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Critical Advice For Traders

Anonymous — Mon, 26 May 2008 21:37:46 CDT

A Common Misconception

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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Trading-Coach — Mon, 26 May 2008 21:36:55 CDT

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An interview with David

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One of David's published articles

Common Trading Mistakes

Trading-Coach — Sat, 24 May 2008 23:48:58 CDT

Learn from them, don’t repeat them! There are two types of mistakes:

1. Mistakes you have made
2. Mistakes somebody else has made

Human tendency is to link more pain to the mistakes that you have made as opposed to the mistakes that others have made. It is therefore easier to learn from a painful mistake that you have made yourself than learn from a painful mistake that somebody else has made. This is another reason why trading is so hard. Think of the first three to four years of your trading career as an opportunity to learn from your mistakes. The more you mistakes you make initially, the more you will learn – but only if you consider them as learning experiences as opposed to events that you beat yourself up over!

The less painful way to learn is, as mentioned, from the experience of others. The intention of this chapter is to discuss some of the most common mistakes that new traders make when they start and hopefully guide you in the right direction and accelerate your development.

Common Trader Mistakes

1. Trading without training is a recipe for disaster. It takes many years for a doctor or other healthcare professional to learn their craft; so what makes a trader so different? Trading is a profession, and as with all professions there is an education that is needed to ensure that you know what you are doing. It does not take a simple weekend or a reading a book to become fluent – it takes many years of hands on experience. Training takes time and as such, do not be impatient otherwise the market will certainly punish you.

2. “I want to make 10,000% a year – that isn’t unreasonable is it?” Many expert investment fund managers barely make more than 20-30% a year (and many even make a loss). This should indicate to the new trader not to overestimate their return potential. In general, do not consider yourself too much with the return on investment in the first 3-4 years. Use this time to finalise your plan and develop good trading habits – the profits will then follow automatically.

3. The trading plan is the essential element of any good trader. The plan is there to instruct you what to do, when to do it and how much to do it with! When you by a do-it-yourself bookshelf, you normally have a blueprint on how to assemble it. Think of the trading plan as your blue print to instruct you how to trade. Unless a plan is written down, it is useless. New traders often enter very volatile markets without much consideration to the consequences because they do not have a plan that tells them not to do so. A plan will make you trade consistently and help you to minimise your losses while magnifying your gains.

4. Trading is generally a very lonely experience and many traders find it difficult to improve their skills as a result of it. If, for example, you wanted to learn a new language, you would normally go to a class and learn from somebody more experienced. In a similar manner, if you wanted to improve your trading skills, you would find a coach who would be able to help you in trading. Coaches are necessary to help you realise where you are going wrong and to help you improve your performance. $100 spent on improving yourself through a coach is much better than losing $100 in a bad trade in the markets. There may also be organisations that you can join that will bring you into contact with like minded individuals to discuss concepts and bounce off ideas – such as the Society for Technical Analysts or other local investment clubs.

5. If you are looking for the perfect system that will always get you in and out of a trade at the right time and not get you into any losing trades, then unfortunately, you are on a fruitless quest. The market is far to complicated to predict with absolute certainty whether a trade will be profitable or not. Much time and money can be wasted looking for this “holy grail” system. The simple answer has been state all along; get out of a trade early if it is going against you and let your profitable trades run. In other words, as described in previous chapters, your gains will more than cover for your losses.

6. Plan the trade before you enter it – and know when to close the trade. You may have experienced a time when, driving at night, you are approaching an animal at great speed in your car. The animal would normally run to get out of the way, but there are times when the animal would be paralyzed with fear – quite literally, the animal is unable to move because it is so scared! A similar reaction can occur in the markets.

Example

A trade is going 30 points against you and you think that you should wait a few more points to see if it goes up. It doesn’t, and heads towards 40 points against you. Again, you rationalise and wait for a move up. It does not happen, and a bad piece of news hurtles your stock more than 70 points against you …. what do you do? A natural human reaction here is to be paralysed with fear – literally not being able to close the trade like you know you should because you are so frightened to take the loss. In this case, a further bad piece of news hurls the stock even lower to 90 points against you. This time, you have had enough and close the trade at a loss of 90 points. This is very disappointing as you should have got out of the trade at 30-40 points loss but your fear made you lose even more!

