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Critical Advice For Traders
A Common Misconception
As seen in the previous chapter, money management is the key to becoming a successful trader.
Example
Let us assume that your trading system provides a profitable trade only a third of a time. This means that for every three trades, two are not profitable and the remaining trade is profitable. Every profitable trade is, according to your system, on average four times more profitable than the equivalent loss in the losing trades. In other words, if say a winning trade provides a profit of $400, the equivalent losing trade will make a loss of $100. Let us now take six random trades. According to your system, two of these should be profitable and four of these should not be profitable.
As can be seen in the above simple example, even though the trade wins on average a third of the time, the final amount the account is up by (i.e. the cumulative profit / loss) at trade number 6 is +$400.
The Perfect Indicator
The above example shows that you do not need to be right all the time to be successful at trading. This is where a number of novice traders find exceptional difficulties. Emotionally, it is difficult to see your account going down and losing money during the losing trades – novice traders want to be right all of the time. They do not like witnessing their account going down at all even though they may know that the winning trade will more than compensate for their losses. It is perfectly possible in the above example to have a string of four losses and then two successful trades. Psychologically, taking many losses at a time can lead to a trader becoming disillusioned with his or her system before the winning trades start kicking in and in extreme circumstances may lead to the novice abandoning the system altogether before it has a chance to prove itself! Some start searching for the perfect indicator that will get them in and out of a trade profitably and all of the time without any loss. It is important to note that there is no perfect indicator or system that will work all the time – going down this road will only lead to a lot of wasted time and effort.
Money Management
The only way of succeeding in the long term is to control your emotions and control the amount of money that you risk on any trade. A written trading plan will help you to take control of both of the above. A well written plan will tell you when to get into a trade and when to get out without you even thinking about it. It will also determine how much risk to take on without your account being wiped out completely in a few trades.
As seen in the previous chapter, money management is the key to becoming a successful trader.
Another common misconception is that a trader has to be right about all or the majority of his or her trades in order to make money. It may be surprising to realise that profitable trading systems need only be correct 30-50% of the time. This can seem rather strange – how can a trading system be right only a third of the time but still be profitable? The simple answer to this question is that the winning trades more than make up for the losing trades.
Example
Let us assume that your trading system provides a profitable trade only a third of a time. This means that for every three trades, two are not profitable and the remaining trade is profitable. Every profitable trade is, according to your system, on average four times more profitable than the equivalent loss in the losing trades. In other words, if say a winning trade provides a profit of $400, the equivalent losing trade will make a loss of $100. Let us now take six random trades. According to your system, two of these should be profitable and four of these should not be profitable.
| Trade number | Winner or Loser | Profit / Loss ($) on the single trade |
| 1 | Loser | -100 |
| 2 | Loser | -100 |
| 3 | Winner | +400 |
| 4 | Loser | -100 |
| 5 | Winner | +400 |
| 6 | Loser | -100 |
| TOTAL PROFIT | +400 |
As can be seen in the above simple example, even though the trade wins on average a third of the time, the final amount the account is up by (i.e. the cumulative profit / loss) at trade number 6 is +$400.
The reason for this is that each winning trade more than compensates for the losing trades!
The Perfect Indicator
The above example shows that you do not need to be right all the time to be successful at trading. This is where a number of novice traders find exceptional difficulties. Emotionally, it is difficult to see your account going down and losing money during the losing trades – novice traders want to be right all of the time. They do not like witnessing their account going down at all even though they may know that the winning trade will more than compensate for their losses. It is perfectly possible in the above example to have a string of four losses and then two successful trades. Psychologically, taking many losses at a time can lead to a trader becoming disillusioned with his or her system before the winning trades start kicking in and in extreme circumstances may lead to the novice abandoning the system altogether before it has a chance to prove itself! Some start searching for the perfect indicator that will get them in and out of a trade profitably and all of the time without any loss. It is important to note that there is no perfect indicator or system that will work all the time – going down this road will only lead to a lot of wasted time and effort.
Money Management
The only way of succeeding in the long term is to control your emotions and control the amount of money that you risk on any trade. A written trading plan will help you to take control of both of the above. A well written plan will tell you when to get into a trade and when to get out without you even thinking about it. It will also determine how much risk to take on without your account being wiped out completely in a few trades.
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