One of the major challenges that unsuccessful traders need to overcome is to recognise or admit that they are making trading errors. Even though their trading results will always be a stark reminder that they are not making money in an environment that is an endless stream of opportunities to enrich ourselves. (Trading in the Zone by Mark Douglas)

Why do traders not recognise that they are making trading errors?

There are a number of reasons for this—however, it all comes back to beliefs. The beliefs that stand people in good stead to make them successful in society/business, do not work in the markets. I call these the 10 Perceived Beliefs to Obtaining Success.

Many people hold that to be successful in society/business they must:
1 control people, companies and any opposition
2 be better than other people, companies, and any opposition
3 have better ideas than all others
4 have bigger targets than all others
5 manipulate data, people, companies and situations, to achieve those targets
6 convince people that they are right and their company is the only solution
7 compete and beat, and compete and beat again
8 win and be right—or, more appropriately, not lose and not be wrong
9 outsell and outmaneuver the opposition
10 be a step ahead of the opposition, always trying to predict their opponent’s next move

This is the paradigm of our success-at-all-costs society. People have created, formed and embellished this time-grown set of beliefs over the years to ensure that they survive day to day in society and business. Like them or loathe them, these beliefs determine everything that many people feel, perceive, think, say or do.

Typically when you achieve any of the above perceived success you are rewarded either by getting paid, getting a bonus, getting a commission or through being victorious and luxuriating in the associated feelings of joy that come with positive feedback and acknowledgment from other members of society.

We are social creatures and constantly monitor how we are doing in society by subconsciously measuring and judging feedback that we get from our environment – those around us such as competitors, colleagues, strangers, friends and family. Trading is not a social activity – it is a lonesome activity where your only feedback is your trading outcomes.

So we focus on these and use them as an avenue for the same positive acknowledgment and feedback that we get from our other social activities. The only source that we can find for such positive feedback is winning or profitable trades. Therefore we make profitable trades our focus and magnify the need to have winning outcomes to make us right and feel good.

The paradox is that to achieve sustained profitability in the long term we need to do just the opposite, forget about outcomes and focus on process and hence remove the meaning from the outcome.

Of course, you cannot achieve all of the above perceived successes on a regular basis. And when you do, they don’t always work! You will, however, achieve some of them from time to time with an associated perceived successful outcome. When you do–on a random basis, I might add–your existing beliefs, which are counter-productive for consistently trading successfully, are reinforced and strengthened. When you don’t achieve the above in any given situation society will enforce that we have failed and hence you will feel pain—emotional pain. Along with emotional pain come negative feelings of anger, frustration, revenge, betrayal, envy, not belonging, missing out and so on.

In that context, two of the automatic hard-wired programs that all human beings have are to associate the current moment with previous experiences, and to avoid emotional and physical hurt at all costs. For more detail on this material study Mark Douglas’ book “Trading in the Zone”.

We need these two automatic hard-wired programs to learn what is dangerous for us to survive in society (which used to be the jungle in humans distant past). For example, a young child associating a stove’s hot plate that can potentially cause physical pain. Of course, there are other variables that need to be assessed like is the hot plate on at the moment.

In a market environment, emotional hurt is experienced through:
• being proven wrong,
• losing money,
• missing out,
• leaving additional profit in the trade.

These are the four primal trading fears that traders–whose trading paradigm is set by the same 10 Perceived Beliefs to Obtaining Success that they operate under in the community and in business–try to avoid. Consequently they become hard-wired to avoid the above four situations in a market environment. The point is, any action that a trader takes to avoid any of the above four situations is a trading error.

This is why people do not recognise that they are making trading errors. To them, their mind, through their time grown beliefs, is operating correctly. And it is! Only it is operating correctly for a non-market environment without putting the current situation into the context of their big picture.

To better understand what is going on in our minds we need to understand that there are other variables involved and hence the four primal trading fears need to be put into context within the big picture.

Following on from the interview with Kel Butcher the week before last and last week’s topic on applying knowledge, I would like to discuss the importance of the role that discipline plays in trading.

Discipline is a critical technique that we use in life to build and ingrain habits. We require discipline to engender change in how we think, how we behave and ultimately in what we believe. Whether trading the markets, making the decision to loose weight, desiring regular exercise or wanting to have a few less drinks of a night, the first link in the chain is to define a process before applying discipline. Discipline is required to execute the process to be able to transform to your desired end goal. Quite simply, discipline requires process and process requires discipline. The two work hand in hand during the initial stages of any transformation activity.

It is important to make the point that discipline is not the end goal, it is merely a technique that is used to achieve the end goal. The end goal, no matter what the activity, is to achieve consistency in that activity at the level that meets your desired objectives.

