One of the great things about learning how to trade is you learn a lot about yourself. It forces you to be honest with yourself. This is because the markets will FORCE you to be honest with yourself or they will FORCE you out of the game.

Is it easy to be honest with yourself? Of course not. That’s also what makes trading a very difficult profession to learn. But there’s just no way you’re going to have a long career of consistently profitable trading without knowing who you are and what you’re good at, and of course what you’re NOT good at.

If you think you’re a stock trader who has a special gift for picking the direction of the FAANG stocks, the markets will tell you if you’re not. If you think you’re an intraday trader of stocks or futures and will make millions of dollars at it, the markets will tell you if you’re not.

But you have to listen. That’s the key. You have to be willing to listen and to accept the markets’ conclusions because the markets know if you’re being honest with yourself or not. If you’re stubborn and ignore reality by insisting that you’re right and the markets are wrong you’re going to get forced out of the game.

The good news is that the markets will also tell you what you actually are good at. If you’re adept at reading the charts and seeing probable price moves in certain chart setups, the markets will let you know. They might push back a little bit in the beginning to make sure you earn it, but a path of least resistance will start to form if you’re showing a willingness to listen and be disciplined when executing your trade plan.

And the more disciplined and humble a trader you are, the more the markets will let down their guard and let you reap the many benefits.

You see, markets change. That’s just a fact. That’s why there’s no Golden Goose or Holy Grail strategy and that’s why it’s so important to be adaptable and flexible. But in order to notice when the markets are changing or when they’ve already changed, and then to understand what you should or shouldn’t do in response to that, you have to know how to pay attention and then to swallow your pride and care more about making money (or not losing a lot of money) than being right.

When the markets went straight up in 2013 I remember a lot of traders complaining about losing money because they kept talking about how overbought stocks were and how they were going to fall apart any minute. The thing is, the markets weren’t showing any signs of that. They were just going up. So what was the edge? Well, it certainly wasn’t in complaining about it. The edge was going long the markets in whatever way worked best for each trader until the markets stopped going up. 

2014 was the year of the V-shaped bounce. If you go back and look at a daily chart of the S&P 500 you’ll see what I mean. The market would sell off and then literally bounce like a rubber ball several market days later, leaving the shape of a V in the print. It did this enough throughout the year that it threw many traders off because they weren’t adaptable and flexible. They would stick to their guns and believe their opinions of the markets were more powerful than the actual markets. Big mistake. That is never an edge in the markets. What was the edge in 2014? If you would have been paying attention, noticed this pattern emerge and then started trading strategies that either took advantage of this kind of behavior or weren’t phased by it, you would have been fine. And you would have traded this approach until it stopped working. That’s just trading.

The first seven to eight months of 2015 were the greatest market environment for positive Theta, market-neutral options trading I’ve ever seen. It didn’t matter what strategy you traded in that particular discipline during that time, it was abundantly clear they all had edge. But then in August of 2015 the market fell apart and everything changed. Those options strategies were suddenly no longer viable and you had to adapt or you’d lose all the money you’d made that year. Good thing I was trading long volatility by that time. That’s what suddenly took over the edge and what ultimately saved me that year.

If you were trading at the beginning of 2016 you’ll remember that it felt like the bottom dropped out. This kind of market environment is tough to trade because at any moment that big bounce could happen and it’s very painful if you find yourself too short the market. But the prospect of that bounce can be a bigtime opportunity. If you believe that unlike in 2007-2008 there’s no real structural or fundamental economic problems looming then it can be a good time to start carefully building a position that would benefit from a bounce. Even a “dead cat” bounce, which is really just a pause in a continuing selloff, can be played this way as long as you’re nimble enough to get out once it looks like the selloff is ready to resume. That’s just trading.

Of course, sometimes it’s just better to stay out of the way until there’s a little more clarity. There’s nothing wrong with staying on the sidelines until things become a little clearer for you. But if you would have positioned yourself for that bounce in 2016 you would have ended up benefiting all the way through 2017 because the markets just kept going up for almost two years.

Then in February of 2018 the markets experienced what everyone would later call the “volpocalypse.”  This was a sudden and vicious selloff that saw the VIX explode into the stratosphere. Many market-neutral options traders were taken completely off guard and their positions were annihilated, and the moniker for the event came from the fact that volatility spiked so high so quickly that people who were short volatility got crushed and lost huge amounts of money. One of the inverse exchange-traded volatility products even went out of business. Up until then the short volatility trade had been very popular.

