1/ DETERMINE WHY YOU WANT TO TRADE
Before you even start on the trading adventure….why do you want to trade?
If the answer is “to make money” then I am sorry to disappoint you but it will be very difficult for you to achieve that solitary goal.
Successful traders love the game and the personal challenge, the money is secondary.
Good traders are well grounded “together” people, they think in a logical, sequential manner and they do not identify themselves as traders, trading is what they do but it is not who they are. They are not emotionally devoid but have learnt to step aside from their emotions and view them with understanding, not fear.
They are a partner, father, mother, friend, footy coach, volunteer, mentor, spiritual, kind and loving person first, that is what they identify with, not being a trader.
It is this belief system that keeps them sane and relatively stress free through hard times at their trading job.
Trading requires a lot of often very challenging personal introspection into who we are, and then doing the work to fix what you find is broken.
Examine your motives before starting, and be very, very honest with yourself, if you don’t I will guarantee you will lose money.
2/ SET OBJECTIVES AND REALISTIC GOALS
Before starting any project or journey you need to decide where you want to go. You may say again…“I want to make money”
How much money?
What is a realistic percentage per year of your capital for a beginner to achieve in trading and what is required for you to do to achieve that?
Examine your experience in investing, trading, business, personal finances, budgeting etc. If you have little financial literacy then you have a big learning curve ahead of you.
I suggest whatever your knowledge and experience that trading is very different, if you are very intelligent and experienced in other professions you may have to “unlearn” many things, if you have a modest education background you may have to work very hard to learn what you need, and I don’t mean technical things, but more learning how to think with an enquiring mind, hard work for the inexperienced.
Start by reading websites like this one, read books and attend courses to gauge what is realistic and achievable for you.
Start with a modest goal so that it can be achieved. I suggest your first year results should be one of not losing, if you do that you will be in the top 5% of the class, as around 95 % of traders either lose or break even. (one of my objectives is to improve those statistics through quality instruction)
3/ SELECT WHAT TIME FRAME YOU WILL TRADE IN
Decide (trading involves being decisive) what time frame you will trade in, monthly, weekly, daily or intra day. Intra day means you are trading in and out of a financial instrument (an instrument can be a stock, currency, commodity, option etc) within 24 hours.
In general, the shorter time frame you trade the harder it gets, the better and quicker you need to be, and the more stressful it is.
If you are not currently profitable, and statistics show that will be most of you, I suggest you seriously consider weekly time frames.
Weekly will give you plenty of action to keep you more than stimulated but it also removes some of the market “noise”.
Noise is what makes the market swing about from day to day with the daily press releases, but normally by the end of week if there is a predominant trend it usually re asserts itself therefore making analysis and keeping your emotions in check a lot easier.
Monthly is good too, and not to be under estimated like it often is, some excellent long term methods and systems work well on monthly time frames.
Most beginners are drawn to short term time frames, mistakenly believing that more quick trades means more money. Wrong. Normally more trades means more work, time, stress, cost, errors and experience required. Listen to the above tip, you won’t, but will later.
4/ ADOPT OR DEVELOP A METHOD OR SYSTEM
You need a method or a system to trade with. DO NOT trade without it.
Think of what you do now for a living, it has a method or a system you have learnt or been taught, you do not approach it in a haphazard way, but with a sequence and plan to give a certain result.
Trading is no different, yet so many people think it is.
Before you place a trade you should know;
A/ why you are buying
B/ when you will sell
C/ how much you will lose if the trade goes against you
D/ the is trade part of your overall strategy of trading/investing
Can you answer those questions in detail?
Because each question requires more than just one answer.
If you cant then you don’t have a method or a system and you need to learn one, and if you trade without a plan you will become part of someone else’s. Those “someone else’s” is the 5% of winning traders surviving off the 95% of traders without a plan!
5/ DETERMINING THE SIZE OF YOUR TRADES
Although this technically comes under part of your plan it is so important I have devoted a separate point to it.
This is the most important part of developing a good method, apart from knowing and implementing your exit, position sizing will make a huge difference to your results. It will make or break your profits or losses.