One cannot suddenly become consistent in a given activity. Consistency is achieved in an activity when executing the activity becomes effortless and requires no struggle, strain or pain. Once consistency is achieved the overall outcome will be successful on an ongoing basis and discipline will no longer be required as the process will have become ingrained as a habit.

In the heady atmosphere of the stock market, being consistent and objective is not only absolutely essential, it is the foundation to success. Yet the great majority of traders are inconsistent and subjective — exactly opposite to how they should be for trading. Worse still, in an inconsistent and subjective state of mind it is virtually impossible to measure how consistent and objective you are with your thoughts and actions.

This is why I am so passionate about mechanical trading. The rigour and structure of a mechanical system combined with applied discipline, enforces us as investors to put our discretion aside and follow a process that can create a habit of consistency and objectivity in the activity of trading. I personally struggle to understand how the masses buy and sell shares without the call to action of a mechanical decision support system.

The vast majority of traders and investors fail in their endeavours due to a lack of discipline. They spend an enormous amount of time researching systems and trading styles and refining their entry and exit techniques, and after much debate and deliberation finally decide to have a go at this trading caper. They start off full of confidence and buoyed by the rhetoric delivered by so many supposed experts and market educators. Full of this confidence, they can’t believe it when their first trade or first few trades are losers! Annoyed, but not devastated by this chain of events, they decide to stop trading for a while. Low and behold the next 3 trades are winners, but they aren’t in them. Seeing that the ‘system’ has produced a winning streak they decide to re-enter the market and you guessed it, they hit another losing streak and this time give up or turn to a new and ‘better’ strategy in an attempt to rectify their poor trading results.

The lack of discipline to follow a process in trading and investing (like the lack of discipline to do regular exercise) manifests itself in a myriad of ways and forms. Those without a disciplined approach to their trading and to life in general constantly struggle their way through unable to make any clear headway or to make the progress and the profit they know is possible but they just can’t seem to break through to their desired level and profitability. In short, they remain inconsistent and subjective, flowing with the noise of the market. Such people need to get disciplined as a first step!

Those that do reach a level of above average profitability are typically disciplined with their trading, and more often than not, with their lives in general. They are able to maintain a level of consistency and their trading is uncomplicated and struggle-free. They have a strict set of rules or guidelines that they deploy to help guide them through the maze that is the financial markets and they stick to the rules unequivocally. They are able to do this because they fully understand and trust the process they are using. They know and understand the range of possible outcomes of their system and they accept and trust the edge that it gives them over the market and over the majority of undisciplined market participants.

Applying discipline to execute the processes of your trading edge as flawlessly as possible will not only greatly improve your performance, but will ultimately lead to consistency which will, in turn, decrease stress and anxiety, and result in a calm and relaxed acceptance of the outcome of each and every trade regardless of the outcome – win or loss. As Kel Butcher also said in his interview this is a life long journey, not a sprint.

Knowledge is mandatory to be a successful trader but knowledge alone does not guarantee success, much more is needed.

The application of new knowledge requires that repeated experiences of the new awareness be executed many times over. Discipline is required to repeat the experiences in the face of fear and of unsuccessful individual outcomes. A bombardment of the subconscious is required from all fronts. Of the many techniques used to achieve this, discipline is just one such technique.

The repeated experiences of the new awareness will eventually re-program the subconscious mind; then new awareness becomes a new belief. Repeated experiences of the new belief energises the new belief which will ensure that the belief becomes first nature as a habit. At this stage the knowledge will be a part of who you are—and discipline, force or strain will no longer be required to execute the habit. Execution will be effortless without struggle, strain or pain. This is why there is more to successful investing than just money.

Examples of successful transition are riding a bike, driving a car, brushing your teeth, writing and reading in your native language or even crawling, walking then running. I’m sure that you can think of many more. It is no different with trading.

Can you change your ways? Can you transform yourself? Well, consider the following:

• Books on general psychology use the word ‘wiring’ when discussing the way that our minds work. The wiring, or neural pathways, is created in the brain by learning new information and formulating new beliefs which manifest themselves as newly formed habits.

• New neural pathways can be established in your brain if you are prepared to step into a process to establish them.

• This can be done at any age.

• A process to embark on creating new neural pathways with respect to trading is detailed elsewhere on this Blog, in the documentation for the SPA3 mechanical trading system and in Mark Douglas’s book ‘Trading in the Zone’.

• The process uses exactly the same learning capabilities that you have used your whole life. The major difference is that you will be choosing what you want to learn rather than being bombarded by your environment which has usually occurred without your conscious choice.

