Circle of Competence: Avoid What You Think You Know

Circle of Competence: Avoid What You Think You Know

Circle of Competence

The concept of circle of competence has been used by the best professional traders for years as a way to focus on only trading in areas they know best.

Most people will be familiar with this concept if they’ve ever read any of the shareholder letters of the famed investor Warren Buffett. But the concept applies just as much to trading as it does investing.

As traders we all build up our own unique skill sets in the markets. Through our own experiences, observations and training we build up models of how the markets work. We become masters of certain markets and masters of the strategies that work in those markets.

“I’m no genius. I’m smart in spots, but I stay around those spots” – Tom Watson, Founder of IBM.

One of the keys to succeeding in the markets as a trader or an investor is to operate within an area that you know and understand. Ignore everything else.

You don’t have to be an expert in every market or every strategy. You only have to trade markets within your circle of competence. The size of that circle is not very important but knowing the boundaries is vital for making money trading the markets over a long time frame.

Having a narrow circle of competence in trading isn’t necessarily a bad thing as long as you apply a rigid focus and discipline to a strategy that makes money. The best traders I’ve met only have one trading strategy but they’re the masters at executing that one strategy and really know how to strap on size when the opportunity presents itself. Concentrate on the trades that work and ditch the ones that don’t.

If you’ve ever worked on a trading floor it can be very seductive to try and emulate the top traders on the floor. Traders tend to gravitate to where others are making money. I completely understand the allure of trying to replicate the top traders but in practice it can be extremely difficult. You may never know all the nuances of the way they trade and their trading style may not fit your personality. The majority of traders tend to lose money when they veer away from what they know and understand.

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