A Catalogue of Errors

Every two or three months I go back through my trades – to see where I’ve made mistakes. This isn’t as easy at it as it seems. Because I don’t view losses as mistakes. If you think about it, they’re not. If you’re playing poker, you reckon you’ll win with a straight, you have a one in six chance of drawing to fill a straight, and the pot is offering you 10 to one. Well, that is a good bet, irrespective of whether you win or lose. The same with trading, as long as you’re making good risk/reward bets, it’s no mistake to lose on a trade.

The first mistake I noticed was in my blog from a couple of months ago. I said that there just weren’t enough books about how to lose money. Well, now I’ve found several. One I read last week was ‘Wiped out – how I lost a fortune in the stock market while the averages were making new highs’ by an anonymous investor. It’s clearly written and utterly cringemaking. The guy gets into a trading death spiral. He makes lots of mistakes – and six whoppers.

He’s way too ambitious. He wants 100% a year. So each position he takes is much too large (often risking 10-20% of NAV). That’s mistake one. He operates entirely on tips, with no sense of how they deliver a competitive advantage. Mistake two. He adds to losers, and runs no stops. Mistake three. He takes quick profits. Mistake four. He never takes any profits out to spend on his family – mistake five. And he borrows his wife’s money to put on a trade. Mistake six.

One of the best bits of advice I ever got was from the book Zurich Axioms, by Max Gunther. He said – set trading targets. And when you hit them, take some money out and treat yourself and the family. My rule is to do this every 5%. We’ve had a cracker since I started in Mid-February. Today we hit a new target for the seventh time, and the posh dinners are backing up. The coolest place we’ve been so far is downstairs at L’Atellier de Joel Rubichon. I never regret taking profits when it’s in a good cause.

Now, if it’s not necessarily an error to make a loss – what constitutes a mistake? I’m looking for any one of four things;

a) Did I do enough work to identify the self reinforcing trend, and the good risk/reward before the trade?

b) Did I bet in the right size?

c) Did I cut when I hit my stops?

d) Did I run my winners?

So what mistakes have I made? I’ve made three stand-out mistakes over the last couple of months.

I built up too big a short position in gold too quickly, and I quickly hit my stops. This was an error because I didn’t adjust the position size for volatility as I normally do. This was basically because I put the position on fast, without the normal testing. Going too large cost me 0.5%.

Second, I built up my Euro/Yen short and straight long yen positions too quickly. I’d done sufficient work to justify the positions, but I was too aggressive too quick – assuming that the severe pressure on financials over the past couple of weeks would break the currency trend. So I got up to four risk units in the time it would normally take me to two. That was costly, as I was forced to cut them as soon as I hit stops. That mistake also cost an extra 0.5%.

Third – I got too aggressive on a short sterling trade. Now, I’d tried a couple of small short sterling trades in previous weeks and lost on them. Then, when I looked into it further, I felt that it was not the greatest risk/reward trade to go long (expect fewer rate hikes) – given the pound’s move lower, and the escalation in inflation expectations. Anyway, I kept watching it, and then a mate told me that there was a trading opportunity. At 9.30 on Wednesday RPI was due out, and he reckoned it could print high. But then at 10am Merv’s letter would get released and there was no evidence it would talk hikes. The inflation report had inflation back on track with no hikes. Given the moves we’d seen of late, and the size of the short position, I thought I could rip out a decent trade. So, in five minutes from 9.35 to 9.40am on Wednesday I put on six risk units long – which wasn’t against the larger trading limits that I’d set four weeks before. But it was large given that I’d previously identified it as an uncompelling trade.

In this case I got away with it. I made 1% for the fund in about two hours. I then took profits on almost the whole position on a 35bps move – 25 was my target. That was lucky. Had it moved 10bps I might have left it on. The next morning, the freak retail sales caused a 35bps move the other way. That would have been exceptionally painful. The basic lesson I learnt from that – don’t get too large unless the risk/reward is great and you believe it enough to stick with it. Second – avoid markets where the elephants are stampeding around. There are too many stressed banks with haemorrhaging fixed income and structured product positions. It’s causing horrific trading volatility.

Life’s too short to play these sorts of moves. Better, simply, to be short the banks themselves.

The three things I’m proud of are doubling my risk exposure in May to play the short side. Then I was up 22% and I was prepared to risk half my gains to play what I thought was an exceptional risk/reward opportunity. And then sticking with it over the past week or two – when the market bounced, only to fall to new lows. Earlier today I hit 35% up.

Second, not allowing a single trade to run through its stop.
Third, spending much more time reading and writing – and much less time watching the screen. I’ve found reading during the trading day makes me much more patient on the big risk/reward trades – and that’s definitely helping my trading.