If this material is challenging you, consider how you would go about learning to read, write and speak a new language. Would you just head out there and start engaging a conversation with somebody who speaks your target language? To read the target language would you acquire a book written in it and actually try to read it?

Obviously not! You would start a process of learning. You learn the mechanics of writing the language and of shaping your mouth and tongue to speak the language. This is exactly the same process that you went through as a toddler and juvenile learning your native language.

The process would probably entail classes and / or DVD’s or CD’s, vocabulary lists and practice through repetition of execution. All the while you would be rewiring the neural pathways of your subconscious.

Why is it that the majority of newcomers to the market don’t see the need to go through such a process with respect to trading? Perhaps they are lead to believe that they already have the necessary neural wiring to successfully read, write and speak the language of the market? I say not!

If you don’t step into a process to change or transform, your current beliefs will simply continue to manifest themselves in the form of your current outcomes. And you know what outcomes you have been achieving with respect to trading! These will simply continue as before without any change. You will never be able to change your outcomes until you change the way that you think, feel, see and do. Ultimately, to be a successful trader you will need to be able to think, feel, see and do from the market’s perspective, not your perspective – to become empathetic with the market.

In this weeks blog I interview author, trader and traders mentor Kel Butcher. Kel started his trading journey way back in 1989 and has been involved in the markets for just on 20 years. Kel is the author of A Step-by-step guide to buying and selling shares Online and 20 Most Common Trading Mistakes and how you can avoid them. He also writes for Your Trading Edge magazine. Kel trades a variety of markets but what is most interesting is that all his trading is mechanical – from short term auto-trade intraday systems on the major world equity indexes, end of day position trades in the futures and commodity markets, to use of SPA3 for his and his family’s superannuation funds that he manages. Kel’s journey and story is an interesting one and I hope you enjoy reading it.

My trading journey began quite early in life as I learned early from my Dad that everything could be bought and sold at a price. He was a farmer but also specialised in trading sheep and cattle, constantly buying and selling stock rather than holding on to any particular breed or line of stock. His favourite saying was ‘never fall in love with your stock”. After completing a degree in Ag Science (with merit) I fairly quickly determined that working for someone else and grinding out my life to someone else’s drum beat didn’t really suit my personality or dreams and ambitions.

My first trades in the ASX were based on gut feel and stuff I read in the newspaper. I bought Westpac bank and Western Mining and paid some stodgy old broker about 2.5% commission for the privilege of having him tell me that I didn’t know what I was doing and that investing with a long term view was the only way to make money in the share market. Being a fairly independent kind of a dude, this raised my shackles somewhat and I set out on a course of learning and discovery that continues to this day. Originally a discretionary trader by default I guess, my scientific mind lead me to mechanical and systems based trading based on probabilities, money management and the need for a slight ‘edge’ over the market. My first exposure to this came from attending original Turtle Trader Russell Sands workshop in Sydney in about 1992. I then began my own voyage of discovery about mechanical trading through books, seminars and anything I could get my hands on. Some of my other mentors include Louise Bedford and Chris Tate, and I have worked extensively with Larry Williams. I learned money management concepts and their application from Ryan Jones.

I am now a 100% mechanical trader and have been for many, many years before the term became well recognised. It seems as though the retail component of the financial markets are beginning to more fully understand the importance of system based mechanical trading as opposed to discretionary trading and even pseudo technical trading using personal interpretations of indicators and patterns. For me, a mechanical approach allows me to crunch the numbers on the system to determine if it works. If it does, I then implement the system and trade it according to the rules. In this way, my job becomes one of managing the various systems, rather than managing individual trades. I run equity curve drawdown and volatility filters over all my systems and switch them on and off as these filters require me to do so. Some of my systems are auto-trade which means the computer fires the orders into the market electronically when the orders are triggered. Some still require me to place the orders into the markets manually at predetermined price points for both entry and exit. This I do with no emotional attachment what-so-ever. If I have an entry to buy or sell according to the rules of the system, I just do it. Similarly, if a stop price is reached, I simply exit the trade as specified by the system – no debate.

I trade the major equity indices including the SPI, E-mini S&P, DAX, and others, commodity futures, commodity options, ASX shares and CFDs at times. I use the SPA3 system for my Super Fund and my Mum’s Super Fund.

The biggest downfall I see for the majority of private traders and investors is a lack of belief in themselves and their own abilities. Most are constantly looking for someone else’s opinion and support to backup their view. Instead of either developing their own system, or buying one that has a proven track record, they are constantly searching for other people’s opinions and continue to trade in an ad-hoc way with no systematic approach to their trading. They are constantly jumping from one idea to the next, from one guru to the next, or one market to the next. They are inconsistent, undisciplined and impatient, and as a result unprofitable over the long term.

