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I made 20% ROI in six months and then lost it all in one month. In the next month, I lost 30% on ten trades. I have lost and earned thousands of dollars, nearly blew up my entire account twice, and received dozens of margin calls. I also tried multiple Machine Learning techniques and traded multiple markets, time frames, and instruments. I made every mistake possible, but I managed to survive and learn a lot.

My path in software engineering was predictable after four years. Data Science projects would be my main focus. My industry experience was shaped by working in small companies, enterprises, and startups. However, nothing was more satisfying than that. I would not let my passion for Algorithmic Trading go. I was looking for something more, so I quit my Data Science job to pursue day trading as a career. Below is a summary of the mistakes I made and what you can do to avoid them.

Machine Learning Hype

Machine Learning applications are everywhere. The media love it, but people don’t get it. Investors call it “buzz words” because they won’t get it. DiscoverNikon development is fantastic, and this is just the beginning. My colleagues and I were always saying to each other that we would one day be able to sit down and reflect on Java classes in Eclipse right in front of us, and then we’d be injected with books like in The Matrix during sleep.

Machine Learning can be very difficult to use in trading. Machine Learning is more of a filtering tool than a decision-making tool. Many paper trading tests will prove to be great but will not work in actual trading. Cross-validation will help you to identify the most successful models from out of your sample.

It will allow you to be more secure and prevent bias and leakage. It is not the right way to go.

Markets have different train/test distributions
Markets have different train/test distributions

Avoid over-fitting. Instead, carefully average and evaluate different assets, times frames, or periods. To test your generalization power, use non-conventional train/test breaks and add random noise. You don’t always know what you don’t know, so be careful. Although you don’t know what might happen, Monte-Carlo simulation can help you at least simulate many scenarios.

Risk

Several times throughout my trading, I felt safe and believed I had it down. I thought there was nothing that could surprise me. The mister market repeatedly rebuked me. A single trade that goes wrong can wipe out 10 of your profitable trades. Volatility spikes and stops are broken like paper by knives. Free liquidity becomes a deadly stranglehold on your portfolio. After a foul margin call, your broker will fix all positions before they become a total loss. If you haven’t seen it, you will think it’s fantasy and war stories. It is the truth, people. There is no money for everyone. It doesn’t matter how well you understand your chances and probabilities of losing; all investments involve risk.

My edge as an options trader is selling high-priced options and purchasing them back when they drop. Several pricing models exist nowadays, such as Black-Scholes-Merton, Binomial Trees, and Monte Carlo. Each of these models provides an estimate of the price of the asset over a given time. Usually, IV (Implied volatility) is overstated. Sometimes, fear can be confirmed.

2018–02–06 TripAdvisor was actually up
2018–02–06 TripAdvisor was actually up

Market fear can sometimes be real, as we saw in February 2018. ETFs and equities started to fall, and people fled to safe havens like gold and cash, where cash is the true king. People realized that marauders would prefer cash and gold to digital currency.

Alpha

Crazy classifier ensembles, averaging, and other methods win all of the Kaggle competitions. I was a hard worker trying to be innovative. I used cutting-edge algorithms, tools, and techniques. Sometimes they work, sometimes they don’t. It can take weeks or even months to figure out what went wrong. You will either have to pay money for this evaluation, or you can paper trade it off the market. As mentioned, this is non-deterministic and adds noise and data.

Simple statistics, Monte Carlo simulation and a bit of Python are all you need—simply making assumptions that are valid and well-validated can spot over-priced or under-priced bids. These fancy models can be helpful for your ego as well as general understanding. A CS 101 probability and statistical analysis are sufficient to make a market strategy profitable.

KISS (Keep it Simple Stupid)

You must be able to explain how you make money to someone who has no trading experience. Before that, I used to tell people how complicated my Machine Learning flows were without explaining the alpha. It’s easy now: I sell premiums for overpriced options. Although the asset price bounding method is complex, the alpha source is simple.

