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.
I used the Sharefinder system in 2008. The WFC clogged the market and my mind as a beginner. Disillusioned I bailed out. I continued with my portfolio in 2009 which improved for reasons well known to all. If I knew how your system operated,why it signalled buy,sells,stop losses etc and I felt integral to the system and not a robot, I would reconsider using the system once again. Who wants to be anxious or stressed I certainly don’t and would welcome your answer. Making money is important but understanding the system that makes the money is important to me.
What intrigued me the most about Kel Butcher is that he uses both manual-trade and auto-trade mechanical systems. I’d suggest auto-trade mechanical systems are very different to manual-trade mechanical systems, as the auto-trade systems leave no ‘discretion’ at all to the human trader. Consequently if there is no manual process at all, then the trader will not gain the benefit of developing a disciplined trading process nor the other life benefits of a disciplined way of thinking. This also leaves me to wonder what the system/edge performance difference is for Kel Butcher, between his auto-trade and manual-trade mechanical trading systems? Would Kel be willing to throw some light on this?
Robert makes a important point re the value of education about the stockmarket and trading using fundamental and technical analysis beyond simply robotically following a mechanical trading system, as has been previously debated under achieving competence. While competence may be obtained in following the rules of a mechanical trading system this is a low level of competence and not of much value when the system gives continued negative returns and the user starts to lose faith in the system. Blind faith in following the rules is not enough and as Robert indicates an uneasiness can set in resulting in anxiety and stress from lack of knowledge and a sense of lack of control of one’s fate.
Tell me what do you consider to be the minimum and optimum levels of investment in the system you promulgate – one has to consider the costs of commissions etc
Picking up Robert and Barry’s point, I would agree that some knowledge of a system is important for confidence to be developed but perhaps not to the extent of the operational details. For example, a gambler may not be able to follow the statistical calculations that prove his edge as banker when playing roulette or pontoon but, when he understands completely that he has one, the only question of concern remains his ability to withstand a run of reverses. To help his understanding, he nowadays need not wade through the maths but simply run a sequence of simulation tests to demonstrate that edge.
Similarly with the SWS systems. Though a conclusive mathematical proof of edge is not possible as it is with roulette, the statistical evidence is there and the demonstration is provided by the simulation tests. Reliance on statistics is somewhat woollier than reliance on probability maths so the confidence level can never match the 100% level of the roulette banker. At the same time, it has to be understood that it does not need to. Depth of pocket should be controlled by money management structure and routines – the control of one’s fate (or lack of it) raised by Barry.
The low level of operating competence required is part and parcel of using a mechanical system; the time and effort that would otherwise be expended on more intellectual stimulation and excitement is directed to continual application of rules and discipline. Infinitely more boring but also, in the long term, more profitable. And that, after all, is what investing should ultimately be about.
Response to Comment by Robert:
“If I knew how your system operated,why it signalled buy,sells,stop losses etc and I felt integral to the system and not a robot,…”
Your comment refers to Intelledgence which is very different to SPA3. Allow me to explain the difference in levels of transparency between the two.
The detailed SPA3 documentation explains every signal in detail which we believe is necessary for medium-term traders that need to put time into their portfolio every day, 10 – 15 mins a day, on average. Even though we believe that medium-term traders should understand all the details about the signal logic and exact unambiguous criteria for entry and exit I would say that around half comment that the documentation is too detailed.
The Intelledgence documentation is nowhere near as detailed as SPA3. Intelledgence is aimed primarily at the more passive investor who typically doesn’t put time into knowing the finer details of the method for stock selection.
Passive investors typically invest their capital with managed funds, portfolio managers or use newsletters. None of these explain their methods for stock selection and could even be termed ‘balck boxes’. Does anybody know the exact criteria of the method that a managed fund uses in which they invest?
The Intelledgence documentation explains the concepts used for stock selection and the stop loss exit criteria but not in as much detail as SPA3.
Response to Comment by George:
“Tell me what do you consider to be the minimum and optimum levels of investment in the system you promulgate – one has to consider the costs of commissions etc “
For the SPA3 methodology (unleveraged) we recommend a minimum starting capital base of $80,000. Being an active methodology one of the main reasons for the minimum being $80K is brokerage.
Optimum? Hmmmm. Whilst we have researched many many historical SPA3 portfolios we haven’t done so to specifically calculate an optimum starting capital base. I will provide a range which takes into account the overall liquidity of the Australian Stock Exchange. The range is $300K to $600K. This range would apply for any medium term methodology that has average hold periods of around 2 to 3 months.
For those with greater than $80K but less than $300K, the more the better.
SPA3CFD utilises leverage. An absolute minimum for SPA3CFD is $25K although $40K would be preferred.
Trust that this helps.
What a powerful note on Consistent application of discipline.