Ingredients to a Profitable Trading

As people get into this great business of trading, many are exposed to a heck of a lot misinformation.  So, that being said, let me lay out what I truly believe are the 5 keys to a profitable trading methodology:

·         Reliability.  This basically means at what percentage of the time do you actually make money?  A lot of people (most in fact) emphasize this.  Many traders want to be right on every trade because they were taught that 70% or less is failing.  NOT in trading though, you can be right only 50% of the time and still make a lot of money…as long as you have the other four keys in place

·        Risk to Reward Ratio in other words, this is the relative size of your profits compared with you losses.  Ultimately you want to have a 2:1 (or better) risk to reward relationship when first putting on a trade.  However, this may be pretty difficult to find.  It would be more realistic to find (or create) a trading methodology that has a 1:1 risk to reward relationship; then once you factor in your ‘trade management’ to the trades it comes out to a 2:1+ risk to reward type of trade.  You’ve heard this many times before I’m sure, and it applies here too:  cut your losses short, and let you profits run.  It’s obviously one of the keys to successful trading, but is very hard for many traders to do.

·        The number of your trading opportunities.  This means how many trades does your trading methodology actually generate?  If your system only generates, let’s say only 25 trades a year (for swing or position trading), that’s fine, but you’re limited to how much you can make due to the low amount of trade set ups.  However, if you have a system (trading methodology) that trades five or ten times that amount (25)you will make a lot more money, assuming that the other 4 keys are in place that are outlined here.

·        The size of your trading capital.  Let’s face it, if your trading account is real small (i.e. 50000 to 100000) it’s harder to make really good returns.  But, when your account is larger (i.e. 500,000+) it becomes easier to make good returns.

·        Position sizing strategies.  Position sizing strategies tell you how much to risk throughout the course of a trade.  It’s an essential ingredient to the whole money management philosophy.  In fact it’s so very important that without implementing a position sizing strategy the chances of you succeeding are doubtful.  Position sizing is responsible for about 90% of your overall performance variability; that’s how important it is.

So, there you have it, the five keys to a profitable trading methodology once again are:

1.  Reliability,

2.  Risk to Reward Ratio,

3.  Number of Trading Opportunities,

4.  Size of Trading Capital, and

5.  Position Sizing Strategies

And regardless of the market or time frame you decide to trade, all five of these keys are important to a highly profitable trading methodology.  At the minimum, you need number one (Reliability), two (Risk to Reward Ratio) and number five (Position Sizing Strategies) to make a lot of money in the markets.  So, I urge you to honestly evaluate your current trading system/methodology to see how it stacks up against these five keys in a successful trading approach.

Trading vs Gambling – Is there a Difference?

Put a trader in a group of non-traders and the conversation will inevitably turn to gambling.   At a recent family gathering I was asked about my share trading by an interested (or polite) family member, to which I responded with my usual cheery, ‘Good thanks!”

I had just mentioned that we were planning on selling our house and using the money to trade with, when a bystander with good hearing said rather loudly ‘Put it on Black!

These situations come up rather a lot; in fact some of my closest friends have expressed their thought that in the stock market it’s all luck and pretty much a 50/50 bet.  And for them, it probably would be.  Meanwhile I quietly bit my knuckle (hard) to stop myself from climbing a-top my soap box.  Because it was a dinner party, after all.

It seems the general population (in particular men in their forties on grand final day) don’t seem to consider a few quite important points, including but not limited to the fact that –

1.      It is highly offensive to be considered a gambler, particularly when you’ve just said you’re selling your house for funds.

2.      As traders we might have a slightly better idea of how the markets work than they do.

3.      A ‘girl’ in her extremely early thirties could have any knowledge at all of things they themselves don’t understand.

So, what is the difference between Trading and Gambling?

The difference between trading and gambling is, for me, enormous.  But I must admit that for a lot of ‘traders’ (or ‘speculators’ which is probably more accurate) there really isn’t any difference at all.  Even though I didn’t realize at the time, I started out as a share market gambler.  Now, however, I am not. To me, these are the differences –

·        A gambler is in it for quick bucks.  A Trader knows that profits often take time.

·        A gambler is caught up in the excitement.  A Trader knows that the job is boring, repetitive and mundane.

·        A gambler has the odds against him.  A Trader has a back tested edge that, over time, will consistently win.

·        A gambler focuses on the potential for winning, with no concept of risk.  A Trader focuses on the risk before anything, knowing profit will come as an afterthought.

If you are involved in the stock market, does your trading style sound more like that of a gambler, or a trader?   You might be surprised!

Quotes from successful traders

·        The key to trading success is emotional discipline. Making money has nothing to do with intelligence.

·        The big money is made by the sitting and the waiting — not the thinking. Wait until all the factors are in your favor before making the trade. (Jesse Livermore)

·        It’s not the mathematical skill that’s critical to winning; it’s the discipline of being able to stick to the system.

·        When you really believe that trading is simply a probability game, concepts like right and wrong or win or lose no longer have the same significance

·        A successful trader is rational, analytical, able to control emotions, practical, and profit oriented. (Monroe Trout)