Trading can seem like a challenging task to most people. It is why it requires financial education and training. People act as traders every day, often without realizing it. You go to the supermarket to purchase stuff. It is your exchange (market). Your bid-ask spreads are the prices (level 1). The supplier cannot sell, but you can only buy (ask). Level 2 is the supply at the supermarket’s back. Your order book is the cashier’s. You can now apply it to all your purchases and sales. It’s all trading.

My losses were more significant the more complex I made my algos. My income was lower because of fancy Spark jobs, Lambda Expressions, and Jupyter notebooks. The truth is, I started out using simple multi-threaded flows. I used a few simple scripts to evaluate my alpha. Once I started focusing on ease and performance, I lost sight of my alpha. It is essential to maintain a simple working flow. Then you can add jewelry. While performance and ease are imperative, simplicity and consistency are more important for retail traders.

Also read: How To Become A Successful Forex Trader?

The Market Roller Coaster

It is nice to be profitable for six months, but losing more than you did the previous two months is possible. Sometimes, the market can be brutal and swift like an alligator. Play small to avoid these situations. Over betting was one of my biggest mistakes. Kelly’s criteria are an essential consideration. However, it is better to be under than over-bet. Your success depends on your ability to assess risk and determine the size of your position. A strategy with a high chance of winning is just as important as the correct position sizing or analysis of margin requirements.

Buffett quotes Munger as saying that there are three options to go bankrupt: “liquor,” “ladies,” and “leverage.”

Smart Hindsight

You will always hear from others what you should have done. Everyone who made a mistake in my life was there to tell me how I could avoid it. Friends, family, and colleagues will question you, your alpha, skills, and ideas. Robert Kiyosaki seems to have been correct. People are afraid to try things, so it is easier to judge someone else than do it. Your environment will discourage you most of the time. From the trolls on the social networks to potential investors, everyone thinks it’s easy. But then again, they are only watching and learning the art of hindsight. You are fighting for your life, so don’t let the spectators fool you.

Go a Little Mad

It’s also going to happen for you. Pro trades emphasize the need for psychological resilience. You will feel the volatility in market movements. Margin requirements will increase from 40% to 2% before the market open. You will feel helpless and miserable because you placed large trades at unbounded risk and didn’t consider the rainy day. You will have rainy days, so be ready.

I also lost my soul. My friends kept repeating the same comments about being “cold,” aggressive, and “rude.” One moment, I nearly forgot how to play the guitar. I found every social event annoying, time-consuming, and a waste of my precious coding time. I worked long hours, weekends filled with development and hundreds upon commits, eating disorders, and the apparent weight loss. It is extreme. Said that it was a sign that I had done an excellent job in my venture. It is wrong for trading. It is best to avoid it.

The Rebirth

After a series of missteps, my expectations have been drastically reduced. I realized the old saying about how much money you could actually take from the markets and how much you could keep. I have enough gas to last me a few more months. It’s now that I realize I need to start earning a monthly salary.

Most importantly, I suddenly felt fearless, and nothing could scare me. I was not naive anymore and fully understood the risks. This business was fragile and extremely dangerous. It’s like walking through a minefield.

I began trading very small. Instead of jumping into trades like a panther, I researched the company first. Plus, multiple trade ideas for the same symbol will often appear, so there is no Fear of Missing Out. In addition, I decreased the number of watch lists and emphasized liquidity and volume. It was my most critical moment. It is essential to get in and out of trades. My losing trades all involved low liquidity assets and poor fundamentals. It is something that can take you seconds to assess nowadays.

Commissions

Before my losses, I was making 4% ROC per month. Commissions were considered minor and insignificant. When I had to close more than 30% of the account and reduce my positions, I realized how vital low commissions were. IB (Interactive Brokers), I pay the lowest commissions due to the platform’s robustness and the flexible API. IB recommended that IB “provide liquidity” since they don’t negotiate rates and will not accept 200 trades per month. Also, I need historical EOD prices (End of Day), so Quandl is essential. Retail traders don’t care about brokers.