Position sizing means “how many” you buy of a stock ( I will use stock as an example) not just how much in dollar amounts.
For example, many people buy an equal amount of dollar value stock across their portfolio, they buy 10 stocks worth 10k giving them a 100k portfolio. So a 10% allocation.
They think this is good safe diversification, its not.
Stocks have different volatility, some move up and down slow, others fast. By putting equal dollar amounts into your stocks you are not allowing for this individual volatility.
A slow steady stock requires a larger position size, a fast stock requires a smaller position size. Trading is about controlling losses much more that chasing big wins, a volatile stock that has been allocated an equal % size, like 10% of your capital, can really damage your account if it plunges quickly.
Alternately, the slow steady performer does its thing and goes up slowly, but you should have allowed for this and bought a bigger allocation. So you lose big on the loser and win little on the winner, because you didn’t calculate the volatility of the stocks before buying.
Correct sizing based on volatility would have resulted in a smaller loss on the plunging stock and a bigger win on the steady performer.
There are many good books on position sizing and the different ways of calculating how many shares to buy, read them or do courses until you understand the theory. It is not hard.
One of the big benefits of learning how to use back testing software is that you can experiment and get to see for yourself how much an impact position sizing makes to a method or system, consider that also as a tool in your trading toolbox.
6/ DRAWDOWN (DD)
Drawdown means the maximum amount in percentage terms that you expect your portfolio to go down when the market has periods of volatility. It could mean you get stopped out on all your positions during a falling market, if that’s the case what is the maximum you expect your portfolio to fall before it recovers?
If you don’t know what your estimated drawdown is with the method you are using then how do you know how you will react when it happens?
How much will you lose if the markets crash and all your positions get wiped out?
If you have 10 positions with a 2% risk on each one and they all get stopped you lose 20% of your portfolio value, are you prepared for that?
If your system has 7 trades lose in a row, each trade has a loss of 2% of capital, will you be strong enough to buy again after 7 losses and your portfolio is in the red and down 14%?
If the system you are trading has a previous maximum DD of 20% and you have not reached that level then its more likely you could keep taking the buy signals, if you have no idea of the maximum DD of your system is how will you know statistically when the system should turn in your favour?
My experience is that most people overestimate what they can tolerate in a real live trading situation. If you think you could psychologically cope with a 20% drawdown on your portfolio than I suggest you halve that expectation to 10%.
I personally set my DD at 10 to 15%, but when I first started trading I thought I could cope with around 35%, but when it happened I discovered I couldn’t and lowered my expectation considerably.
In general, the lower DD the lower the returns of your method, the higher returns the higher the DD, you will need to find a compromise between desire of profits and the emotional pain of watching declining equity. It’s a personal thing, you need to find your level.
The market likes room to move, but we don’t like to give it that room because it hurts us emotionally, it’s like dancing with the devil, you have a ball until it comes time to pay.
7/ STICKING TO YOUR PLAN
Sticking to your plan is easier once you know what the probabilities of your plan are, particularly after you do the work described in points 4, 5 and 6. But even if you have been most diligent, and covered every possible worst case scenario and have developed a sound and high probability low risk method, your greatest challenge will be sticking to it.
Why? Because it is just a hard thing to do, we are human.
We have fear.
Fear of losing and fear of giving back what we have made. So we don’t take losing stops and we don’t take profitable sell signals.
Because we have fear.
So how do we stop the fear?
I can give you a couple of tips, but the work is really up to you.
Do the work in parts 4, 5 and 6, it will make you feel better and lift your confidence. Being well trained and understanding something reduces the feeling of the “unknown”, it’s the unknown we fear.
Start small. Starting with small trades reduces stress, stress is the greatest inhibitor to clear thinking, if you are not thinking clearly you will react without thinking, which will most probably result in you not sticking to your plan.
Determine what level of fear and anxiety you have in your life, everyone has their level, and if you can discover yours it will be a great asset to your trading, that’s why I recommend you do the following…..
