Keep your losses small

By Jake Bernstein –
Great traders are created, not born. Those who lack discipline, persistence and self-confidence lose the never-ending challenge of trading profits. But those who survive the battle by using the tools of the masters enjoy the fruits of consistent success. Here is an opportunity to learn from some of the best-known international traders ever. . . this time from Bruce Babcock,
Bruce Babcock, received his bachelor’s degree in Business Administration as well as a law degree in 1979, at the age of 35. Bruce left his law office to concentrate on Commodity trading. He has written six commodity trading books. He has had numerous articles published in Futures magazine and Technical Analysis of Stocks and Commodities. In 1983 Bruce started publishing Commodity Traders Consumer Report, a bimonthly news-letter that tracks the performance of top commodity advisory services and makes a significant impact on the industry. He also publishes Major Moves, a long-term, special situation advisory letter. Bruce has designed numerous computer software programs for traders, including optimizable trading system programs, trading tools and a data management program for using continuous contracts.

Bruce’s work has been featured in The Wall Street Journal, Barron’s, Forbes and Money magazine. He has appeared frequently on the Financial News Network and is an occasional seminar sponsor and speaker.
An active commodity trader since 1975, Bruce continues to trade the markets for his own account and actively pursues his futures market research.
This is what Bruce Babcock had to say about his trading methods and risk management procedures.
What qualities do you feel contributed most to your success as a trader?
My natural aversion to risk and to gambling helped keep me from bankrupting myself while I learned how to trade. My skepticism, analytical ability and logical mind enabled me to sift through all the misinformation and discover the truth about profitable commodity trading. It took a very long time, however — over ten years.
Do you use specific techniques for coping with losses?
Yes. I have learned that I trade better when I isolate myself from my trading as much as possible.
Virtually all my trading is accomplished with computerized, mechanical systems. My own software, which I sell to the public, generates all the trading signals. By the way, I hold nothing back from my customers. I have no secret methods I keep to myself. Every system I use is available at a very reasonable price. Customers are free to trade exactly like I do.
My broker has a copy of my software programs. He runs the software himself, generates the trading signals and puts in the orders. Although we talk every once in a while, he can trade my systems on his own without any input from me.
When I am in town, I run my software myself and print out the signals to keep up with what is going on. When I travel, which I do frequently, I don’t worry about my systems until I return.
I don’t re-optimize or change my systems. Occasionally, I may add or delete a market from the portfolio that I trade. As my account increases, I may add new systems or additional contracts. I would allow myself to discard a system that does not perform, although I have not done this for three years.
Since I watch what goes on in the markets, I am aware of losses. But I don’t dwell on how big they are or what is happening to the equity in my account. I try to follow the conventional wisdom — not to become too elated during good periods or too depressed during bad periods.
What percentage of a trader’s success is a direct result of a good system as opposed to trading skills. What would be the split?
I will assume your successful trader is following a mechanical system. If that is the case, I suggest that one-third of his success would be the result of the quality of his system. One-third would be the result of his choice of markets to trade and keeping the size of his portfolio in line with his available capital. The remaining one-third would reflect his ability to trade the system religiously for a number of years. The correct choice of system and portfolio would give him a statistical advantage. The discipline to trade the system long enough would ensure that he could realize his statistical advantage.
What do you feel is the single greatest skill a trader can possess or develop?
This is a difficult question. Obviously, there are a number of different skills that a trader needs in order to be successful. They are all important. If I had to pick just one that is most important, I would say it is the ability to perceive true reality.
Unsuccessful traders have a distorted view of the markets, themselves and what they are really doing when they trade. It is difficult for them to shed these misconceptions, so they are doomed to long-term failure.
The whole market universe is constructed in a way that reinforces their misconceptions. This compounds the challenge of overcoming them.
Do you feel that your success was inspired by any famous traders? If so, who, and how so?
Certainly, I learned many things from the famous traders whom I have known and whose work I have read over the years. However, I can’t think of a single famous trader who trades like I do. Nor was there any famous person who inspired me to start trading or keep trading after an unsuccessful period. Thus, it would be hard for me to single out any one person as having inspired my success.
Are you in touch with any specific experiences that either facilitated or inhibited your trading success?
I can recall two especially large losing experiences. Both involved trading without a stop.
In one case, I was trading the yield curve with T-bill spreads. They were at an all-time historically low level, so I kept averaging down. Eventually, I gave up and took a huge loss. This taught me, I hope, never to average down and never to bank on historical price extremes as a barrier.
In the other case, I was holding a very large profitable position with a trailing stop loss to protect profits. I convinced myself to remove the stop loss without at least replacing it with another further away. The market made a historically large move in a short period of time and cost me a great deal of money. I learned from that never to trade without a stop in the market.
My learning process was evolutionary rather than revolutionary. Therefore, I can’t really pinpoint any specific positive experiences that had a great influence on my progress. My first really big score was in the silver market in 1979 and 1980. At that point, I had quit law practice and was pursuing trading full-time. Those profits helped me continue my trading career.
As part of your business, you market trading systems. To what extent do you feel that a good trading system is important for success?
For many years, I have thought that the only chance a person has to be consistently profitable in the long-term is to use a mechanical system. Only the most exceptional individuals have the ability consistently to overcome the emotional influences that prevent long-term profits.
Stated another way, it is virtually impossible to consistently trade with the trend, cut losses short and let profits run without depending on a mechanical system. Winning traders may not all use a computer to generate their entries and exits, but they probably use a mechanical system in their head.
The more a person trades without fixed rules, the less chance he or she has to be profitable over a multi-year period. Trading without fixed rules enhances the chances that a person will be trading with losing methods that over time give him or her a statistical disadvantage. Furthermore, trading without fixed rules allows emotional factors to influence trading decisions. This will usually result in bad decisions.
If you had to choose between discipline as a trader and a good trading system but could only choose one of these, which would it be, and why?
This is a false choice. If someone has a good trading system but no discipline, he or she will not follow that system. Having the system will be meaningless. If a trader has perfect discipline but no method to follow in a disciplined way, success will depend on luck.
If absolutely required to choose, I would choose the discipline to keep losses small. If a trader could do only that, he or she might stumble on enough winning trades to make some money. But I wouldn’t bet on it.
Source: Sify India

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