The Most Valuable Trading Tool I Have

06/16/2011 6:00 am EST

Focus: STRATEGIES

Michael Toma

Author, The Risk of Trading: Mastering the Most Important Element of Financial Speculati

Having a trade journal is important, but tracking the right data is imperative, says one risk manager, who reviews “opportunity risk” and why traders can’t afford to overlook it.

Since I started trading, I have kept some form of records in a trade journal. The actual data components I track and the structure has changed several times since my spreadsheet days, but the information gathered from the journal still acts as the basis for my trading decisions.

I applaud those who maintain a trade journal in any form and use the information to develop solid strategies that provide a consistent trading edge.

See video: Using Data to Gain an Edge

Even the best-kept journals, however, miss the mark on one of the biggest risk exposures to the trader: opportunity risk. Simply put, it is the appropriate market opportunities that you don’t execute—the ones that never make it to the journal— that create a gap in your performance.

In all the risks associated with trading, I find opportunity risk, whether in the form of unexecuted trades or pre-target exits, to be the difference between traders who reach that much-talked-about top 10% in the profession and those who remain in the novice pool, struggling to keep their heads (and P&L) above water.

See related: How to Keep an Effective Trade Journal

To overcome such risks to your trading business, the first step is to acknowledge that your source of trade data should be expanded to include eligible, yet unexecuted, valid set-ups.

Actual trades executed are only a fraction of the total population where the market provided you with such legitimate opportunities. For example, let’s say you had several trades for the week with one of your favorite set-ups and you recorded them precisely in your trade journal. It’s your favorite set-up, of course, because it produces consistent gains and you are proud of your ability to execute them. You assess your journal regularly, and the results confirm your positive variance. So far so good, right?

Good perhaps, but how many opportunity dollars are you leaving on the table? Perhaps your daily goal is relatively low and having a few good trades forces you to close up the platform early.

Or maybe you get a bit timid after a green morning and pass up the afternoon opportunities that would have provided you with a similar historical edge. Let’s also not forget all those set-ups that were perfect, but for which you stood aside because of your personal beliefs of where the market was heading.

As traders, we need to continuously remind ourselves that we are playing an opportunity game. When the market kindly grants us that historical edge, we as traders are paid to take advantage to optimize our reward for taking such pre-determined risks in the marketplace.

So how do we overcome this opportunity gap? First, don’t assess your performance based solely on the actual trades taken. The data assessed should be based on the actual valid opportunities when the market presented a particular trade set-up in your plan.

After all, your trading plan doesn’t tell you to trade only some of the opportunities that are giving you an edge over the market. Consider adding a plan-compliance ratio to your performance reviews that capture executed trades versus total market opportunities. This will allow you to pass up legitimate set-ups that your plan rules may not allow you to trade, such as set-ups just prior to news events, or set-ups during periods of high volatility.

If a valid set-up that has historically provided a trading edge is working for you and you are only executing it 50% of the time, you are leaving good money on the table!

It’s like winning a horse race and neglecting to cash in some of the tickets. It takes focus, desire to succeed, and of course, discipline to execute your plan in robotic fashion.

See video: Improving Your Trade Execution

As you develop and improve your trading skills, be sure to consider your execution compliance as a developmental metric and measure it consistently. You and your capital account will be glad you did.

By Michael Toma, CRM, Dir., Risk Management, TWC Futures Group

Discover Mike’s popular book, Trading with Confluence: A Risk-Based Approach to Trading Equity Index Futures, here.

Related Articles on STRATEGIES