Diary of a Professional Commodity Trader

1. Classical charting principles provide a framework for successful commodity trading

Charts are a trading tool, not a predictive tool. Charts can provide traders with a slight edge, but should not be used to make price forecasts.

Chart patterns as trading signals. Classical charting principles, developed by pioneers like Charles Dow and Richard Schabacker, offer a systematic approach to analyzing market behavior. Key patterns include head and shoulders, triangles, channels, and flags. These formations can indicate potential trend reversals or continuations.

Edge, not certainty. Chart patterns provide traders with a slight edge, not guaranteed outcomes. Successful traders use this edge consistently over time to generate profits, similar to how casinos rely on small statistical advantages. It's crucial to understand that charts are tools for identifying potential trades, not for predicting exact price movements.

Pattern recognition skills. Developing the ability to quickly identify valid chart patterns is essential. This skill comes through experience and studying historical examples. Traders should focus on patterns with clear, well-defined boundaries and avoid over-interpreting ambiguous formations.

2. Successful trading requires discipline, patience, and emotional control

Successful trading is an upstream swim or uphill run against human nature.

Emotional challenges. Trading consistently triggers powerful emotions like fear, greed, hope, and anxiety. These emotions can lead to impulsive decisions, overtrading, or hesitation at crucial moments. Successful traders develop strategies to recognize and manage these emotional responses.

Discipline in execution. Adhering to a pre-defined trading plan, even when it feels uncomfortable, is crucial. This includes:

• Entering trades only when specific criteria are met
• Sticking to predetermined stop-loss and profit-taking levels
• Avoiding the temptation to overtrade or chase missed opportunities

Patience in waiting for setups. The best trading opportunities often require extended periods of waiting. Resisting the urge to force trades during quiet periods is a key skill. Successful traders understand that preserving capital during suboptimal conditions is just as important as capitalizing on clear opportunities.

3. Risk management is more crucial than trade identification

Risk management must be given priority over trade identification to achieve consistently successful performance.

Position sizing. Proper risk management starts with determining appropriate position sizes. The Factor Trading Plan typically risks no more than 1% of capital on any single trade. This approach helps preserve capital during inevitable losing streaks.

Stop-loss placement. Utilizing concepts like the Last Day Rule (placing stops beyond the high/low of the breakout day) provides a systematic approach to limiting losses. Trailing stops and other techniques can be used to protect profits as trades develop.

Overall portfolio risk. Consider correlations between different positions to avoid overexposure to similar market factors. The Factor Trading Plan aims to limit risk in highly correlated markets (e.g., grains, currencies) to 2% of total assets.

4. Develop and stick to a comprehensive trading plan

A trading plan must address the issue of risk management, namely, what proportion of capital will be risked on any given trading event.

Key components of a trading plan:

• Trade identification criteria
• Entry and exit rules
• Position sizing and risk parameters
• Overall portfolio management guidelines

Consistency is key. The power of a trading plan comes from its consistent application over time. This allows traders to benefit from their edge across a large number of trades, smoothing out the impact of individual winners and losers.

Flexibility vs. rigidity. While consistency is crucial, the best trading plans have mechanisms for periodic review and refinement. This allows traders to adapt to changing market conditions without falling into the trap of constantly tweaking rules based on recent performance.

5. Trade identification should focus on well-defined, mature patterns

The longer I need to examine a chart, the less likely the market in question is offering a trading opportunity. For me, signals are patently obvious.

Pattern clarity. The most reliable trading signals come from well-defined chart patterns that are immediately apparent. If a trader has to strain to see a potential setup, it's likely not a high-probability opportunity.

Time frame considerations. The Factor Trading Plan focuses on:

• Major patterns: 10-12 weeks or longer on weekly charts
• Minor patterns: 4-8 weeks for continuations, 8-10 weeks for reversals on daily charts
• Avoiding very short-term patterns unless they confirm larger structures

Context is crucial. Individual patterns should be evaluated within the context of longer-term trends and support/resistance levels. The most powerful setups often occur when multiple time frames align to confirm a potential move.

6. Effective trade management balances profit-taking and allowing trends to develop

I am more certain than ever that no two consistently profitable traders can or should operate exactly the same way. No two traders think the same way.

Profit-taking strategies:

• Using predetermined targets based on pattern measurements
• Trailing stops to protect profits while allowing trends to continue
• Partial position exits to lock in gains while maintaining exposure

Balancing act. One of the most challenging aspects of trading is knowing when to take profits versus letting winners run. This often requires different approaches for different types of trades (e.g., more aggressive profit-taking on short-term setups vs. giving more room to major trend breakouts).

Adapting to market conditions. Effective trade management may need to shift based on overall market volatility and trend strength. In choppy markets, quicker profit-taking might be appropriate, while strong trends may warrant giving positions more room to develop.

7. Continuous self-analysis and plan refinement are essential for long-term success

Trading to the far right of the chart page.

Regular performance review. Analyze trading results on a monthly, quarterly, and annual basis. Look beyond simple profit/loss metrics to evaluate:

• Win rate vs. expectations
• Average winner vs. average loser
• Distribution of profits (reliance on "home run" trades)
• Adherence to trading plan rules

Identifying areas for improvement. Use performance analysis to pinpoint weaknesses in the trading plan or its execution. Common areas for refinement include:

• Adjusting profit-taking strategies
• Refining entry criteria for specific pattern types
• Improving risk management techniques

Avoiding optimization pitfalls. Be cautious about making changes based solely on recent performance. Focus on addressing fundamental flaws in the plan rather than trying to optimize for the last set of market conditions.

8. Market behavior is cyclical; drawdowns and losing periods are inevitable

There are losing trades, losing days, losing weeks, losing months, losing quarters, and, unfortunately, there can even be losing years. I have experience with all of these.

Drawdowns are normal. Even the most successful trading systems experience periods of underperformance. The Factor Trading Plan has historically encountered drawdowns of 15% or more in 9 out of 10 years.

Psychological preparation. Understanding the inevitability of losing periods helps traders maintain emotional stability during drawdowns. This prevents panicked departures from sound trading principles during difficult times.

Recovery strategies:

• Avoid increasing risk to "make back" losses
• Focus on executing the trading plan consistently
• Consider reducing position sizes temporarily if drawdowns impact emotional state

9. The human element is the most challenging aspect of trading to master

Successful market speculation is an upstream swim against human nature. The human aspect of trading is far more important than trade identification, the subject that gets most of the attention of books, seminars, and web site trading services.

Common psychological pitfalls:

• Fear of missing out (FOMO) leading to overtrading
• Hesitation to take losses, hoping losing trades will turn around
• Overconfidence after a string of winning trades
• Paralysis by analysis, constantly second-guessing decisions

Developing mental toughness. Successful traders cultivate:

• Emotional detachment from individual trade outcomes
• Confidence in their edge and long-term process
• Ability to admit mistakes quickly and move on

Continuous improvement. Mastering the psychological aspects of trading is a lifelong journey. Traders should regularly assess their emotional responses to market events and work to develop coping strategies for challenging situations.

Last updated: October 9, 2024