Overtrading is a problem for many.
But, to continue on last week’s stack and a recent thread, many problems are merely symptoms of different issues.
This also aligns to something Tom Dante teaches: you must figure out the root causes of your problems, or you can’t resolve them.
So, what might cause overtrading?
Treating the markets like a big casino — i.e. having a gambler’s mindset — is one possibility.
Another might be that you don’t have realistic expectations of your strategy.
Many traders are intimately familiar with:
What price and volume action they want to see;
Which fundamentals, if any, are essential to them; and
Where to place their stop losses and, if applicable, targets.
However, too many traders don’t know their strike rate. More importantly, even if they do know it, they haven’t necessarily grasped its implications.
The odds of losing streaks
Losing streaks are a mathematical fact. Particularly if your strike rate — even when trading profitably — is low.
To give you some hard numbers, suppose you have a respectable 50% strike rate, and place 50 trades a quarter.
What are your odds of having 5 consecutive losers within that quarter?
Answer: just over 50%.
In other words, even if you’re right half the time, you’re more likely to suffer a string of 5 losers within any quarter than not.
What if your strike rate is a bit lower — say, 40% — and you still place 50 trades a quarter?
Your odds of suffering 5 consecutive losers within any quarter are nearly 80%.
Isn’t that a bit simplistic, Kyna?
Sure. For one, this calculator — which you can build yourself in Excel by following my instructions — doesn’t take complexities like market environment into account.
But that’s not the point of this exercise.
I’m trying to show you, with hard numbers, that the odds of suffering a losing streak are worse than most traders intuitively believe.
And the odds get exponentially worse as your strike rate drops.
Factoring in market conditions will also worsen the odds, particularly for swing and position traders. Even Qullamaggie says he’s in a downtrend most of the time. But when the tide turns, he makes explosive gains that more than make up for the money lost during these downtrends.
And as Qullamaggie’s legendary returns show us, being in a drawdown for most of the time, and trading with a low strike rate, aren’t inherently bad things. Not at all.
But you must understand that losing streaks and extended drawdowns are to be expected.
More to the point, you have to accept them.
If you don’t make peace with these facts, you’re prone to making emotional decisions and to overtrading.
Marios Stamatoudis’s perspective
As I’m putting together my Marios notes based on his TraderLion interview, I’m also revisiting his Medium articles. His “Demystifying Trading Psychology” post is highly relevant here.
Marios points out the following:
“major emotional swings and major damage [are] often the result of unrealistic expectations.
“Better risk management results in better trading psychology[,] NOT the other way around. So, instead of fixating on emotions, focus on understanding the true nature of your trading approach and your expectations. […]
“The best trader isn’t someone who lacks emotions or manages emotions[, but] the one who quickly snaps back to the reality of their methodology and sticks to [their] approach without wasting time.”
He likens this to different types of retailers.
A discount store relies on high sales volume to be able to turn a profit, whereas a luxury retailer can make a profit when making just one sale every few days.
Both can be profitable, so long as they’re aware of this and act accordingly.
But what if the luxury retailer hasn’t fully accepted this reality?
They might panic when they haven’t had any customers for a few days and take action to make matters worse — launching an unnecessary and expensive marketing campaign, for example.
Of course, the trading analogy is that a swing trader shouldn’t force trades when they haven’t seen their edge for a few days. In similar vein, traders with low strike rates shouldn’t panic when suffering multiple losses in a row.
In short: know the reality of your strategy.
More stacks like this
I hope you found this article helpful!
If you did, you may also enjoy this stack:
The Trading Resource Hub’s full archive is here.