Trading size is the only way to avoid commission ripping. Many people talk about diversification and all that stuff. How small positions should be. Trading too small can lead to your death. It depends on your account size, risk aversion, etc.

Also read: 5 Best Forex Trading App For Android/iOS

Patience

Patience is one of the most challenging things to do when day trading. Sometimes it is better not to trade. It is similar to Zugzwang’s strategy in chess. Day traders are market junkies and can lead to addiction and an adrenaline rush at the opening bell. Cash is sometimes the best thing, but waiting or not trading is better than nothing, especially in crisis or sellout markets. Trading is like breathing; you can’t exist if you don’t trade. This urge is crucial to your success. It has happened so many times that I have tried to add to the losses or save terminal positions instead of waiting and keeping the money.

The big money is not made in the buying and selling… but in the waiting (Charlie Munger)

Entry and exit are both affected by patience. The prices will be what you want, but they will alter the LMT order, and you won’t get it. You will then adjust and chase the price, which will move again. It takes time and patience. You will eventually be able to hold onto your views and wait for the other side. My experience is that if the underlying material is liquid, then all day trades at moderate prices will be completed.

You can’t escape losing trades, and expiration is weekly, so don’t rush to fix them. You could lose your entire portfolio if the market bounces. Your losses may be more minor. After the market selloff of February 2018, I created a bear spread and fixed it with a 0.7 spread loss. It rose to 0.2 the next day, so sometimes waiting can help. Do not keep losing positions exposed; markets can bounce even if they are just a few days away from expiration.

Mastering the Art

Trading is more art than science. A new instrument may be easy to learn, and you might soon find your way to playing it. You will be able to play some notes and maybe even a song after a month. How long will it take to be able to play like Steve Vai’s guitar? He said that he practices 8 hours per day and is gifted. However, hard work is the key.

Trading requires practice. Professional traders and hobby traders are separated by their ability to trade effortlessly. Day traders are often mistaken for lucky cowboys who have plenty of money. People seem to overlook the path because it is the hardest part of this game.

I have read hundreds of articles, hundreds of books, and hundreds of hours of video-related content. Learning never ends. Each day that passes without learning something is a wasted day. You must constantly improve and engineer your trading plan. Otherwise, you will lose relevance and your edge. Online content is the best and most useful, and it’s free. You should check out OptionAlpha, tastytrade, and OIC if you’re interested in options trading. These guys will show you everything. It depends on how motivated you are.

Also read: What Forex Trading All About Is Easier Than You Think

Think like a market maker

After hundreds of manual trades, you begin to notice things. Market makers are one of the most frustrating aspects of trading options. Market makers are the actors that control the show. It is well-known that HFT (High-Frequency Trading) players like Final, Citadel, and Final have complete control over the market’s price inefficiencies. Because fast players can get ahead of you and either sell the same product at a higher price or buy it from your company at a lower price, it is easy to rip off big institutions that want to buy and sell. These minor differences can add up like a snowball.

Commissions are part and parcel of the problem. However, without them, there won’t be any trading venues. The problem is that market makers are lying to the order books. The infrastructures are all automated, and fast players are always available to capture your trades and happily provide high prices for buying and low costs for selling. Limit orders are the best way to beat it. Also, try to predict the median price. Although this may seem like a minor issue, multiplying 200 trades with 2.5$ to rip off fees is similar to the commissions you already pay. Never use market orders, bid-ask raw price, or market orders. Always target the mid-price and better.

Know Your Gear

The first step to great photography is controlling your camera. It is essential to understand how to use setups and combinations depending on the lighting conditions. Real art starts once you have mastered it.

IB TWS takes time for mastery.

