel I’ve erred. If I didn’t tag it as a mistake, I am saying I would take the same trade again tomorrow, whether it was a win or a loss.
I should add that, even if you are the most discretionary of the discretionary traders, I think you can do this exercize. You ought to be able to give yourself an honest answer about whether you considered all the factors you really should have, etc. The answers will be fuzzier, the more discretionary you are, but you can still spot glaring execution mistakes and bad judgement.
Summary
There are at least two time scales on which traders can measure performance. Across a large sample of trades, we can (and should!) use expectancy and other statistical measures to judge our progress. Performance in the small, however, is best judged in terms of how well we executed our plan. It’s entirely possible that the best trade you ever made went swiftly, and immediately, right to your stop. Just as your losing trades can get a perfect score, your winning trades can be riddled with mistakes. Mistakes and deviations from your plan mean you are trading an unknown system with uncertain expectancy. That’s a sure way to lose in the long run.
nice post, man – I’m going to start a checklist. Thanks.
@Ugly: Cool, glad to hear it. I am going to start, too, I think.
[...] I also read an interesting article on Move The Markets regard on how to Tell if the Trade is Good. This is making me rethink a few things about my trading journal and may make some adjustments to bring in aspects of this article. [...]
[...] As I mentioned in the article on assessing a trade: I wouln’t beat myself up if a coin came up tails, would I? Trading is a probability game, just like tossing a coin. Just as I should not be surprised or upset when a coin flip goes against me, I should not be surprised or upset when a trade goes against me. [...]
[...] Risk Control – track your trades in such a way you see how many times you lose more than what your initial risk was. You could also track each mistake and put a $ sign on it to show you what it cost – as in this article. [...]
[...] It’s now 50 minutes later, and I see the stock is trading at 38.85. Still not at my target, but I could have had more profit if I had waited. Maybe by the end of day it will hit my target. Then again, maybe not. As a trader, you can’t fret over what could have been, had your choices been different. For one thing, it is a leading cause of unhappiness. Secondly, had I sold at the top I’d be inclined to call myself a genius right now. But, forming an opinion about myself, whether the stock went up or down post-sale, is nonsense. The stock market is a probability game. Think about that! It could have gone either way. This is why I say the only way to measure the quality of a trade is if you followed your plan. [...]
very good post, i’ll use some of the ideas for my research
thank you ;)