The Universal Principles of Successful Trading: Essential Knowledge for All Traders in All Markets (Wiley Trading)
Brent Penfold believes that there are universal principles that are applicable to all traders, regardless of which trading systems, time frame and instruments you trade.
A typical journey of a novice trader
I found his descriptions of a novice trader’s journey accurate as I can relate to some of them. The novice trader will lose money in the beginning as he interact with the market. Many traders give up at various stages as they fail to accept the losses. It takes a lot of self awareness and acceptance to learn the ropes of trading. Here is the typical journey:
- React to news and tips
- Begin a trading education
- Switch methodologies
- Switch gurus
- Switch markets
- Switch time frames
- Switch client adviser
- Blame psychology
Imagine you have to go through this to learn more about yourself and the market? And meanwhile you made these mistakes, you are constantly losing to the market. Not easy I would say. Brent thinks that the turning point to become a profitable trader is when you learn to apply money management rules to minimise your losses.
Brent has 6 universal principles of successful trading.
He thinks that the first principle is about preparing your mind to have the right perspective of the market. The belief to plant in your mind is that the market will put up many obstacles to prevent you from profiting. Since you are bound to lose, make sure your losses are small. The best loser is the eventual winner.
He believes all traders must have 0 percent for “Risk of Ruin”. Risk of Ruin is the probability that your accumulated losses are so huge that would make you stop trading. You can find “Risk of Ruin” calculators online to do your calculations.
Second, you must understand that it is the expectancy of your trading system that matters. It is not the accuracy. Casinos use a slight positive expectancy to win over the gamblers. The edge of a trading system is positive expectancy. You can find out more about expectancy here.
Third, the more opportunities you can trade, the more money you can make for a period of time. Your trading system must allow sufficient trading opportunities.
Fourth, the trading system must be simple. Brent said it must pass the McDonald’s test – the trading system is not good if a teenager cannot understand your method. Ultimately, trading is about identifying resistance and support, do not complicate it further.
Fifth, you must search opportunities that are contrarian to the crowd, since 95% of the traders lose.
Sixth, test your system backwards but not to the point of tweaking it such that you curve fit it perfectly according to the past data.
#3 Trading Style
Here are some of the key characteristics of various trading styles and time frames:
- Short-term swing trading (time-frame: days to a week, small capital, small drawdowns, high accuracy)
- Medium-term swing trading (time-frame: weeks, small capital, medium drawdowns, high accuracy)
- Short-term trend trading (time-frame: days to a week, small capital, small drawdowns, low accuracy)
- Medium-term trend trading (time-frame: weeks, small capital, medium drawdowns, high accuracy)
- Long-term trend trading (time-frame: months, large capital, large drawdowns, low accuracy)
Brent believes that each trader must find the style that best suits his capital size and personality – tolerance level for drawdowns and accuracy of the system.
Brent favours the Futures market. Some of the good attributes of a market or instrument are:
- Price and volume transparency – Reflect the true price and volume
- Liquidity – healthy demand and supply so that you can buy and sell easily
- Zero counterparty risk – good governance to enforce honoring of trades
- Volatility – you need decent volatility to make money
- Growth – the market volume must be able to accommodate your increased position as you grow as a trader
There are a lot more attributes stated in the book. You should trade an instrument that satisfy most of the attributes.
#5 Three Pillars
To him, there are three main pillars to trading:
- Money Management
Money Management – The chapter on money management is simply the longest chapter in the book. I cannot describe it in detail and I urge you to read the chapter as money management is one of the most important component to successful trading. Brent explained the various money management methods and ran tests with the methods. Based on the results, he found that the “Fixed Percent” and “Fixed Volatility” had the lowest “Risk of Ruin” but they are not suitable for small accounts. The methods suitable for small accounts are “Fixed Risk”, “Fixed Capital”, “Fixed Ratio” and “Fixed Units”. There are pros and cons for each method and Brent has stated them clearly in the book.
Methodology – Brent talked about mechanical and discretional trading. He advise that it is easier to start with a mechanical approach when you are a new trader, as it would provide structure and consistency to your trading. As a Elliott Wave and W.D. Gann trader for 15 years, he shared his disappointment in predictive indicators. he also discourages the use of technical indicators like moving averages and stochastic. To quote, “most indicators are derivatives of price that contain adjustable parameters. Consequently, they represent second-hand curve-fitted information.” To him, traders should focus on price and volume and use tools like breakout analysis and market profile. He also emphasised the importance of having a system that is objective. There are not 2 ways to interpret the data.
Psychology – Brent suggests we should manage our greed, fear, hope and pain. He even has a list of affirmations to manage his psychology from time to time.
This Principle is about learning the mechanism of trading. The different types of orders that you can use to your advantage.
In the final chapter, he interviewed 15 traders for a piece of advice. In conclusion, I think this is a good book for all aspiring traders and existing traders who are having problems with their trading. If you are able to understand and apply the principles in this book, you would be able to become a successful trader.