This week’s article is submitted by Michael Toma.
Michael is a Certified Risk Manager, author, and trader and is our “resident risk” contributor at The Trading Edge (thetradingedge.org).
Since I started trading, I have kept some form of records in a trade journal. The actual data components I track and the structure has changed several times since my spreadsheet days but the information gathered from the journal still acts as the basis of my trading decisions. I applaud those who maintain a trade journal in any form and use the information to develop solid strategies giving you a consistent trading edge. Even the best kept journals however miss the mark on one of the biggest risk exposures to the trader; opportunity risk. Simply put, it is the appropriate trade opportunities that you don’t execute that never make it to the journal thus creating a gap in your performance.
In all the risks associated with trading, I find opportunity risk, whether in the form of unexecuted trades or pre-target exits, to be the difference between traders reaching that well talked about top 10% in your profession or one who remains in the novice pool struggling to keep their heads (and P&L) above water.
To overcome such risk to your trading business, the first step is to acknowledge that your source of trade data should be expanded to include eligible yet unexecuted valid setups, or ‘phantom trades’. Actual trades executed may only be a fraction of the total population where the market provided you with such legitimate opportunities. For example, let’s say you had several trades for the week using one of your favorite setups and recorded them precisely in your trade journal. It’s your favorite of course because it produces consistent gains and you are confident in your ability to execute them. You assess your journal regularly and the results confirm your positive variance. So far so good, right?
Good perhaps but how much opportunity dollars are you leaving on the table? Perhaps your daily goal is relatively low and a few good trades forces you to close up the platform early thus passing up golden opportunities in the afternoon that would have provided you with a similar historical edge. Let’s also not forget all those setups that were perfect but you stood aside because of your personal beliefs of where the market was heading.
As traders, we need to continuously remind ourselves that we are playing an opportunity game. When the market kindly grants us that historical edge, we as traders are paid to take advantage to optimize our reward for taking such pre-determined risks in the marketplace.
So how do we overcome this opportunity gap?
- First, don’t assess your performance based solely on the actual trades taken. The data assessed should be based on the actual valid opportunities when the market presented itself with a particular trade setup in your plan. After all, your trading plan doesn’t tell you to trade only some of the opportunities that are giving you an edge over the market. . You can use a column in your spreadsheet or code each trade to identify if it was actual or phantom.
- Consider adding a plan compliance ratio to your performance reviews that capture executed trades vs. actual plan compliant market opportunities. This will allow you to weed out legitimate setups that your plan rules may not allow you to trade, such as setups just prior to news events or setups during periods of high volatility.
If a valid setup that has historically provided a trading edge is working for you and you are only executing it 50% of the time, you are leaving good money on the table. It’s like winning a horse race and neglecting to cash in some of the tickets.
It takes focus, desire to succeed and of course discipline to execute your plan in robotic fashion. As you develop and improve your trading skills, be sure to consider your execution compliance as a developmental metric and measure it consistently.
You and your capital account will be glad you did.