On the 19th April 2017, Tom Dante, tweeted a poll on whether traders had monthly, quarter or annual financial targets.
The responses were interesting, and seemed to be along the lines that setting these sorts of goals could do the following
Limit Potential Growth or returns from trading.
Add pressure to the trader.
Give the wrong mindset.
Pressure the trader into taking trades not in the plan just to meet target.
Cannot manage returns only risk.
All of these are valid responses and to certain extent I agree with them.
I feel that financial targets do have a place as a tool to improve a trader’s performance.
And I mean using financial targets as a tool to improve a trader’s performance rather than target or end game to hit.
Therefore, I think they should be used as goals to help drive the behaviours and focus needed to be improve.
As with all tools, they need to be used appropriately.
Here is a list of when I think financial goals are a waste of time.
Trader has no edge.
The target / goal here should be to find an edge. At this stage, the trade does not even know what they are potentially capable of, and it is bit like saying that I want to win the Formula 1 Championship when I have never even seen a car.
Whilst that might be a dream it is not a relevant goal at this stage and would do nothing to improve the traders lot.
The primary goal here should be to find an edge.
Trader has an edge but not applying it consistently over time.
Primary goal in this situation is to be applying the edge. Financial goals will do nothing but add more pressure to the already hard task of applying the edge consistently.
Trader has an edge, applying it consistently but still makes mistakes in applying the edge.
Primary goal, should be working on reducing the mistakes down to acceptable level, as close to 0-10% as possible.
Financial goals in this situation will do nothing to improve a trader’s lot. It will just add pressure to the situation and increase the error rate.
Where a financial goal could help, would be to track the financial cost of these mistakes, to help drive behaviours that will reduce the error rate.
When financial goals can be beneficial.
Trader has an edge, applying it consistently, mistakes are rare. They are at stage 4 and above of the competency curve.
Stage I – Unconscious incompetence – the person is blissfully unaware of their ignorance
Stage II – Conscious incompetence – the person aware of their skills shortage
Stage III – Conscious competence – the person is able to demonstrate their competence with a high level of concentration or focus
Stage IV – Unconscious competence – the person is able to demonstrate their competence with a low level of concentration or focus
Stage V – Shared competence – the person is able to teach others by explaining not only how but also the the why’s to achieve a level of competency
What does a trader do then to help drive behaviours that will improve the performance over time, when they are at stage 4 and better.
All the low hanging fruit in terms of goals have been done.
I feel that having a long term financial goal can help drive the trader to view their trading and what they should be doing on a day to day basis in a different light or at least give them a structure.
A trader at this level, will have an understanding of their risk profile and the typical returns of the system including the variance based on market and seasonal cycles.
One question, traders / everyone should ask is where do I want to be in the next five years?
By using a financial goal, this then can be broken down into performance goals and what needs to be done.
I always use the following process to help me decide what I need to do to meet my goals. This process can be used for any type of goal.
What is my goal?
What results I need to do to achieve this goal?
What process do I need in place to do achieve the outcome goal?
What skills do I need to achieve these processes?
What do I need to practice / learn to have these skills?
What benchmarks and standards that I need to hit to ensure that I am following my process goals?
As we can only control entries and risk, by setting a long term financial goal, this can then be reverse engineered backwards to see what sort of risk we should be taking and whether realistically, our trading system is potentially capable of giving us this sort of return, bearing in mind variance.
Trader A is at Stage 4
He has built his account up to 15000 USD.
His previous performance shows that the system has 50% win rate and the win to loss ratio is 2 to 1, and averages 3 trades a day.
His goal is to turn his 15,000 into 1,000,000 over a five year period.
Using quarters as the primary measuring device to avoid the focus being on the short term performance.
Trader A needs to return of 23.5% every quarter compounding, to turn this 15,000 into 1 million in 5 years.
Trades taken per quarter.
4 days a week, to allow for days off and unforeseen circumstances,
11 weeks to a quarter, again to allow for holidays and unforeseen circumstances.
4 x 11 = 44 days. Which is under the typical 65 working days per quarter.
Average of 3 trades a day x 44 days = average of 132 trades per quarter.
A return of 23.5% of 15000 is 3525.
Therefore, a performance bench mark for the first quarter is 18525.
Running 100 simulations shows that the variance of this sort of system and gives us a minimum variance of 18,924.
In theory, we can see that it Trader A risks 1.5% of the initial account balance on every trade over the quarter.
This is gives Trader A the best opportunity of hitting his bench march without forcing anything different on to the trader, but just adjusting one of the things that we can control.
This is a rough example of how to use financial goals to guide performance over the long term, but I believe they should not be used as targets and should only be used as a tool when appropriate.