How to Succeed in Trading (by Really, Really Trying)
This was a recent post from a great trader and longtime colleague Jay Kaeppel
Sometimes it’s good to go back to the basics. So here goes.
Trading success comes from a “reality based” approach. It is NOT about “all the money I am going to make!” It IS about “formulating a plan” (see the questions below) AND “doing the right thing over and over and over again” (no matter how uncomfortable or unsexy those “things” may be).
Steps to Trading Success
Trading success comes from:
A) Having answers to the questions below
B) Remembering the answers through all of the inevitable ups and downs
What vehicles will you trade?
Will it be stocks, ETFs, mutual funds, futures, options, or something else? If you plan to trade futures or options understand that you will need a different account and/or approval from your brokerage firm. Likewise, note that you will need to learn about the unique quirks of futures and options BEFORE you start trading.
How much money will you commit to your trading account?
Whatever that amount is be sure to put the entire amount into your account. DO NOT make the mistake of saying “I only have x$’s but I am going to trade it as if it were y$’s. One good drawdown and you will pull the plug.
How much money will you commit to a single trade/position?
We are NOT talking here about how much of a loss you are willing to endure. We are simply talking about how much you will omit to the enter the trade. If you put 10% of your capital into a given stock or ETF that doesn’t mean you are going to risk the entire amount. This question has more to do with determining how diversified you will be.
How much money will you risk on a given trade/position?
Think in terms of percentages. I will risk 1%, 2%, 5%, 10%, whatever. There is no magic, or correct, number. But think of it this way – “if I experience 5 consecutive losing trades how much will my account be down?” If you can’t handle that number then you need to reduce your risk per trade.
How many different positions will I hold at one time? What is my maximum?
Buying and holding a portfolio stocks is different than actively trading. For active traders, holding a lot of positions at one time can be taxing – much more so than you might expect going in. Don’t learn this lesson the hard way.
Do you understand the mechanics of entering trading orders?
The vast majority of trading orders are placed on-line. Each brokerage firm has their own websites/platforms and each has their unique characteristics. “Paper trading” an be a disaster if you come away thinking you “have the touch” when it comes to making money. However, when it comes to learning the in’s and out’s of order placement BEFORE you actually start trading, it an be invaluable.
(Think of trading as sky diving and paper trading as watching virtual sky diving on your laptop. You get the idea, but the actual experience is significantly different).
What will cause me to enter a trade?
There are roughly a bazillion and one ways to trigger a “buy signal”. Some are great, some are awful, but the majority are somewhere sort of in the middle. Too many traders spend too much time looking for “that one great method”: of triggering signals. The truth is that if you allocate capital wisely, manage your risk (more to follow) the actual method you use to signal trades is just one more piece of the puzzle – NOT the be all, end all.
How will I enter a trade?
This sounds like the same question as the one above, but it is different. For an active trader, a buy signal may occur but he or she may wait for “the right time” to actually enter the market. For example, if an “oversold” indicator triggers a “buy” signal, a trader may wait until there is some sort of price confirmation (i.e., a high above the previous trading day, a close above a given moving average, etc.) rather than risking “trying to catch a falling safe.”
What will cause me to exit a trade with a loss?
The obvious one is a loss that reaches the maximum amount you are willing to risk per trade as established earlier. But there can be other factors. In some cases, if the criteria that caused you to enter the trade in the first place no longer is valid, it can make sense to “pull the plug” and move on to another opportunity. A simple example: you buy because price moves above a given moving average. Price then drops back below that moving average without reaching your “maximum loss” threshold.
What will cause you to exit a trade with a profit?
This one is easy to take for granted. Too many traders think, “Oh, once I get a decent profit I’ll just go ahead and take it.” But a lot depends on the type of methodology that you are using. If you are using a short-term trading system that looks for short-term “pops” in the market, then it might male sense to think in terms of setting “profit targets” and getting out while the getting is good. On the other hand, if you are using a trend-following method you will likely need to maintain the discipline to “let your profits run” in order to generate the big winning trades that virtually all trend-following methods need in order to offset all of the smaller loses that virtually all trend-following methods experience.
The problem comes when a short-term trader decides to “let it ride” or when a trend follower starts “cutting his or her profit short” by taking small profits.
Different Types of Trading Require a Different Mindset
Putting money into a mutual fund or a portfolio of stocks is far different than trading futures or even options. While you can be “hands on” with funds or stocks it is not necessarily a requirement (I still hold a mutual fund that I bought during the Reagan administration). With futures or options, you MUST be – and must be prepared to be – hands on.
Also, big percentage swings in equity are more a way of life in futures and options. I like options because they give you the ability to risk relatively small amounts of capital on any variety of opportunities – bullish, bearish, neutral, hedging and so forth.
I also like futures, but it does require a different level of emotional and financial commitment than most other forms of trading. Many years ago, I wrote about the following “Litmus Test for Futures Traders”. It goes like this:
To tell if you are prepared emotionally and financially to trade futures doe the following.
1. Got to your bank on a windy day.
2. Withdraw a minimum of $10,000 in cash
3. Go outside and start throwing your money up into the air until it all blows away
4. Go home and get back to your routine like nothing ever happened.
If you can pass this test then you are fully prepared to trade futures. If you cannot pass this test it simply means that you need to go into it with your eyes wide open regarding the potential risks (with the knowledge that something similar to what was just described can happen at any time).
Summary
In a perfect world a trader will have well thought out and detailed answers to all of the questions posed above BEFORE they risk their first dollar.