I was lucky that at the time I had put my automated short VXX system back into testing so I wasn’t trading it live (actually, it wouldn’t have mattered because the system would have gotten me out before the actual spike in volatility) but I was trading a market-neutral options strategy at the time that had become my first successful options strategy. That was a butterfly strategy, and like so many other strategies of its kind it’s short Vega, which is the options Greek that measures an option’s sensitivity to implied volatility. Luckily, I got out quickly and wasn’t hurt that badly. But it really woke up a lot of traders to the dangers of sudden market changes. In fact, I started focusing more on long volatility strategies after that event.

Again, as a short-term trader, you had to sit back and wait for clarity. And then you trade what the markets are telling you might have edge until it doesn’t. That’s just trading.

Of course, let’s not forget the huge selloff of February-March 2020 due to the coronavirus pandemic. My automated system in long volatility had a field day but I had to get out of everything else until there was more clarity. Once the markets bounced and seemed to get some footing, I got long the markets and made money on the way back up. You just have to pay attention and stay flexible. That’s what gives you the best chance at long-term success as a trader.

Let the markets guide you. They’ll tell you what to do and what not to do. I can only help you walk through the door. The markets can help you set up and run a prosperous business.

Remember the famous John Maynard Keynes quote: “Markets can remain irrational longer than you can remain solvent.” This is absolutely true. So don’t fight the tape.

Did I let the markets guide me?

It’s hard to hear what the markets are telling you until you’ve learned enough and traded enough and watched enough price action. But if you take the time to look at what’s happening in the markets and understand how you got there, you might be able even at an early stage in your journey to formulate an idea of what is most probable. This is a good way to start paying attention to the markets and how they change. If you start trading based on your evaluation, you just have to remember to stay flexible if you turn out to be wrong. Always have a “What if?” as part of your plan.

I remember struggling with my trading a few months after I’d learned Technical Analysis and options. This was very early on. I contacted the guys who had provided the course and asked if they would be willing to grant me a follow-up session. They did, and during the session the very sympathetic instructor said he understood and asked me to take a look at a chart of the S&P and tell him what I thought was most probable: did I think the S&P was going to go up, down or sideways? I studied it for a few minutes, thought about how we’d gotten there and what was going on in the financial world and said I thought it was most likely going to go up.

I turned out to be right but that really wasn’t the point. The point was that I was able to step back and really study what was going on and formulate an opinion, from which I could have formulated a plan of action. I just had to have faith in myself, which hadn’t quite come yet but was certainly developing. If I had formulated a plan of action (I didn’t, unfortunately) and turned out to be wrong, I would have been fine as long as I’d remained flexible. The more you do this and the better you get at your strategies the more you’ll be able to pair the two and really start making hay.

Once I had enough experience and developed enough faith in my ability to read the markets it was a huge event for my trading. Eventually I developed a core approach that adapted to changing environments. Within my core approach I enter the markets each day by asking myself, “What has edge?” and sometimes more importantly, “What doesn’t have edge?” 

This is really a more discretionary way to trade the markets. I’ve heard it called the “toolbox” approach because if you develop a toolbox of strategies and let the markets tell you what’s working and what’s not working you can dig around in your toolbox and find the right tool – or strategy – for the job. 

But it’s important to understand that paying close attention and letting the markets guide you can also be very helpful for a portfolio that is traded through all environments. I call this a “constant” portfolio. It’s generally made up of either a diversified set of asset classes or a diversified set of strategies that is traded through any market environment. For instance, the former would be trend following in stocks and sectors hedged by positions in bonds and gold. The latter might be different market-neutral options strategies that each work in different environments so that when one is underperforming the others are outperforming.

Even if you’re trading a constant portfolio it can be helpful to watch the markets closely so that you know when it might be time to temporarily decrease risk allocation in those strategies that are underperforming in order to help your overall returns. In other words, you can improve your performance if you just take the time to watch your environment and stay adaptable and flexible.

Of course, the difficulty with a constant portfolio is having to continue trading components that are underperforming. That’s why I prefer the toolbox. I like to trade what’s working until it doesn’t work anymore and then dig around in my toolbox for what the markets are telling me might be the right tool for the job. That kind of trading just fits my personality.