IntroductionMany traders think that to make consistent profits in the markets, all you need is a holy grail. From my experience, a trading methodology or system is only one of the ingredients of success. The advancement of technology blinds us into thinking that all we need to be successful is state-of-the-art kit and the latest software. After all, banks fit into this category and they tend to do pretty well. However, technical wizardry is only of value if you know what to do with it. Does Warren Buffett rely on the latest technology to make his investments, or does he put his faith and his money into time tested principles of yesteryear? Modern technology is a useful tool for many traders, but to ensure it’s used wisely and to full advantage, they may benefit from studying some military principles dating back to around BC500.
The Art of War is an ancient Chinese military treatise attributed to Sun Tzu (also referred to as “Sun Wu” and “Sunzi”), a high-ranking military general, strategist and tactician. Regarded as a classic military text, it was thought to have been compiled during what is known as the ‘Era of Warring States’, which resulted in a unifiedChinaunder the Qin Dynasty. What does war have to do with trading? Well, the two are comparable in many ways. Soldiers fight the battle, but it’s the thinking and decision making processes of the generals and politicians that tend to win (or lose) the war. Similarly, traders require computers and fancy software to execute their trades, but it’s their ability to assess the markets and how well they execute their trading plan that results in profit or loss.
Like war, trading is a brutal game. Generally speaking, for every winner there are one or more losers. To help ensure you are on the right side of this divide, it may pay you to consider the principles contained in The Art of War. What follows is just a selection, not the complete book, and your interpretations of the text may be different from those offered here. For clarity, the principles are divided into four sections, all of them are quoted foe “The Art War”
Section 1: PurposeIf you are to progress beyond the initial learning stage, a mere desire to make money is not enough. Your trading must have a clear purpose.
Section 2: Market ConditionDo you know who your enemies are?
Section 3: StrategyThe importance and value of having a proper trading methodology or strategy
Section 4: Trading RoutineWhat is your daily trading plan and if you utilize tools available to you?
Section 1: Purpose1. “Maintaining the goodwill of the people is essential to win the battle.”
Applied to trading – The people of a nation will support a war if it has a clear purpose and benefit to them. Similarly, as a trader, Scalping too much and/or applying automated trading programs isn’t an acceptable behavior to the broker, which will end up with him closing your account and then with you not being able to sustain your trading activities. A better approach is needed to maintain the goodwill of the people.
2. “In battle, where there is no retreat or surrender, soldiers will have nothing to be afraid of and there will be nothing that they can’t achieve.”
Applied to trading – As a trader, you must have a winning mindset and focus on the big picture. Do not allow small setbacks in the form of inevitable drawdowns to shake your confidence or weaken your resolve. Even small winnings can set you of the big picture which should be good Risk/ Reward Ratio.
3. “Maintaining the momentum of troops during war is important.”
Applied to trading – Try to maintain your momentum and do not get sidetracked and depressed after a string of losers or overexcited after a string of winners.
4. “So in war, the way is to avoid what is strong, and strike at what is weak.”
Applied to trading – Understand the strengths and weaknesses of currencies you trade, and always pain the weak with the strong. Apply that in your methodology and your ability to a weak/ strong pair quickly using the news and price action on the charts. Add more positions once the market confirms your trade direction. If in any doubt, either get out or reduce your position size.
Section 2 – Market Condition1. “If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”
Applied to trading – Once you understand the current state of the market, you’ll have a better idea of how to trade it. Determine whether it is a bull market, bear market or a range bound market. Also, assessing the volatility is crucial in order to determine position size and stops placement. Equally, you must know your own strengths and weaknesses and how you can capitalize on the former and cap the latter in any market condition.
2. “To know your Enemy, you must become your Enemy.”
Applied to trading – To really understand the current state of the market, you need to think like everyone else, see what they see and feel what they feel. But, you don’t have to act the way they act.
Applied to trading – You need to adapt to the prevailing market condition and trade an appropriate methodology or strategy every time. There’s no point utilizing a trend following strategy based on a moving average cross-over in a range bound market.
Section 3 – Strategy1. “Outwit the enemy instead of trying to outfight the enemy.”Applied to trading – Trying to outfight the market is sheer folly. You will lose. For example, if you risk 50 pips for a gain of just 5 pips, you may have a series of small wins, but you’ll end up giving back all your profits and more in one or two losing trades. A application of a good Risk/ Reward Ratio will end up in risking 25 pip (or less) for a gain of 50.
2. “The supreme art of war is to subdue the enemy without fighting.”
Applied to trading – Take two traders who make the same amount of money using same capital in the same amount of time. The better trader is the one who has fewer trades and lower transaction costs and spends less time gazing at their computer screen. That’s why a plan is important. You will end up to be a better trader, with more winning traders and less gazing at the screen.
3. “Victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win.”
Applied to trading – Traders don’t need to trade every day or every minute to make money. Always wait for correct setup before entering the market.
4. “In battle, use a direct attack to engage and an indirect attack to distract enemy attention.”
Applied to trading – Always look at the major trend. When there is pull back in prices, don’t assume that it is a change of trend. Trading with the trend will increase your chances of success.
5. “Use attack to exploit victory, never use attack to rescue defeat.”
Applied to trading – Do not add to a losing position in the hope of being able to average out. Only ever add to profitable trades.
6. “Victory comes from deep thinking and detailed calculation.”
Applied to trading – If you try and trade a methodology that you don’t understand fully (e.g. someone else’s) or one that hasn’t been properly thought out and tested (e.g. your own) – then most likely you will fail. Construct your own strategy, plan it well, you will know ever detail of it and the reason you used it, then follow it.
Section 4 – Trading Routine1. “Superior command structure within the army.”
Applied to trading – You need to organize, plan and structure your trading to ensure you’re doing the right thing at the right time. For that, you need a detailed trading plan. Every must be accounted for and every possibility must be considered to ensure that mistakes are kept to a minimum. This will help to minimize losses and maximize profits.
2. “Even the finest sword plunged into salt water will eventually rust.”
Applied to trading – Even the best traders will crumble if there is no support from tools around them such as Fundamental and Technical Analysis. Do not allow your desire to trade and lack of research have a negative impact on your family and friends.
In SummaryThe Art of War by Sun Tzu has inspired lots of people from many different walks of life and disciplines, ranging from business to sports and everything in between. Some commentators believe that there are wars that could have been avoided and battles lost that could have been won – had the politicians and military leaders followed the principles contained in this ancient text. This article is intended to offer a flavor of how the text might apply to trading. Indeed, your interpretations of the principles may be very different to those offered here – and that’s fine or even better.
Regardless of your views about this article, there are two overriding principles that emerge from the Art of War that you could benefit from. The first is to look beyond your computer screen or the trading books on the shelves in your study for ideas and insights about how to trade the markets. There are lots of fields of human endeavor that utilize techniques and approaches that could be applied to trading. The second is that if you’re to be successful, then you need to approach your trading with the same degree of care, thought and attention to detail that Sun Tzu advises military leaders adopt when preparing for battle.
Razi Hammouda can be contacted at FxLords.com