My trading software took six months for me to be used, and the API was easy to use. I have entirely cloned my trading setup on my computer, laptop, and AWS instance. I have all the software I need to resume trading in case of an error quickly. My network connectivity is very stable. Multiple network adapters are available to ensure that my smartphone is always connected, even in bad weather. To make trading as consistent and robust as possible, I created multiple automation layers. Trading is prone to analysis paralysis. As much as possible, eliminate manual interrogations.

Numerous fat finger mistakes led to me losing thousands of dollars due to incorrect prices and a combination of multiple trades. The risk of making stupid mistakes and losing capital is high when you rush and are not well-informed. Do not run. You are a retail trader and not an algorithmic trading machine. You should be familiar with your trading software.

Analytic Paralysis

It is a bad idea to trade too often. Trading can be fascinating, and it can lead to addiction. Too eager to trade, improve, and modify can lead you to become a junkie, and eventually, you end up doing more harm than good. My screens were my only barrier to entry at the beginning. It displayed my positions and futures on one screen. I also had tastytrade and futures broadcasting on the other. I would spend 6 hours modifying, trading, improving, or otherwise ‘touching’ my trading. It can only do trading options at the closing bell and opening bell. It was something I had to learn the hard way. All else is horrible.

It is easy to remove balance, PNL market price, and other money-related indicators from my portfolio. You care about how much money you have earned and how much you’re likely to lose. It is going to make you miserable. It’s good for your performance to drop money from your routine. It is better to think in probabilities, the risk to reward than in dollars. Once I had cleared my portfolio balance and summary numbers, I focused on execution and consistency and not money.

Trading like a robot is the only way to survive in this game. While it is okay to try new things, and that’s part of the learning curve, trying new stuff with your live account can prove disastrous. I was changing my probability of profit thresholds and risk to reward ratios way too quickly. I eventually converged and found my optimal ratios. It cost me thousands of dollars to do it in my live account. I could have saved all the pain and used pen and paper to evaluate things a-priori. It is essential to be consistent and persistent.

Pattern Day Trader

PDT (Pattern Day Trader) rule requires that you trade at least 25K$ per day. You cannot trade more than three days in a week. It’s a terrible rule that I detest, everyone hates it, and they think it’s stupid. Although it’s irritating, the logic behind the PDT restriction is solid once you trade like a cowboy.

The restriction was irrelevant to me as I’ve been trading with a decent account. As I could make all trades, I didn’t have to prioritize them. When I lost half my account, I realized how vital each trade was. Instead of trying to shoot all over again, I decided to laser focus on my trades.

Expectancy

I was curious to perform a statistical analysis of the trades I made, especially the ones we’re losing. Let’s divide the study into symbols traded vs. raw trades. This slight difference was significant.

From June 2017 to March 2018, I have made 1068 trades (621 profitable and 447 losings), which is 0.58 chance for a win or 0.42 for a loss. I have earned 87459$ and lost 122069$. The average win is 140$, and the average loss 273$. It is a 0.51 return-to-risk ratio. It is the effective edge.

0.58 * 1 = 0.42 * 1.96= 0.0.24

There is no edge because of the low probability to profit and high risk-to-reward ratio. Let’s now group trades by the symbol. I have traded 130 symbols with positive PNL and 51 with a negative PNL. It totals 181 symbols. 0.28 of the symbols were losing, while 0.72 were profitable. Each symbol has an average profit of 134$ and an average loss of 1020$. It is a 0.13 return-to-risk ratio. That is the effective edge.

0.72 * 1. - 0.28* 7.69= -1.43

There is no edge, and this is even more frustrating. It is essential to know the probability of profitable symbols and how important it can be to trade only a subset of assets. Let’s now look at the theoretical edge, assuming we use proper position sizing and asset selection.

0.72 * 1 = 0.28 * 2. = 0.16

It is 16%. It was a simple lesson for me that success is achieved by trading small and often. It was impossible for me due to inconsistent position size and too many symbols. You are doomed if you tilt your trades. A losing strategy is to take more than 1 to 2. It was my most significant aha moment.

