Should you take this trade?

Have you ever got a signal from your stock trading system that you felt uncomfortable about?

One of my students in The Trader Success System just launched his own trading system. He got a signal in a stock but said “this doesn’t look like the type of stock that would make any money – the share price doesn’t move that much!”

His portfolio would soon be maxed out on exposure and so he asked, what would you do ?

1. Take the trade?
2. Modify the system?
3. Ignore the trade ?

Has your system ever generated a trade that you were uncomfortable with for some reason?

In my experience, some of the trades you least want to take turn out to be the trades you most need to take.

But how do you eliminate that psychological discomfort?

Just knowing you should take every trade does not mean you will feel comfortable with every trade!

So to make trading your system easy you need to eliminate the discomfort.

The way you do this is to validate whether the discomfort is well founded… If it is then you can modify your trading system to exclude trades like that one OR if the discomfort is not well founded then you can prove that to your self and just follow the rules.

Simple process to validate / invalidate your discomfort:
1. Write down why the trade makes you uncomfortable
2. Create a rule which excludes trades that match your description in step 1
3. Backtest your system with this new rule added
4. Backtest your system with the opposite rule (ie. Just include trades that are like the one which makes you uncomfortable)
5. Compare the expectancy of the trades in step 3 with step 4
6. If step 3 had a MATERIALLY higher expectancy then you can keep the rule, otherwise you must reject the rule

After going through this process you will know if your discomfort with the trade was well founded or not. If it was then you can change your system, but if both groups of trades have similar expectancy then your discomfort should be gone!

This sort of emotional response to your trading system is EXCELLENT to observe, but the ONLY correct way to act on this is to write down a hypothesis and then do a backtest to test if your hypothesis is correct.

If you skip the trade because of this feeling without testing then you are on a slippery slope of picking and choosing your trades – this leads to disaster in terms of performance.

Test everything!

This is how you get absolute confidence in your system. Every time something like this comes up, follow steps 1-6 above and test it. Modify the system if the test shows you should and keep trading it if it doesn’t.

Eventually (after you have been through that many times) you will stop having emotional responses to your trades and you will have complete faith in your system and you will take every trade without worrying!

And that is the whole point of having a trading system – to get you in and out of the market without your emotion impacting your decisions!