Many Forex traders seem to think that by trading more frequently they are opening themselves up to more opportunity and that this will cause them to make more money. This is wrong; in fact, the main thing that high-frequency trading does is cause you to become stressed, frustrated, and take low-probability trades. The truth is that if you know what you’re trading edge is and you are 100% certain of how and when to trade it, you will find that you don’t really need or want to trade that much. There is indisputable evidence that day-traders and scalpers make less money on average than lower-frequency traders. We will discuss that and more in today’s lesson, so let’s get started…
After you read today’s lesson, please leave me a comment! Tell me if you learned anything in today’s article, and if so, how will you apply it to your own trading?
Quick note: We are strictly referring to retail human-being high-frequency traders in this article, not proprietary commercial computer trading programs or algorithmic trading which sometimes results in thousands or tens of thousands of trades a day.
The quickest way to improve your trading is to…
…Stop trading so much! It is just a fact of human nature that the more we stare at a price chart the more we get tempted to click our mouse button and enter a trade. The fact that we worked extremely hard for the money in our trading account seems to go right out the window after staring at a 5 minute chart for a while. We also tend to over-estimate our own capabilities of predicting the market’s movement as well as ignore the real potential of losing the money we are about to risk.
More trades equal more time and more stress. I personally believe in trading the daily chart with low frequency, meaning I take much fewer trades than most traders. We all know most traders lose money…most traders also trade a lot, so commonsense dictates that simply trading less often (doing the opposite of most traders) will improve our returns over the long-run.
By knowing what your trading edge is and being 100% confident of how and when to trade it, you will find that it’s a lot easier to ignore the market when your edge is not present. When you trade less you can also risk a bit more per trade if you’re comfortable with it. Think about it, one trader trades 30 times a month and the other trades 3 times a month, obviously the guy trading 30 times a month can’t trade as big of a position size per trade as the guy trading 3 times per month. Not to mention that the higher-frequency trader is going to spend much more of his precious time in front of the computer, probably stressed out and frustrated. I prefer to spend less time in the markets and I also prefer to have low levels of stress, thus I mainly stick to the daily charts and I trade relatively infrequently compared to most traders.
The point is this: when you increase the quality of your trades you also increase the risk reward potential, and rather than fighting against the market you are simply being patient and acting only when the market shows your edge. This will work to accelerate your profits whilst spending less time in the markets. It’s sort of counter-intuitive, because in most professions more time = more money, that’s not so in trading, in fact most traders do a lot better by spending less time in the markets. Thus, you need to fight the urge to over-analyze, over-trade, or trade on low-time frames charts.
Low-frequency vs. High-frequency; An example
Do you want to increase your overall R-factor whilst reducing your stress and emotion in the markets? R-factor is basically your profit factor, and it’s how much money you make over a period of time in terms of your risk (R) per trade. So, if you risk $100 per trade, your R-value is $100; if you made $500 in one month that would be a 5R return. This is how you should think about risk and reward, not in terms of percentages. Percentages don’t really matter because a 50% return could mean you made $50 dollars or that you made $50,000 dollars…you see percentages are relative to your account size, what matter is dollars risked vs. dollars earned. If you are looking to build a consistently profitable track record to try and get an investor to fund you, they are ultimately going to be concerned with how many dollars you have returned relative to what you have risked.
In order to show that higher-frequency trading does not equate to higher overall profits, let’s look at a hypothetical example of a trader who over-traded on the 4hr charts during one month versus a trader who traded less-frequently on the daily chart for the same month. The key point to take away from the example below is that both traders ended up with a 3R return for the month of May, but the first trader traded over 3 times as much, taking 15 trades in the month compared to the 4 trades of the other trader.
You can imagine that the trader who only entered 4 daily chart trades that month had far less emotion, frustration and stress, and far more time and ease of mind than the guy who entered 15 4hr chart trades and ended up with the same result. This is actually a relatively mild example, I know many traders who trade far more than 15 times in a month and lose money still, some of you are probably in that boat right now. So…why not try something different? TRADE LESS:
(Note: these were not actual trades; they are all made up for the sake of example)
So, as we can see from the example track record above, higher-frequency trading does not necessarily mean higher-profits. Obviously, this is not a real track record, but the point still stands; when you take more trades you are naturally going to have to endure more losing trades which will need to be offset by more winning trades just to achieve the same profit factor. Note the guy who traded the daily chart had a 50% win rate with the 4hr trader had only a 40% win rate.
