By Owen Trimball – Investing in the Stock Market can be one of the most profitable skills you’ll ever master. Whether you’re trading indices, foreign currency, stocks, commodities or options – there are some vital matters you must understand before you can even begin to make money.
The Stock Market is one of the largest markets in the world, so it is going to be around for a long time. This means that if we can master a few strategies that bring consistent profits, it is not inconceivable that we could set ourselves up with a reliable income stream. The fact is, one of the most profitable skills we can ever master, is the skill of trading.
But trading the markets can also be very stressful. Many an optimistic graduate from some guru’s course, has become disillusioned with the passage of time, as they watch their hard earned capital draining away to the point where further trading is no longer viable. Sometimes this even accompanies a career being neglected, as professional development gives way to an obsession with “finding a way” to make it work. Every spare minute is spent swamped in the markets. Newsletters, bulletin boards, forums, articles, books, courses, software, even tipping services – all become the new learning path.
Trading can be the fastest way to go broke. The market doesn’t do the same things all the time. So one day a particular tactic will work, the next day it won’t. Compare this with a normal everyday function like walking down the street. If you walk into a lamp post, you soon learn that you need to walk round them. But in the market-place, the lamp posts keeps moving as you approach them, you can never be sure that you can get round them. But what you can do is develop the mental discipline so that even when you do bump into them it’s OK.
You have to learn trading skills, which ultimately are about 95% of this game. In the end, it’s not about the markets – it’s all about YOU. You are the essential element behind the way you trade.
Markets move from extreme to extreme across all time frames. They are a manifestation of human psychology, driven by fear and greed. Peaks are driven by greed, troughs by fear. This is obvious in the very long-term extremes. At the extremes the key point is that price is stretched unrealistically. Why is this? Because traders and / or investors are paying too much, selling too cheaply, because it is an emotional decision.
To win you must put yourself outside that emotion.
The big question here is whether you can develop the discipline if you do not have it naturally. I believe that the answer is “yes, you can,” but you must have the necessary commitment to do so.
Clearly self discipline is going to be a requirement even to start the process. However, the market itself is going to be helpful, although not as helpful as it might be. Ultimately undisciplined behavior is going to be punished by the market, either by direct losses or by the loss of profits which would otherwise have been available. But the market does not help as much as it might because of the principle of random reinforcement. This is the market’s tendency to reward bad behavior from time to time. What works one day may not work the next and this applies to the “best” trading practice. Similarly , bad habits do bring rewards from time to time.
This crucial fact is one of the reasons that it takes so long to learn how to trade. It is important then to discover techniques designed to develop and enhance your discipline and to recognise when you have let your discipline slip. You’ll be amazed at how much easier your trading becomes when you master this.
MONEY MANAGEMENT
Money Management is what makes your analysis/system work, not the other way around. Money Management is far more important than analysis. It is not your entry which is that important – it is your exit. Your exit determines your overall risk, your overall profit and your overall control. Your entry cannot wipe you out – but the way you exit can. Your entry does not make you a profit – the way you exit can.
RISK MANAGEMENT
The traders who win are those who minimize risk. This is another key lesson and cannot be overemphasised.Those who do not minimize risk inevitably pay the price and get wiped out.
Risk Control includes the following:- (1) Not trading in too big a size, thus reducing the risk of a wipe out. (2) Not holding overnight unless you have a profit buffer in place. (3) Not holding over the weekend, subject to the same as reason “2”. (4) Taking appropriate action prior to major news items. This means not normally opening positions, maybe reducing position size if already positioned – although it does depend on your trading objectives.
DESIGNING A SYSTEM
First, you must define the aim of your system. What do you want it to do? Do you want it to catch trends? Do you want to trade ranges? How much risk do you want to incur? What success ratio are you looking for? Primarily you can look to trade ranges or you can look to trade trends. Trading ranges means looking for extremes and entering when such extremes are reached. Trading trends means looking to catch trends and entering once your system indicates that a trend is in place. You can also combine these two approaches.
In both cases you need to define your trading conditions. You need to define a range or a trend. Once you define what you are looking for, you simultaneously define how to catch it.
You can define trends in many different ways. First you have to decide over what time frame you wish to define the trend. You must then use that time frame to give your trending signal, for example if you feel that you want to day-trade trends then you must in some way define the trend using charts of a few minutes.
Once you have defined the trend you will have your trend indicator. So if you decide that a higher high on a 5-minute bar chart means that you have an uptrend then that is your indicator.
There are 7 fundamental components of a successful trading system and every one of them must be in place before you can hope to become profitable. We have covered 2 of them (define your objectives and trending signal) and touched on a third (risk) and I hope you found them useful.
For further information, visit this link:– The Way to Trade
Owen has traded options for many years and writes for “Options Trading Mastery” – a popular site about option trading and all the best option trading strategies.