My number one trading rule is “discipline, consistency and patience”. This is a life long journey of endeavour, not a sprint. Those that can trade with an edge over the long term will be the survivors and the profitable traders. In my role as traders coach and mentor I tend to concentrate on this rule and teaching people the importance of money management and risk management. I also help them focus on what they want to achieve in their trading and aligning their goals with their time and lifestyle commitments and requirements. Kel can be contacted at kel@tradingwisdom.com.au

The Australian superannuation industry has been in the news again this week with researchers Dr David Ingles and Josh Fear from The Australia Institute revealing some very interesting numbers on the industry. Their findings and research make interesting reading. I have extracted some information from their findings which add to my persistent calls for people to take charge of their own financial destiny.

Ingles and Fears opening comments from their research report summarises well the conflict that occurs within the superannuation industry in this country.

"The existing superannuation system is built on a contradictory notion of the way people make financial decisions. On the one hand, the concept of compulsory superannuation suggests that Australians are myopic, irrational and have to be forced to save. On the other hand, when forced into the system, fund members are assumed to be informed and discerning investors, able to make rational decisions about how to allocate their retirement savings among a host of competing alternatives. Only one of these opposing views can be correct and it is the responsibility of policymakers to design systems that accommodate real-world human behaviour."

The report also highlights the cost to the nation’s wealth of the running and management of these superannuation funds, with the researchers finding that:-

"Widespread lack of engagement with superannuation means that competition in this sector is structured around intermediaries (like financial advisers) rather than consumers. The aggregate administrative cost of the Australian superannuation system is 1.35 per cent of assets according to Rainmaker Information;1 Rice Warner Actuaries give a similar figure of 1.26 per cent,2 neither of which sounds substantial. However, given the $1.1 trillion size of superannuation assets, this amount in fact represents a transfer of $14.3 billion per annum from fund members to the financial services industry, equating to half the $28 billion cost of providing the age pension—a payment that accrues to over two million retirees."

Administrative costs of 1.35 per cent have been estimated to reduce final super fund balances by up to 27 per cent or over $130,000 for a worker on the average wage. To rephrase, this cost constitutes around one-quarter of a typical worker’s total superannuation accumulation, a much larger figure than if expressed with reference to total assets.3 Whether this represents true value for money remains an open question.

High fees also impose costs on the public purse. People are expected to maintain themselves, wholly or partly, in old age and the government has provided very generous public subsidies by way of superannuation tax expenditures in order to attain this end. But substantial degrees of self-support are not likely to be achieved if, as at present, high fees reduce retirement lump sums by very significant percentages. The effect of the current system is to raise the proportion of retirees who are wholly or partly dependent on the age pension, which will inevitably result in higher government expenditure and a commensurate burden on taxpayers.

As educated investors we have the skills and ability to manage our own financial destiny. Not only is it possible to outperform the majority of the fund managers, but we are also able to save ourselves substantial amounts of money in fees and charges which is money better off in our pocket than that of a fund manager and financial adviser.

As reported in yesterdays Sydney Morning Herald written by Annette Sampson, more Australian’s than ever are moving away from traditional Managed Funds and Investment Managers in the hope of doing it better themselves.

Some 410,000 Self Managed Funds have been established by more than 770,000 people. According to the Australian Prudential Regulation Authority, self-managed funds held $332 billion in the kitty, or just under 31 per cent of the 1.1 trillion invested in super until June 2009.

Reasons vary about why so many investors choose to manage their nest egg, but control is chief among them. Self-managed fund investors typically want greater flexibility and the opportunity to take a more active role in their savings strategy.

It must be said that establishing a SMSF is not for everyone. It is also a highly debated topic about the minimum capital requirement which should be considered before setting up a SMSF. Some say as little as $50,000 but I would suggest closer to $100,000. You must consider the auditing and account keeping fees which are mandatary for all SMSF’s.

The decision to mange your SMSF is the first of many decisions you will have to make upon taking control of your financial investments. As always, I encourage those taking this path to undertake the required education and training so your journey is a success.

1. Rainmaker Information, 2009 Rainmaker Fee Review, March Quarter 2009 Edition.
2. M Rice, Superannuation Fees Report—Market Segment Analysis at 30 June 2006, prepared for the
Investment and Financial Services Association by Rice Warner Actuaries, May 2007.
3. Sydney Morning Herald - Annette Sampson - September 2009