The way to get over this reaction is to have a plan to exit the stock even before you enter the trade. By placing stop losses, you know exactly when you will leave the trade if it goes in the opposite direction.

In a similar manner to the example above, it is human instinct to take your profits very quickly and not let the trade have time to develop. The emotion is one of greed where the trader feels that the profit is theirs and does not want to give it up. This may cause the trader to take the profit too quickly and not allow the profitable trades to compensate for the losing trades. The way to deal with this scenario is to have a target in mind based on the characteristics of the stock in the same way you plan your stop loss.

A trader should always go into a trade with a predefined stop loss and a target that they plan to exit the trade at.

Summary

Trading is not an easy profession, but it is one that can give you great rewards. Avoid these common errors, create a simple, well-designed trading system, and learn your market. If you take the time to study the market, and learn from other's mistakes as well as your own, you will become a successful trader.

Last Trading Article: Learning To Lose Like An Expert
Next Trading Article: Trading Vs. Gambling - Sneaky Tips For Beating Stock Market Odds

Learning To Lose Like An Expert

Trading-Coach — Sat, 24 May 2008 23:46:22 CDT

There will come a time in your trading life that you will experience a number of losses that will make you question both yourself and your trading plan. For example, if you had 10 losing trades in a row, you will almost certainly start to think, “is my trading plan working for me?” or “what on earth is wrong with me?” The losses will almost certainly have an effect on you psychologically. If this happens to you, fortunately there are a few things that can help you get back into the mindset of a winning trader.

Getting Back Into The Mindset Of A Winner

1. Stop trading altogether for a week or two. This will give your mind a rest and will help to defuse the negative emotion that has built up. The worst thing you can do is to trade in a bad mindset. For example, if you had 10 losing trades, and then had a further losing trade after that, how would you feel? Likely, you will not feel too good about yourself! Taking a break will help you refocus and regroup your mind and help to remove the negative emotion that can be so destructive.

2. Trading is just as much learning how to control your emotions as it is about learning how to read charts and company financial statements. If you let your emotions take over, you will fail at trading. Thankfully, there are a number of meditation and visualisation techniques that you can employ that will help get rid of negative emotions and focus your mind.

3. In trading, it is important that you record each of your trades. The reason for this is that in times of need, you can look at your past performance and alter your trading plan if necessary. This will help you to objectively assess whether you have been following your trading plan.

a. If you have departed from your trading plan, you need to think about why you did and what you need to do to get back on track
b. If you have not departed from your plan, you then need to think about the alterations you may need to your plan.

Getting Back Into The Game

1. When you start trading again, follow your plan flawlessly. Do not get tempted to alter the approach you have written down in your plan and if you do, your emotions are eventually going to take over again!

2. Unfortunately, the market can play some evil games with you. There are times that the market can reward “bad behaviour” – in other words, there are times when not following your plan can perversely result in winning trades! This is one of the reasons why it is hard to trade as this may tempt you to use your emotions even more when trading. Eventually, in the long run, this will cause you to lose. This is another reason why you need to follow your plan flawlessly.

3. Use the concept of positive reinforcement. Perhaps say to yourself that you will give yourself a reward after every 10 trades providing you have kept to your plan and regardless as to whether or not the net result of those trades was profitable. This will help you to associate positive emotions with trading your plan flawlessly and will help you against using your emotions to trade.

4. Get a coach. A coach is more than simply a teacher or instructor. A good coach is not there to answer your questions but is there to help you find the answer to your questions yourself. They are there to ensure that you do not stray off your chosen path and help you focus on achieving your goals. You can have coaches in all areas of your life – spiritual, emotional, financial, physical etc.

Some of the best sportspeople people in the world have coaches – Gary Kasparov, Tiger Woods, Andre Agasi etc. If they have coaches and see the benefits of those coaches in their life, then perhaps emulating them and getting a coach yourself may help you to achieve your financial and personal goals as well. Trading after a string of losses is undoubtedly difficult. However, using the suggestions in this chapter will not only get you back on your feet again but it will also improve you as a trader. Remember, you should not consider losing trades as “losses” – consider them to be “learning opportunities.” With enough learning opportunities, you will undoubtedly excel in your quest to be a master trader!

Last Trading Article: Mistakes That Stand Between You And Your Success in the Market
Next Trading Article: Common Trading Mistakes