Is this insanity?

No doubt, at some point in your life, some know-it-all has quoted this wisdom at you (perhaps they’ve even quoted it at you over and over again):

‘The definition of insanity is repeating the same mistakes over and over again and expecting different results.’

The implication is that any ‘sane’ person should learn from their mistakes.

Well, last week, I spent the half-term holiday in a quaint cottage by the seaside. It looked straight out of a chocolate box, with thatched roof, roses around the door and low-beamed ceilings.

Each morning for a week (and sometimes again in the evening, for good measure) I cracked my skull on the quaint low beam in the bedroom.

Apparently, I’m not that good at learning from my mistakes.

Problem is, it’s really quite important that we do learn from our mistakes in life. It’s what helps us to improve in our relationships, in business, and keeps us from walking around with a huge bruise on our foreheads.

So, what stops us learning from our mistakes?

The first sticking point is breaking bad habits. Just as, on my holiday, my habit of walking (as opposed to crawling) down to breakfast in the mornings was causing me to bang my head – so, in trading, my habit of obsessively watching my trades unfold, can cause me to take profits too early.

As anyone who’s given up smoking will know, breaking bad habits just comes down to dogged determination and perseverance. And, when you trip up (or bang your head) you just pick yourself up, and start again.

The second thing that stops us learning from our mistakes is failing to recognize those mistakes in the first place.

Whilst my wife is usually very good at spotting (and telling me about) any mistakes I make, I find that I’m usually pretty oblivious to my own flaws. I’m pretty good with keeping my trading journal, and keeping track of my results. But actually analysing those results to pick out where I’m going wrong is trickier.

I’m going to assume here that we all keep a trading journal, recording every trade. If you’re not already doing this – it’s really just about the most important change you can make to your trading.

However, a trading journal isn’t worth a thing, if you’re not going to look back through it and analyse the data in it.

So, there we are faced with a spreadsheet showing all our trades… the good ones, the bad ones, hopefully some comments about what went right or wrong…

Where do we begin in pulling all this information into a practical ‘to do’ list?

The key to analysing your trading record is to look for patterns. We want to find the patterns that are creating the best trades, so we can follow those. And we want to find the patterns that are creating the worst trades, so we can avoid those.

Here are things to look for…

1. Pick out each instrument that you trade. Which is creating the most profit? Which is letting you down?

2. Split your trading time into ‘sessions’. Depending on how much time you spend trading, it could be morning, afternoon, evening… or 5am–6am, 6am–7am, 8am–9am… or days of the week… or beginning of the month, end of the month. Look at which of these sessions is your most profitable, and which isn’t pulling its weight.

3. Look at your profit targets and stop distances. Which are getting hit? And which aren’t? It’s worth comparing these results with the average daily movement on an instrument – are you expecting unrealistic movements in a price for the timescale you’re trading? (More on this in a moment.)

4. Any trader worth his or her salt should be on top of one vital figure: the R value. An R value is nothing more complicated than a risk-reward ratio – i.e. how much your reward on a trade is compared to how much you risk. So, if you’ve risked £50 to make £100, then your R value is 2. If you’ve risked £200 to make £200, then your R value is 1.

If you know what your R value is on each trade, you can also know your average R value – and this information should quickly point to where things are going well, and where they are going wrong.

The great thing about R values is that they turn our attention away from the profit and loss figures, which can be very distracting. We can have had a great winner, putting £££s into our accounts, but if it was at the expense of a low R value, then we probably shouldn’t get too smug about it.

5. While your R value is important, a good R value doesn’t mean that you’ll be profitable. You need to ensure that your win rate (i.e. the percentage of your trades that win) is high enough. This is a simple figure to calculate: (number of winning trades / total number of trades) * 100

So, if I’ve placed 68 trades, and 43 of them have been winners, my win rate is 63%

6. In general, a trading strategy with a high win rate, will tend to have a lower R value. And a strategy with a high R value will have a lower win rate. It’s simply not reasonable to expect to have a high win rate of 70% combined with an R value of 3 – nice as it would be! Either way, this shouldn’t be a problem, as long as the two combine to make your strategy profitable. However, there’s one more stumbling block – drawdowns.

Unfortunately, even the best win rate doesn’t produce a nice even balance of winners and losers. Winners tend to come along in groups (great!), and losers tend to come in groups too (not so great!) – and this leaves the trader prone to drawdowns.

Some trading strategies are, by their nature, more prone to drawdowns than others. Keep an eye on your drawdowns – they tend to hurt, so aren’t easy to forget. If they are hurting too much, then consider reducing your risk-per-trade to a lower percentage of your fund – say 1% instead of 2%.

7. For every second that your money is in the market – it’s at risk. That’s not to say that we should all be scalpers (quite the opposite), but your expectations of trades should be linked to the length of time they are open for.

For example, if you’re day trading the S&P and the average daily range is around 15, you shouldn’t be expecting to catch 50 points in a single trade. It’s just not realistic.

Likewise, if you’re holding positions for several weeks – your trade should be working hard for you in that time, and aiming to make bigger profits relative to the time your money is in the market.

Keep an eye on how long your trades are open for, and how much they are earning relative to this time.