Because of Inadequate Trading Systems
I didn’t just pull this 95% figure from thin air either. I borrowed it from the work of the late, great Dr. W. Edward Deming, who is the father of Total Quality Management, commonly known as TQM. His story is quite interesting, and it actually has a lot to do with how to trade well.
Dr. Deming graduated with degrees in electrical engineering, mathematics and mathematical physics. Then, he began working with Walter A. Shewhart at Bell Telephone Laboratories, where he started applying statistical methods to in dustrial production and management. His early work with Shewhart resulted in a seminal book, Statistical Method from the Viewpoint of Quality Control.
Since American industry spurned many of his ideas, Deming went to Japan shortly after World War II to help with early planning for the 1951 Japanese Census. Impressed by Deming’s expertise and his involvement in Japanese society, the Japanese Union of Scientists and Engineers invited him to play a key role in Japan’s reconstruction efforts. Deming’s work is largely responsible for why so many high quality consumer products come from Japan even to this day.
In turn, Japanese society holds Dr. W. Edward Deming in the highest regard. The Prime Minister of Japan recognized him on behalf of Emperor Hirohito in 1960. Even more telling, Deming’s portrait hangs in the lobby at Toyota headquarters to this day, and it’s actually larger than the picture of Toyota’s founder.
So why do people fail? According to Deming, it’s not because people don’t try hard enough or don’t want to succeed. People fail because they use inadequate systems. In other words, when traders fail, it’s primarily because they follow faulty trading systems—or they follow no system at all.
So what is the right system to follow as a trader? To answer this question, I offer you what the trader who broke the all-time real-money profit record in the 1984 United States Trading Championship offered me. He told me that a successful trader needs five essentials:
1. A Method
You must have a method that is objectively definable. This method should be thought out to the extent that if some-one asks how you make decisions to trade, you can quickly and easily explain. Possibly even more important, if the same question is asked again in six months, your answer will be the same. This is not to say that the method cannot be altered or improved; it must, however, be developed as a totality before it is implemented.
2. The Discipline to Follow Your Method
‘Discipline to follow the method’ is so widely understood by true professionals that among them it almost sounds like a cliché. Nevertheless, it is such an important cliché that it cannot be ignored. Without discipline, you really have no method in the first place. And this is precisely why many consistently successful traders have military experience—the epitome of discipline.
It takes experience to succeed. Now, some people advocate “paper trading” as a learning tool. Paper trading is useful for testing methodologies, but it has no real value in learning about trading. In fact, it can be detrimental, because it imbues the novice with a false sense of security. “Knowing” that he has successfully paper-traded during the past six months, the novice believes that the next six months trading with real money will be no different. In fact, nothing could be farther from the truth. Why? Because the markets are not merely an intellectual exercise, they are an emotional one as well. Think about it, just because you are mechanically inclined and like to drive fast doesn’t mean you have the necessary skills to win the Daytona 500.
4. The Mental Fortitude to Accept that Losses Are Part of the Game
The biggest obstacle to successful trading is failing to recognize that losses are part of the game, and, further, that they must be accommodated. The perfect trading system that allows for only gains does not exist. Expecting, or even hoping for, perfection is a guarantee of failure. Trading is akin to batting in baseball. A player hitting .300 is good. A player hitting .400 is great. But even the great player fails to hit 60% of the time! Remember, you don’t have to be perfect to win in the markets. Practically speaking, this is why you also need an objective money management system.
5. The Mental Fortitude to Accept Huge Gains
To win the game, make sure that you understand why you’re in it. The big moves in markets come only once or twice a year. Those are the ones that will pay you for all the work, fear, sweat and aggravation of the previous 11 months or even 11 years. Don’t miss them for reasons other than those required by your objectively defined method. Don’t let yourself unconsciously define your normal range of profit and loss. If you do, when the big trade finally comes along, you will lack the self-esteem to take all it promises. By doing so, you abandon both method and discipline.
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So who was the all-time real-money profit record holder who turned in a 444.4% return in a four-month period in 1984?