I received a letter to the editor this week that highlights one of
the paramount hurdles a trader must cross before becoming successful.
Here is the letter:
"Mr. Bill Kraft
I truly enjoy your weekend newsletters they are very
informative and try to apply your advice to my trading style. I have been paper trading
for about a year now and in the last 2 months my success rate has improved to 70%
winning trades. I'm writing to you for advice on transitioning from paper trading
to live trading. My fear of risk of losing money has limited my success. Emotions are
changing the way I think. I'm not sticking to my trading plan, and I'm exiting
my trades too early which I don't do on my paper trades. If you can't control your
fear, then you won't have patience. If you have any advice maybe you could write on this in one of
your newsletters.
Steve (last name withheld)"
Steve, I want to thank you for your letter and assure you that you
are not alone. Steve has done all the right things so far. He has
developed and tested a trading plan. Without such a plan, he would have
been doomed to failure absent uncanny luck. By paper trading his plan,
he has demonstrated unequivocally that it works. In the last 2 months
he has had a success rate of 70% which is not shabby by any standard.
He has demonstrated patience by sticking to paper trading for a year.
In short, Steve has paid his dues. Now he would like to cash in on his
efforts, but emotion has hurt his effectiveness.
Paper trading has great value and, in my view, is a necessary
foundation to real money trading. As Steve (and almost everyone else
who has ever paper traded) has learned, though, it is not the same as
real money trading. Once we put our hard earned cash at risk, fear of
loss rears its head and can take control if we let it. In order to
overcome this hurdle, let's see what paper trading really does for us.
When we paper trade we are learning how to implement a strategy. We
learn the "ins" and "outs" of entry and exits and we test our plan.
Over time, we come to see whether our plan succeeds or not. We can see
where we make mistakes and learn from them. As time goes on, and we
develop and use a successful plan, we can see that we can do it. We
have proved to ourselves that we can do it -- we can trade profitably!
That realization brings a justifiably higher level of confidence with
it. Now we are ready to trade with real money. But, folks, it just
isn't the same. When we were paper trading, we had nothing to lose.
Now, with cash on the line the "pucker factor" arises.
Instead of doing what we were doing so successfully on paper, we
change things. As Steve wrote: "I'm not sticking to my trading plan."
It is easy to say: "Why not, Steve, it was working quite well, wasn't
it?" But that does not really help. Steve and the rest of us know that
is the logical truth, but trading encompasses the danger of so much
emotional reaction that is hard to control. One answer to the dilema is
to realize that the vast amount of traders in the retail market are
trading on emotion and losing. If you can be one of those who separates
from the emotional crowd and sticks to a plan that you already know is
successful, you have increased your odds of being a winner dramatically.
Another important factor that I have found helps overcome emotion is
to set your exit plan before you ever enter a trade. I suggest, for example,
that it not be a target since once a target is hit what is to say that
the move will not continue. Instead, as a target is approached, why not
just tighten stops. If the target is reached and the move backs off,
you will automatically be out. If the move goes on past the target, you
will not have cut your profits.
As time goes on, I'll try to address the critically important issues
raised by Steve's letter. For now, let me congratulate him on
developing such a successful plan and suggest that he answered his own
question. He recognizes he is exiting too early and he recognizes he is
not following his already proven plan. Maybe it would be a good idea to
take the cash off the table for another month and paper trade some more
to satisfy himself that the plan does work, or, if he still wants to
trade cash, make small equal dollar risk trades and follow the plan.
I want to thank Steve, again, for writing. Almost all of us who have
become successful traders have gone through what he is going through
now. The emotional barrier is extremely difficult to overcome.
Developing the discipline to follow a proven plan is necessary and
definitely worth the effort, but is difficult to achieve.
Good Trading!
Bill Kraft
Mr. Kraft's past articles are posted on our website for your review.