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services,
Sometimes it’s good to go back to the basics. So here goes.
Trading success comes from a “reality based” approach. It is NOT about “all the money I am going to make!” It IS about “formulating a plan” (see the questions below) AND “doing the right thing over and over and over again” (no matter how uncomfortable or unsexy those “things” may be).
Steps to Trading Success
Trading success comes from:
A) Having answers to the questions below
B) Remembering the answers through all of the inevitable ups and downs
What vehicles will you trade?
Will it be stocks, ETFs, mutual funds, futures, options, or something else? If you plan to trade futures or options understand that you will need a different account and/or approval from your brokerage firm. Likewise, note that you will need to learn about the unique quirks of futures and options BEFORE you start trading.
How much money will you commit to your trading account?
Whatever that amount is be sure to put the entire amount into your account. DO NOT make the mistake of saying “I only have x$’s but I am going to trade it as if it were y$’s. One good drawdown and you will pull the plug.
How much money will you commit to a single trade/position?
We are NOT talking here about how much of a loss you are willing to endure. We are simply talking about how much you will omit to the enter the trade. If you put 10% of your capital into a given stock or ETF that doesn’t mean you are going to risk the entire amount. This question has more to do with determining how diversified you will be.
How much money will you risk on a given trade/position?
Think in terms of percentages. I will risk 1%, 2%, 5%, 10%, whatever. There is no magic, or correct, number. But think of it this way – “if I experience 5 consecutive losing trades how much will my account be down?” If you can’t handle that number then you need to reduce your risk per trade.
How many different positions will I hold at one time? What is my maximum?
Buying and holding a portfolio stocks is different than actively trading. For active traders, holding a lot of positions at one time can be taxing – much more so than you might expect going in. Don’t learn this lesson the hard way.
Do you understand the mechanics of entering trading orders?
The vast majority of trading orders are placed on-line. Each brokerage firm has their own websites/platforms and each has their unique characteristics. “Paper trading” an be a disaster if you come away thinking you “have the touch” when it comes to making money. However, when it comes to learning the in’s and out’s of order placement BEFORE you actually start trading, it an be invaluable.
(Think of trading as sky diving and paper trading as watching virtual sky diving on your laptop. You get the idea, but the actual experience is significantly different).
What will cause me to enter a trade?
There are roughly a bazillion and one ways to trigger a “buy signal”. Some are great, some are awful, but the majority are somewhere sort of in the middle. Too many traders spend too much time looking for “that one great method”: of triggering signals. The truth is that if you allocate capital wisely, manage your risk (more to follow) the actual method you use to signal trades is just one more piece of the puzzle – NOT the be all, end all.
How will I enter a trade?
This sounds like the same question as the one above, but it is different. For an active trader, a buy signal may occur but he or she may wait for “the right time” to actually enter the market. For example, if an “oversold” indicator triggers a “buy” signal, a trader may wait until there is some sort of price confirmation (i.e., a high above the previous trading day, a close above a given moving average, etc.) rather than risking “trying to catch a falling safe.”
What will cause me to exit a trade with a loss?
The obvious one is a loss that reaches the maximum amount you are willing to risk per trade as established earlier. But there can be other factors. In some cases, if the criteria that caused you to enter the trade in the first place no longer is valid, it can make sense to “pull the plug” and move on to another opportunity. A simple example: you buy because price moves above a given moving average. Price then drops back below that moving average without reaching your “maximum loss” threshold.
What will cause you to exit a trade with a profit?
This one is easy to take for granted. Too many traders think, “Oh, once I get a decent profit I’ll just go ahead and take it.” But a lot depends on the type of methodology that you are using. If you are using a short-term trading system that looks for short-term “pops” in the market, then it might male sense to think in terms of setting “profit targets” and getting out while the getting is good. On the other hand, if you are using a trend-following method you will likely need to maintain the discipline to “let your profits run” in order to generate the big winning trades that virtually all trend-following methods need in order to offset all of the smaller loses that virtually all trend-following methods experience.
The problem comes when a short-term trader decides to “let it ride” or when a trend follower starts “cutting his or her profit short” by taking small profits.
Different Types of Trading Require a Different Mindset
Putting money into a mutual fund or a portfolio of stocks is far different than trading futures or even options. While you can be “hands on” with funds or stocks it is not necessarily a requirement (I still hold a mutual fund that I bought during the Reagan administration). With futures or options, you MUST be – and must be prepared to be – hands on.
Also, big percentage swings in equity are more a way of life in futures and options. I like options because they give you the ability to risk relatively small amounts of capital on any variety of opportunities – bullish, bearish, neutral, hedging and so forth.
I also like futures, but it does require a different level of emotional and financial commitment than most other forms of trading. Many years ago, I wrote about the following “Litmus Test for Futures Traders”. It goes like this:
To tell if you are prepared emotionally and financially to trade futures doe the following.
1. Got to your bank on a windy day.
2. Withdraw a minimum of $10,000 in cash
3. Go outside and start throwing your money up into the air until it all blows away
4. Go home and get back to your routine like nothing ever happened.
If you can pass this test then you are fully prepared to trade futures. If you cannot pass this test it simply means that you need to go into it with your eyes wide open regarding the potential risks (with the knowledge that something similar to what was just described can happen at any time).
Summary
In a perfect world a trader will have well thought out and detailed answers to all of the questions posed above BEFORE they risk their first dollar.
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services,
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