Setup, not profit!

(From John Carter, Mastering the Trade, 2006, p.20-21. McGraw-Hill, New York)

I continued to trade actively through college, where I started out studying business in California, used my trading stake to finance a year abroad studying history in Cambridge, England, and eventually graduated from the University of Texas at Austin. During this time, I quickly developed a very consistent approach to my trading: I would routinely turn a $10,000 account into the high 5 or low 6 figures over the course of a year. I would then buy myself a piece of rental property and a couple of nice gizmos. Then I would sit back and decide what other bigger and better things I wanted to buy. Once I figured that out, I would go back to trading. Armed with these visions of "bigger and better things," I would dive back into the markets—and promptly give back the rest of my trading account in less than a month. This happened not once but three times. The most memorable trade happened right out of college, when I was able to give back a $150,000 trading account in less than a week. (That's what happens when you buy 200 OEX puts at $7.20 and sell them a week later for 75 cents). Luckily I did have enough real estate at this point to be able to sell one of the properties to raise a new trading stake.

At this point, of course, I had to sit down and figure out what I was doing wrong. I knew I could make money trading—why couldn't I keep it? My studies in history had a huge impact here. I could clearly see that since the beginning of modern civilization, the world had gone through a repetition of similar events all driven by human decisions. This insight really changed my focus and how I looked for opportunities in the markets. I stopped looking for the next great indicator and started looking for repeatable market patterns based on human nature.

During this time I also came across a book by Mark Douglas called, The Disciplined Trader. This book was a real eye opener in that Mark showed how to turn everyday stressful trading situations into "normal" successful trading behavior. His follow-up book, Trading in the Zone, is also excellent. His books have had a huge impact on me, and they are required reading for anyone I'm working with. Mark's insights, as well as my long discovery period, finally gave me the answer: Whenever I focused on the setups and not the results, I did fine. But whenever I focused on the results and not the setups, I got killed. Why is this? Once I got my hands on a decent-sized trading account, I would start to think of things like, "I want to turn this account into a million dollars." Instead of focusing on the setups, I would focus on making a million dollars. This caused me to jump into the trading habits that ruin all traders: betting it all on one trade, not using a stop because the trade "had to work out," and focusing on making a million bucks instead of waiting for a high-probability trade setup. Sure, it would have been easier to just blame it on my mother for hitting me with a wooden spoon once when I was a kid, but at some point we have to step up and take responsibility for our own actions.

Once this revelation sank in, I started to do two things differently: First, I started wiring any profits out of my trading account at the end of each week. This kept me focused on producing a steady income, as opposed to making a grand killing. I also discovered it was a great way to protect profits—the market can't have them if they are safely tucked away out of reach. Second, I started a competition among the various setups I used. This way I could measure the performance of every one of my setups at the end of each month. The setups that made money I kept using. The setups that lost money, I dumped. This was incredibly important to my trading. The only way I could keep my competition going was to execute my trade setups the same way each and every time. Anytime I deviated from a standard setup, I would mark this down in my trading journal as an "impulse trade." I kept track of the performance on these too. After about six months of tracking my impulse trades (wow, this market is going higher, I have to get in), I realized that they were not making me any money and were in fact preventing me from making a living as a trader.