2008 - Lessons Learned In Pursuit of the Holy Grail of Trading

2008 was a year I'll remember vividly in my trading career, and certainly NOT because I made lots of money in the markets.

It is human nature to look for the holy grail, and traders -- professional or amateur -- are no exception. We all deep down would love to find that one indicator or system that will open the coffers to a lifetime of easy profits. Well, I didn't find the grail, and I probably never will, but that doesn't mean I didn't learn some valuable lessons; moreover, I am absolutely convinced will make my trading and future pursuit of the grail more profitable from what I learned -- much of it through mistakes and the adversity that comes along with those mistakes.

Here are some of the lessons I learned in 2008:

1. The ability to go both long and short has the potential to make you more effective as a trader. It makes your equity curve much smoother. Unfortunately, I didn't implement my short systems until February of 2008 (which makes January that much more painful to think about), but once I did results were remarkably better.

2. Position size matters so much more than you could imagine. Keeping your size small allows you to not worry about specific risk such as corporate or sector risk. Smaller size allows you the flexibility to add to positions as your edge increases. With small positions (1% or less), you also have no need to worry about stops for money management, which increases your edge. And by definition, smaller size gives you more cash. The key is to exploit your edge over thousands of trades as opposed to looking for a home run.

3. Knowing your edge and how you it relate that edge to your overall exposure is not trivial. Why enter trades and expose your account when there is little or no edge to be had? Just because you had room in your portfolio? The market doesn't give setups according to your schedule. And during what situation do you want to have more invested (in terms of bigger positions or more positions), when your edge is higher, or when it is lower?

4. Cash is king. Although you may be concerned you are missing an opportunity on the sidelines, having cash on hand can be absolutely liberating, especially if you think of it in relation to your edge. Cash also helps to reinforce your the mental edge (see 5.) that you will always have be able to pursue an opportunity when it should arise. In my system testing, I have found the very best results seem to come from systems that have less exposure than I would have thought -- this comes from not having to reject good trades when you are fully invested.

Think about how one felt during September and October if he or she had cash to take advantage of the fear going on, versus someone who was trading on margin at the beginning of the period and watched their accounts go down hard, powerless to do anything about it (I speak from experience here).

5. Who cares what the crowd is doing? My very worst decisions come inevitably when I listen to the pundits, read newspapers, watch financial television, and then allow that to impact the game plan I have formed -- especially when my plan has much of its success involves doing things counter to the crowd. Your mind cannot be right if you are paying too much attention to the crowd. Which leads me to the last lesson....

6. Having your mind right is what makes all the other stuff work. If your mind is not right, none of the other stuff matters. You can have the best game plan in the world and it crumbles without the ability to execute during the most intense moments of fear and greed. If your psyche is not right to execute your plan, you should not be involved in the markets. Overexposure, overtrading, thinking you have the ability to predict the markets, listening to the herd, hubris, making execution mistakes -- any of these attributes have the ability to derail a great plan.