Interview with Bennett McDowell, TradersCoach.com

December 19th, 2007

For the next interview in the StockTickr Interview Series (RSS feed), I spoke with Bennett McDowell, a well known trading coach and founder of TradersCoach.com.

Bennett is a frequent speaker at the Traders’ Expos and often participates in their live trading challenges. He’s also written several books with two more coming out in 2008.

Read on for more about Bennett, the worst trade he’s ever taken, and the most common mistakes he sees traders making.

StockTickr: Tell us a little about yourself, Bennett.

Bennett: I graduated in 1979 from Syracuse University with an Economics BA degree which gave me a foundation on which he was able to build a solid background in Finance. I started my financial career on Wall Street with the firm J.J. Kenny Co. in 1984 after serving as an officer in the U.S. Navy. I was also a Registered Securities Broker and financial advisor for Prudential Securities and Morgan Stanley before founding TradersCoach.com in 1998.

I then went on to create a reality based trading system called “Applied Reality Trading” also known as “ART” which includes advanced trading software and a 4-week home study course designed around using the software professionally. TradersCoach.com now offers this system and other great trading products and services on their website.

Our systems are now used by traders worldwide and the ART® Trading System has been thoroughly and favorably reviewed by a number of industry publications, including Stocks & Commodities magazine, Futures magazine, and Traders World magazine. In addition the ART Trading Software has been traded in front of live audiences and was a traded at a recent Trader’s Challenge sponsored at the Traders Expo in San Diego and will be again in New York in 2008.

I was honored to be included as a member of the eSignal “Trading With The Masters” team and received a Stocks & Commodities “Reader’s Choice Award” in 2005 and 2007. I lecture nationally and write articles for many leading trading publications and Web sites.

I am happy to announce two new books being published by Wiley & Sons; The ART of Trading and A Trader’s Money Management System – How To Ensure Profit And Avoid The Risk Of Ruin. Both books are to be released in 2008.

StockTickr: How did you get started trading stocks?

Bennett: I have always had an entrepreneur mindset and I first became interested in trading in 1984. I had worked on Wall Street for some major firms and started learning the business. I was really drawn to trading and love it. It was, and is my passion.

StockTickr: Most traders have a horror story about losing their shirt when they first started trading. What’s yours?

I have had many memorable trades, both good and bad. But I learned the most from this trade. When I was a novice trader and really did not know much about trading and risk control, I took a position with a bunch of put options on Applied Materials (AMAT) because my analysis indicated a bear market for AMAT. Well, my analysis was wrong and AMAT began its largest bull move in years and I was holding put options! Within one week, I realized my trade was in trouble when I was down about $15,000. I could not believe it, but I kept saying to myself, well the market can’t keep going higher forever! Well, it did go higher! And at that time I felt like a deer caught in the headlights of a car, I froze and did not know what to do. At this point my emotions determined the outcome of the trade. I lost all objectivity and eventually got out for a $30,000 loss in just two weeks! And of course, I did finally get out near the top! That was a lot of money for me at time, and it hurt me emotionally for a while too. However, this one trade taught me my best lesson, and I have never let that happen again! I learned the importance of risk control!

StockTickr: What single lesson did you learn along the way that has helped you the most in your trading?

Bennett: Trade the realities of the market which is price, volume, and support and resistance levels. ALWAYS use Risk control on EVERY trade.

When I stopped relying solely on indicators and forecasting methods my trading improved immensely. Indicators are usually are nothing more than derivatives of price and volume in a smoothed average or histogram of sorts. So in essence, they take the trader one level away from the reality of price and volume. Because indicators can be optimized, they can take you even further way from market realities. This is why most indicators are called lagging indicators.

All my objective entries and exits are based off of market realities. Indicators can be used as filters or secondary confirmations but never as primary decision makers.

StockTickr: How important is record keeping to long term trading success?

Bennett: Great question! Most traders do not keep good records or logs because they get lazy or do not want to know the results. Either way, it is a form of psychological self-sabotage!

