The second commandment of profitable trading is to use a system. Most people approach the markets the way they approach everything else. They think “I’m pretty smart. I’ve got some experience. I’ll bring that experience to bear, and I’ll make some sensible decisions, and then I’ll make some money, and then I’ll be rich.” But unfortunately, when it comes to trading in the market, what you learn from everything else in life doesn’t apply. It’s almost the opposite. In school, we’re taught to always be right, get the correct answer, get 100% on your test and do well. That carries through university until you have a job. There’s just no tolerance for loss, being wrong, not knowing, or uncertainty.

Unfortunately, in the financial markets, you have to have a high tolerance for loss and uncertainty. Let me give you a quick example. I’m wrong about my trades about 70% of the time. If you hear that I’m wrong 70% of the time, you must think that I’m a terrible trader. How does that work? If I got ten trades and I’m wrong and lose $1 each on seven of them, I lose $7. But then on the three times I’m right, I make $5 each. So on those ten trades, I make a lot of money overall. But if I want to be right when I buy this stock, I need it to go up so I can sell it higher than I bought it for so that I can be right and make money on that trade.

But thinking about that one stock and it goes down, it’s like, “I’ll wait till it gets up to even so I can sell it and be right. I don’t want to sell it because that would be a loss and would mean I was wrong. It’s bad for the ego and its hard for me to take. I’ve been trained to be right. This is just temporary. It’ll go back up because I bought it, and I know it’s a good investment, so it’ll go back up.” But it doesn’t. It keeps going down and the size of your losses gets bigger. And you give up when there’s too much pain to bear. It’s like, “That’s it. I can’t take it anymore. I’m out,” and you sell.

But that’s when everyone else sells too, and that’s the bottom and you don’t know that in advance. You know that you are overcome with emotion. The reason we use a system is that the system tells us when to get in and when to get out — it bypasses emotion. It bypasses the need to be right on each trade because the system is like a process we follow.

When they manufacture cars, Toyota doesn’t micromanage every little car and tries to maximize the profit of that car, forgetting about everything else. What they do is they have a process that build cars consistently. They build the car the same way every single time. Everything in that car might not be perfect from the customer’s perspective, but overall, it’s a viable product that makes money.

Our trading system and our trading rules are the same. If we run the rules repeatedly, they should make money. We can test by putting those rules into our trading software looking over the past 20 or 30 years of history, and ensuring that if we followed those rules over time, we would’ve made money. Using a system bypasses emotion. It eliminates the need to be right on this trade because we’ve got a process that works, and we’re right by following the process — not by making intelligent individual trades.

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