Dave’s Five Principles to Trading for Life

Dave’s Five Principles to Successfully Trading and Investing

Over the past few years I had not written too much at ASX Market Watch, however I have still been trading and I’ve still been testing.  I’ve also still been learning – learning from my own mistakes and of course the mistakes of others.  Reading books, articles, traders and psychologists I follow on Twitter to constantly improve myself and my game.

I distilled the trading beliefs I learned over that time into Five Principles, also (conveniently) hash-tags, so you can see at a glance whether I am living up to them, and also take on the ones you want for yourself knowing they have helped me become a profitable trader (Note: my wife thinks they are too harsh, but considering the landscape out there I think they are necessary 🙂 ).

Read on below.  I’ll explain how I came by these principles and made them my own.

1. Invest or Die Broke

1 Invest or die brokeIn speaking with every day people, in every day jobs, it became clear that fewer than 5% of “normal” people think about investing.  And yet, learning to save and invest is the most critical skill in building enough wealth to eventually retire.  In short – I don’t really believe any normal person has the skill or mindset to retire.

To add to this, upon retirement, most people are at the whim of their financial advisor and sub-par investment returns of 7% per year or less.

So I did some sums, on a person from age 45 to age 65 (retirement), with a $50,000 starting capital (most working people at age 45 should have this in their superannuation or 401k equivalent at the very least), if they were earning the standard 7% per year, their retirement nest egg would grow to just $193,484 in 20 years.  However if they learn to invest and make 17% per year, their nest egg grows to $1,155,280 – over a million dollars.

50k Compounding

2. Anti Spruiker

2 anti-spruikerIt still surprises me how many “stock market gurus” and expensive courses there are out there where the salespeople – who are clearly not traders and rarely even using their own system – charge upwards of $10,000 to attend.

On further investigation, and with a little questioning, it doesn’t take long to see that they have not automated their system tests, have not done Monte Carlo testing (1000 random variations of their system) and can’t even provide the basic variations of historical results for their system.

Most likely because they don’t have proper, validatable rules (#3) 🙂 .

Avoid these salespeople like the plague that they are.  If you’re thinking about a course, ask for the actual results, ask if they have performed Monte Carlo testing, and ask if their system rules can be (or have been) programmed into a trading system using a program like Amibroker.  That will soon separate the wheat from the chaff.

3. Validation Rules

3 Validation RulesWhich brings us to number 3.  Of the few “normal” people who actually get to thinking about trading and investing, even fewer of those ever get around to having a set of rules to enter and exit the market.  And consequently, they often go broke.

Why would we have our own set of rules to enter and exit?  Simple – you can’t prove, or validate, what you don’t have.  If your rules are not repeatable, or are based on fuzzy things like gut feel, you’ll never be able to prove historically, that they work.

And when it comes to the crunch (or the crash, in a market sense), there is a good chance that you will do the wrong thing when your emotions are high and the market is volatile.

So either create a set of entry, exit, and money management rules for yourself, or buy or follow some validated ones from someone else.

4. Downside Deviation

4 Downside DeviationMore than occasionally I see comments on Twitter or on blogs, where someone trading with leverage (or a leveraged product like CFDs, Options, Futures) says that they made 1000% on one trade.

But let’s look at it a little more closely.

If they were using any form of money management, for example splitting their capital into 20 equal parts to avoid the risk of ruin, then that one trade hasn’t really made them 1000%.  It would be 50% at best, which is still good if there weren’t one other thing to consider:

Markets or instruments that move quickly in one direction, often move quickly in the other direction as well.

Traders in LNG on the Australian Stock Exchange made nearly five times their money, before seeing it all fall away again (and at the time of writing, still falling).LNG_DownsideDev

Or traders using a popular Options Writing strategy, before the 2008 bear market, were making at times 15% each month.  The risk was so great however, that when the downside hit, they all went broke and closed their trading accounts and their business (this ties in with #Antispruiker, because the ones perpetuating that “system” – and shall remain nameless – were prone to using more sales tactics than trading tactics).

5. Simple Wins

5 Simple WinsOn forums around the web, the debate rages on – Fundamental Analysis or Technical Analysis?

My take has always been – it does not matter, as long as you can do number three (#ValidationRules) and check that your chosen method really works.

But beyond that – these people are missing the point.  There are only two ways to trade and invest (beyond buy and hold, of course).

Trend following is buying in the direction a stock is going – it is buying into growth, it is following the movement of the stock or its fundamentals.

Mean reversion is buying as a stock is falling with the aim that it will recover to the average, or “mean”.  Value investing is exactly this, from a fundamental point of view.

Both Trend Following and Mean Reversion can be validated using a trading system and a platform such as Amibroker.

I hope you’ve enjoyed my five principles!  Please keep me accountable – let me know if I break one in the future, and feel free to use the ones that suit you as well.

Happy trending,

Dave McLachlan

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November 29, 2015  Tags: , , , , , , ,   Posted in: Articles On Building Wealth

One Response

  1. Daniel - February 6, 2017

    Hello Dave,

    I have been looking at your site and can say good job! I’m a basic Amibroker user trying to pick up my game for long term game and would like to ask you if you know about people in Perth interested in the idea of an Amibroker users group.

    Kind regards,
    Daniel

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