Record keeping is absolutely critical – it allows you to put your trading under a microscope so that you can see how you are doing at any given time.

It allows you to see what you are doing well and see what you need to improve. The bottom line is that unless you keep good trading records you will not know the facts about your trading. A trader needs to know what their largest and average wins and losses are. They need to know what is their average draw-down for their trading approach. What is their largest win or loss over a certain number of trades? All these data points are very important for traders to know.

Bottom Line: If you do not know what is not working with your trading, then how are you going to fix it? Record keeping is essential because it gives you the facts!

StockTickr: How can traders improve upon their trading logs? Is there important information about trades that you see traders failing to capture?

Bennett: I would recommend traders keep detailed logs of each trade with notes on why they took the trade and how they felt about the trade (record any emotions when entering the trade). Noting your emotions will reveal if the trade was taken or even exited based on emotions or based on objective decisions.

StockTickr: What’s the most common but easily correctable mistake you see traders make?

Bennett: Most new traders believe trading is easy and the only thing you need to be successful at it is money to fund a trading account. In other words, money is the ticket to gain entry to making more money. They fail to realize that successful trading is a skill that takes hard work, persistence, time, and education to master. Most traders view trading as a “Get Rich Quick” program.

Another misconception that people have, thanks to the news, is that day trading is foolish and just gambling. While it is foolish and it is gambling to trade without knowing what you are doing, professional day traders are not gamblers and are not foolish. Quite the contrary, they are highly skilled and talented professionals!

Another common mistake is that traders fail to recognize that they need a systematic approach to Risk Control and Money Management. Every trade needs to be carefully assessed as to how large the Trade Size also known as Position Size should be based on the entry, the exit, the account size, the Risk of Ruin tables used to determine the Trade Risk percentage.

StockTickr: What 3 books do you recommend traders read?

Bennett: Well of course my two new books coming out in 2008: The ART of Trading and A Trader’s Money Management System. We anticipate them to be best sellers because they will be loaded with solid information traders and investors need.

But other books I that are excellent are Larry McMillan’s books on options for option traders, Mark Douglas books, and Donald Trump’s books on entrepreneur skills. Trading is being an entrepreneur!

The ART of Trading mcmillan on options trading in the zone trump university

StockTickr: What is the highest % of a trader’s portfolio do you think is reasonable to risk with each trade?

Bennett: The Risk of Ruin (RoR) tables are very specific on this. RoR takes into account several important variables which are:

  1. Your trading system’s “Edge” known as your win-to-loss percentage
  2. Your trading system’s “Payoff” known as your relationship of your wins to your losses
  3. “Trade Size” known also as your “Position Size” on each trade

For a trading system that wins (Edge) 60% of the time and has a Payoff of 1:1 you should not exceed a 2% of your trading account loss on any one trade. If you your edge is only 50% then do not exceed 1%. However if you Edge is 60% and your Payoff is 1.5:1 then you can risk 3%. This is exactly what my new book on Money management and Risk Control discusses.

StockTickr: Obviously there are ups and downs for every trader. Do you have strategies for weathering the inevitable draw downs?

Bennett: All trading systems and approaches experience “DrawDown” periods. You will never know when a drawdown period will occur so you must be ready for it to happen at all times. They may not happen that often, but when they do, be ready to handle them. You must be able to trade through these tough times, which will and do occur in trading. If you stay within a 2% risk on each trade you will have a great chance of avoiding “Risk-of-Ruin.” But if losing 2 % five or six times in a row scares you, then you need to lower your risk even more (under 2%) until you can emotionally feel good so you do not quit trading. Lowering your percent risk will automatically lower your “Trade Size”. Note that the “Risk of Ruin” tables should be used to determine your “Trade Risk” percentage based on your system’s performance.

For day-traders, an alternate way of approaching this is to set a dollar limit on how much you are willing to lose each day and then stop trading for the day when that level is reached. However, if you can adjust your risk so that a number of consecutive losses don’t exceed your daily loss limit, you have the best of both worlds. This is all part of the “art” of trading, since each trader may choose to handle this issue differently based on their beliefs.

