Three Steps to Epiphany

There are three simple steps to being wildly profitable as a trader. The steps aren’t easy, but they are simple.
The steps are:
1) Find your sweet spot.
2) Practice – get good at it.
3) Size up.
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Find Your Sweet Spot
There are virtually unlimited ways to operate. Dozens of products, numerous time frames, hundreds of indicators and unlimited number of settings for those indicators – and everything is available at the click of a bottom. You could operate long term or short term. Only trade stocks that meet a certain set of criteria…or a different set of criteria…or an even different set of criteria. You could trade stocks in a certain prices range…or market cap range…or that have certain volume…or ones that have certain intraday movement. You could scalp for nickels and dimes or shoot or bigger gains over longer periods. You could hold for 5 minutes or 5 months. You can zoom in with 1-min charts or zoom out with weeklies and barely pay attention to the day-to-day. You have virtually unlimited options. All of the methods work to some degree, but none are perfect.
But there is one that is perfect for you. Find it. Find your sweet spot. Find something that works, something that jives with your personality. Unlike, let’s say baseball, where you have to be moderately good at hitting all pitches, trading enables you to zero in on a single type of trade or setup and completely ignore everything else. Think about that. Imagine explaining the concept of trading to someone who has had no exposure. You tell them it’s the hardest thing they’ll ever do in their life…that it could take several years of study and practice to get good at it…BUT there are unlimited ways to trade and they get to pick the one that fits them best. So as hard as it is, at least they get to pick something that fits their personality and keeps them in their comfort zone. And they’re not playing a physical game against others (like baseball) or a mental game (like poker). They’re operating independently where it really doesn’t matter what others are doing.
That’s not bad. It’s the hardest thing they’ll ever do, but they define how they operate, and they’re not going head to head with anyone.
Unlike a basketball player who can’t practice one particular shot without anyone guarding him, a trader can clearly identify a particular trade under specific circumstances…and he operates completely independent all others. Suddenly something very hard becomes manageable.
This is step #1. Find your sweet spot. Take the massively complex and difficult world of trading and find a single profitable setup that you can execute.
Practice. Get good at it
The next step is to practice. Literally, practice. Trading is a performance activity. It’s not enough to learn how to do it, you have to practice to get better. Like a basketball player who learns how to shoot but then needs to take thousands of jump shots. Or a baseball player who learns how to hit but has to take thousands of swings. Or a poker player who learns how to play but still needs to sit down at a table and play. Once you’ve identified your sweet spot, you need to practice.
The greatest trading book you’ll ever read is the journal you keep while you’re practicing. Make a trade, evaluate your performance (and to a smaller degree the result) make a slight change if necessary, and then make another trade. It’s an on-going iterative process. Make a trade, get feedback, make a slight change, and make another trade. It’s an iterative process that can’t be learned at the beginning or from a mentor. It can only be learned while in the arena, playing the game.
This can’t be overemphasized. Many traders think they just need to learn what to do and they’ll be set. They think if they read 5 books or attend a seminar or plop down money for a series of online classes they’ll be most of the way there. They think about learning how to trade in the same light as learning something at the university level. But this is a huge error. Learning how to shoot from the greatest basketball shooter does you no good until you get in the gym and practice. Learning to trade from great traders does you no good until you get in the arena and play the game. You learn and develop by trading, not by reading about it or thinking about it. In fact I can say traders spend too much time learning how to trade and not enough time experiencing trading.
Many traders underestimate this. They think they can learn how to trade and should be successful relatively early. Then they quit, even though they didn’t have nearly enough reps to make an honest assessment. They could have been good, but their expectations weren’t just out of line, they weren’t using the right metrics in the first place.
This is step #2. Once you’ve identified your sweet spot, you need to practice. Trading is a performance activity. You need to practice to get good.
You could stop right here. If you’ve zeroed in found something that works and you’ve practiced it enough to get good at it, you could stop right here and just execute the trade over and over. You can make a pretty good living doing this.
But if you want to make serious money, you have to move on to the next step.
Size Up
A big trading misnomer – that to make a lot of money you have to have a high winning percentage – is completely false.
This isn’t basketball, where shooting a higher percentage is the goal. Great traders are not those who get better and better and have a higher and higher winning percentage; great traders are those who fully take advantage of opportunities. In fact the best traders, those who really make a lot of money, know that winning percentage is irrelevant and a distraction.
Knowing when to size up is what determines how good a trader ultimately becomes. They know when, in George Soros’ words, to go for the jugular.
It’s why Stanley Druckenmiller says: “The way to build superior long-term returns is through preservation of capital and home runs. The few times Soros ever criticized me was when I was really right on a market and didn’t maximize the opportunity.”
It’s why Richard Dennis said: “You have to minimize your losses and try to preserve capital for those few instances where you can make a lot in a very short period of time.”
It’s why Charlie Munger – yes Warren Buffett’s extreme value-investing right hand man Charlie Munger – said: “…And then all that is required is a willingness to bet heavily when the odds are extremely favorable….”
You could stop at the second point above and make a good living, but if you really want to make a lot of money, you’ll need to be able to distinguish between a good setup and a fantastic setup and be able to size up on the latter. Having a high winning percentage is not only meaningless, it’s also a distraction.
Lots of traders have a decent winning percentage and they’re profitable, but they don’t make a killing because they don’t “go for it” when they have the opportunity.
And “going for it” doesn’t mean you have to put all your money in one position. It means every once in a while you need to size up and take advantage of opportunities. It would be unacceptable for a poker player to win a small pot when he obviously had the best hand. It’s also unacceptable for a great trader to make a small amount of money when the market was giving out a great opportunity.
If you put the same amount of money in every position and you win more than you lose and you make more on your winners than you lose on your losers, it still takes a lot of trades to make a living. But if you can size up from time to time when given the opportunity, your profits will significantly increase and you’ll go from being a good trader who makes a living to a great trader who makes what’s called “stupid money.”
Find your sweet spot…practice and get good at it…size up.
Those are the three steps to making superior returns.
Have you identified “your trade?” Is there a setup that you can clearly identify? Do you have a bread-n-butter trade that you find yourself coming back to because you can rely on it? If not, you’re on step #1. You are still trying to find your sweet spot.
If you’ve identified your trade, have you practiced enough that you can find it and execute it without stress? You’re not a robot, but you can methodically execute trades – as if it’s second nature? Have you learned the ins and outs, the little nuances? Do you have a sense for when you can be aggressive and when to tone things down? If not, that’s fine. You need to keep practicing to get really good at it.
If you’ve found your sweet spot and have gotten very good at executing it, the last step is to strategically size up from time to time when you truly get a great opportunity. Instead of having a steadily-rising P&L curve, there will be jumps from time to time.
Trading is likely the hardest thing you’ll ever do, but it’s manageable if you think about from this perspective. Find something that works. Get good at it. Size up when appropriate.