Treat The Market Like A Garden
It might help to think about the market as a garden, and each month there are a limited number of vegetables that the garden produces, but there are a lot of weeds. The more vegetables you take out of the garden each month, the greater the chance you have of pulling a weed next time. In trading, there will typically be a limited number of high-probability / obvious price action setups each month, so if you don’t have the patience to only trade those obvious setups, you’re going to end up getting more losing trades (weeds) than winning trades (vegetables).
The science of why people trade too much
Whilst the reasons why people trade too much can be many and varied, the primary reason is over-confidence. This is especially true after a winning trade or a series of winning trades. Traders tend to become over-confident after they hit a nice winner or winners and especially if they aren’t following a trading plan and are just trading off the ‘seat of their pants’. There is considerable scientific research that backs up the claim that most traders trade too often due to over-confidence. Most people over-trade due to “overweighting” their winning trades as Terrance Odean and his colleagues pointed out in their research titled Do Day Traders Rationally Learn About Their Ability?…
However, when they are successful, these investors irrationally attribute success disproportionately to their ability rather than luck, leading investors to overestimate their own abilities and trade too aggressively; even investors with more past failures than successes may become overconfident by over-weighting their successes.
Odean and company go on to discuss how the “aggregate performance of day traders is negative” and his research also underscores the fact that trading low-time frames and high-frequency trading become very addictive. Trading addiction is the only way to explain the fact that “over half of day trading can be traced to traders with considerable experience and a history of losses”, as quoted from their research. Why else would a day-trader with ‘considerable experience and a history of losses’ continue to day-trade if not for being addicted to it?
The primary thing to take away here is that you have to AVOID over-weighting your winning trades…they do not imply that you are “figuring it all out”…rather they should just be viewed as another execution of your edge. Remember that even if you are a trader who wins 70% of the time, you still never know which trades will be one of the 70% or when one of your 30% losers will pop up, thus you should never over-leverage your account or over-trade it…just trade when your edge is present, and over-time you should make consistent money.
• Men vs. women
Now, I know that most of my readers are men, but the fact of the matter is that we are going to have to swallow our pride a little bit here and take a play from the women’s trading handbook.
According to a recent article on the New York Times website, men have a tendency to trade far more frequently than women, which works to drive up their costs and lower their overall returns, see here:
This added trading drove up the men’s costs and lowered their returns. The economists found that while both sexes reducednet returns through trading, men did so by 0.94 percentage points more per year. In a telephone interview, Professor Barber said, ‘In general, overconfident investors are going to be interpreting what’s going on around them and feeling they are able to make decisions that they’re really not equipped to make.’ Short-term financial news often amounts to little more than meaningless ‘noise,’ he said. Far more than women, men try to make sense out of this noise, and to no avail.
So, there are a couple important lessons to learn here:
1) Men tend to think they “know” what the market is going to do whereas women are more likely to accept the fact that they don’t “know” for sure what the market will do. The fact is that the women are right; no one ever “knows” what the market will do except for insider-traders with illegal information. So, the sooner you accept that trading is just a game of probabilities where the outcome of any setup is never “certain”, the sooner you will stop taking low-probability trades only because you feel like you are “sure” about what the market will do next.
2) Women are less likely to get obsessed with financial news and in trying to “figure out what it all means”. Men need to be more like that on average, if you don’t know why then please read my recent article on forex news and fundamentals.
I personally believe that women have less of a need to “be right” all the time than men do, this also makes them better traders. The market does not care about you or your little feelings, so being right and wrong and having an ego about your trading are all totally irrelevant things to your bottom line. Leave your ego at the door when you enter your trading room, because it’s NOT going to help you make better trading decisions; you can think you are right with every ounce of your being, but the fact is that the market doesn’t care if you think you’re right or not, it’s going to do what it wants because THE MARKET is always right, not you. So, learn to trade according to these facts and not in conflict with them, we can do this by simply learning to read the price action that the market produces for us and only trading when our high-probability price action trading setups are present.
Perhaps the core idea to take away from this lesson is that you should not assign too much significance to any one trade. Meaning, don’t start over-trading just because you become overly-confident after hitting a few good winners. Remember, you can achieve the same overall R factor over the same period of time by trading less frequently. You can do this by focusing on quality of trades rather than quantity of trades. If you want to learn more about how I trade ‘Low-Frequency’ price action strategies on the Daily Chart time-frames; check out my price action trading course and member’s community; my trading philosophy is based on trading only the highest-quality price action trade setups, which means less trades and less stress!