StockTickr: How do you think the market has changed over the last several years? How have you adapted?

Bennett: That is a good question! It is interesting to note that with all the new technology available today, that the ratio of winning traders versus losing traders remain about the same as it was twenty and thirty years ago. Why? Because successful trading comes from within and since we all trade our own beliefs, we all interpret information from a different view point and thus react to that information differently. In trading, this has profound implications since it all comes down to how we interpret information and what information we choose to interpret.

StockTickr: Do you BackTest and if not, how do you instill belief in your system?

Bennett: I cannot stress enough how important it is for traders to test their trading systems and approaches through “Paper Trading” (known also as “Simulated Trading”) for a long enough time so that you encounter various market conditions and see how YOU handle it. If you cannot be profitable Paper Trading, then you will most likely not be profitable when you trade with real money. This is because trading with real money is even harder than Paper Trading because of the emotions of fear and greed that occur while trading with real money. When I trade, I know based on all my testing and Paper Trading what is normal Draw-Down versus losses occurring from poor trading due to emotions. Losses are a natural part of trading and “Draw-Down” periods are as natural as winning periods. The idea is that through proper money management and risk control, we limit our losses into manageable events that are small compared to our winnings.

BackTesting can also be constructed so that you see how your trading system would do with market history. It is important that if you BackTest use REPLAY the market and trade it as if you where seeing it for the first time. This way you will accurately see your results. I do not believe in 100% mechanical trading, based on my own trading and from talking with other Master Traders, discretionary decisions are needed even when using trading software to be consistently profitable. Discretionary decisions are derived from experience and a well tested trading system. For example, if you are using a trend trading system, then you will make money in trends but lose money in non-trending markets. The key then to being highly profitable is to be able to identify a non-trending market cycles early enough so that you change to another trending market cycle before experiencing enough losses to cause poor performance. The Master Trend Trader knows how to do this, and software does not. Since markets trend about 35% of the time, the Master Trader’s skill in moving from winning market trending cycle to the next is very important. If you are a Counter-Trend trader or a Scalper then you need to develop your skills to identify those markets cycles to achieve consistent profitability as well.

StockTickr: What advice can you offer traders who are just starting out?

Bennett: Most new traders believe trading is easy and the only thing you need to be successful at it is money. In other words, money is the ticket to gain entry to making more money. They fail to realize that successful trading is a skill that takes hard work, persistence, time, and education to master. Most traders view trading as a “Get Rich Quick” program.

I feel the most important rule before taking a trade is to calculate the correct Trade Size based on the trader’s account size, trade entry, trade exit, and percent risk which really should never exceed a total of 2%. Of course other important trade elements include reviewing higher and lower time frames, potential risk to reward, and basing your trades on the realities of the market.

I believe that no one was born a great trader and that anyone with the passion, commitment, the right education, and the risk capital has the potential to become a great trader. Trading is not a get rich quick philosophy, instead it is a profession that needs to be mastered in order to be profitable. Through education, practice, and commitment you can potentially master the skills needed to trade the financial markets for a living. Trading should be fun, and if it is not fun for you, then you are doing it wrong!

Every trader trades his or her own beliefs. And therefore, your beliefs and personality will determine how you trade and whether you will be successful or not.

If you must HOPE that your trade will make money, then you are not trading well and hoping creates anxiety, stress, fear, and greed. Paper trading is a great way to practice your trading and develop your skills in a stress free environment before risking real money. If you cannot profitably paper trade, then I believe you will not be profitable trading with real money in the markets. Once you begin to trade in the markets with real money, your psychology becomes the main factor in your being successful or not.

All trading methods involve risk and there are no absolutes in life, the markets, or in trading. In trading like life we live in a world of probabilities.

StockTickr: Thanks, Bennett!

Bennett: Sure, Dave.

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