8/ LEARN TO BE CALM AND HEALTHY
Those who wish to or do perform at high levels in their profession treat their bodies and mind with the utmost kindness and respect. Pilots, surgeons, elite sportspeople, business professionals etc often surround themselves with dieticians, mentors , psychologists, and anyone else they consider necessary to keep them in balance physically and mentally.
I (and many other successful traders I know) have found pursuits such as meditation, yoga, martial arts or a serious spiritual belief system to be enormously helpful. The atheists amongst them have a healthy respect for maintaining the balance in their lives.
We are not looking for divine intervention or expect to one day wake up and be psychic as to the movements of the market, it is more to learn how to be in flow with life, to not identify ourselves as traders but as people first, trading is something we do to earn an income to live life.
Trading is not our identity. Our identity is who we are as people.
Once this attitude is developed you will find it much easier to accept losses more calmly, and to not get over excited with wins, you will be able to more observe the markets with an interest, like a non participant would, rather than get caught up emotionally in its sometimes manic behaviour.
Like trading you will need to seek your own way to be healthy, but you could start by improving what you eat, drink alcohol less, walk some more, breath more slowly and deeply and appreciate little things in life you have that many do not. Hot running water, a clean bed to sleep in, and fresh air to breathe, are things we take for granted in Australia.
Trading for most people is a solitary and isolating profession, which isn’t healthy for a species (humans) that need social interaction to maintain mental health.
So, get out there and meet fellow traders. Do courses, attend seminars and club meetings, organize working groups to share knowledge and learn from each other.
Internet blogs and emails are good too, but from personal experience if you want to be challenged and really catapult your learning you can’t go past doing it in person.
Trading tends to attract introspective and sometimes anxious types, often not really suited to the challenges of trading, but by meeting like minded people and being honest with each other and yourself can help you move past those limiting beliefs.
10/ RECORD KEEPING
Last but certainly not least.
Record keeping is one of the most disregarded and least attended disciplines in trading, but I recommend it very highly, in fact its essential for your progress particularly your psychological development.
At the Australian Academy of Sport elite athletes are taught to record all their performance statistics and review their psychological state regularly, you are now participating in an elite field of endeavour, why not model the experts?
Every trade you do you should “write up”.
Record things like the entry price and date, number of shares bought, the risk amount taken and where your position size calc was, your exit date and price, the loss or profit and what index the stock was in.
I will be honest with you and say doing this is a pain in the ass, but it is the best thing for when you review your trades to see if you are sticking to your system and if you are not (highly probable) it shows where you are making the errors and what pattern there is. It will show your weakness and strengths, and highlight the areas you need to improve and work on.
The other thing I want you to do is keep a personal journal, this can be another column on your record sheet or a separate book or log.
Record your feelings! This is no time to cop out on this one. Put it all down, it may be “I had a fight my partner last night” “I am feeling anxious about my sick mother” “I am worried about this next power bill” “I am sick of this trading, it wont work” “I have doubts about this company” “I have been winning consistently, gee I feel great” “that bloke next door is a real dickhead” whatever it is, record it!
Because this is what makes you trade well or bad, remember “trading is easy but we make it hard” so it’s the recognition of the mistakes, the recording of the errors, the brutal honesty of your feelings that will make you more aware as a person and therefore more aware as a trader what you are doing wrong.
And even better it will assist you in determining what you can cope with emotionally in the market, if you can cope with a portfolio pullback 10, 20, 25, 30, 35 percent or
if you can trade daily or weekly, or cope with doing ten trades a week or ten trades a month or ten a year.
It will show you that things like a fight with a partner at home can affect your decision making, if it was a disagreement about money, maybe trading? You may be inclined to think “I will show em” and take a bigger risk then you should and then whatever the result of the trade you have the mental fallout to deal with. If it’s a loss it will makes things worse, if it’s a win it can make things more worse by setting you up to do it again and fail bigger the next time, maybe wiping out a large amount of your capital and you will be wondering what went wrong.
All the above ten points are as important as each other, I would be doing a disservice to either point if I attempted to rank them in order of priority. Attempt to do them all the best you can and the pieces of the puzzle will come together for you. It is really up to you, or you could say
“If it is to be it’s up to me”