Trading Journal

Although you hear a lot about trading journals being important, most people don’t keep one. It’s not necessary because you can see all your trades on the trading platform. You also think it’s a waste. Your winnings and the amount of money you make are all that matter to you. You will eventually have to mature as a trader and will see how vital a trading journal is.

A trading journal is a great way to improve your trades. You can track trades to track everything, from commissions and odds to the assets they trade. You’ll learn more than you realize, and it will help you improve your trading discipline. As a trading journal, I created a Google Sheet. After one week of running the journal, I realized that my risk was too high and my trades were too small. My trades were too small, so I was putting my risk at more than 1 to 4.

Levels wrote down

In my options strategies, I sold at least 50$ worth of credit. After analyzing the profits, you will see that you only make 0.19 to 19$. Options contracts have a 100 multiplier. Let’s say that you risk 100$ to make $255, which is 1 to 4, and the probabilities are in your favor. However, you make 19$ and still bet the same 100$. The combination of a widely recommended fix at 50% and the courtesy broker who takes between 3$-10$ per trade round trip (inside and outside) is what makes the drop from 25$-19$. These minor differences can compound like a snowball and decrease your edge.

It can solve this problem by raising your minimum entry cost. At that point, I will not accept less than 100$ premium. Instead of taking 50%, I take 75%. We have a 75$ to $200$ risk, which is between 1 and 2.67. It is a bad ratio, but it’s realistic. We can win 75% of our trades, which is much more than the 80%. Long-distance options strategies are common, but weeklies work well for me. You will need to adjust your profit taking and stop loss levels accordingly.

SPX is the King, VIX is the Queen

SPX@CBOE and S&P 500 Index represent the market. These indexes reflect everything that moves and all that is interesting. There is a place for every peak, crash, fear, hype, and fear. VIX@CBOE, or the Volatility Index (SPX), directly reflects market fear and greed. Volatility moves with markets and vice versa. While correlations are helpful for the long-term, when volatility spikes, all things become correlated.

Options sellers will benefit from high VIX values, while those with low VIX are boring and dangerous. Long periods of low VIX can lead to massive explosions.

Historical VIX data

Keep your eyes on the most critical assets of the day. Premium is increasing, and assets falling are more interesting than premium. Premium sellers are the best time to be in the market as the action heats up and the offers are plentiful. Options trades are better if there is market fear. Premium goes up. You must be patient and not rush to act. It is when your edge will be comprehensive and clear.

Also read: 3 Reasons Why Forex Traders Lose Money

A Kill is Not a Fill

Inability to get a fill in your trades can drive you insane. I chased prices multiple times until I found the right price, which did more harm than good. Market makers will always give you a better fill at the moment you’re in. They will rarely provide you with a lower filling or the mid-price. It’s not worth fighting for. Before you accept a bid, make sure to find bids that meet your risk-reward ratios. Two things are almost guaranteed to happen. 1. You’ll get all you need. 2. 2. You’ll immediately see a lower price. This game is not easy, but you can still make a profit. You will be fine if you make a lot of trades. It will be challenging to recognize that two things will happen: Almost no fills 2. The negative expectation is risk-to-reward due to commissions and your target exit prices (which are rarely 0).

Don’t Repeat Your Mistakes.

It’s believed to be a filter that distinguishes successful traders from losing trades. Before you trade, make sure to do a self-examination. I have made trading mistakes multiple times and made them more often.

Trading takes time and is a difficult skill to master. Learning never ends. Markets are dynamic, and they are alive. As cars run out of gas, alpha tends to vanish. It is essential to review and recharge your strategy.

Finally

I hope this will help you save time and money. I wish I had known all these things before I jumped into the pool with sharks. We are tiny retail traders, and the sharks love our stupid fat snacks.

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