The key to trading success | stockbee

11/19/2009

The key to trading success

We all trade our "beliefs". My basic belief is that methodology trumps the market. The market is a unknown variable, it does its own thing, you cannot control it. It is full of surprises, is ever changing, is often unpredictable, it offers too many choices, and so on. So market direction is not under my control. But what methods to use to extract profits from the market are under my control. If I do a very good job of controlling what I can control then there is a profit opportunity in the market to exploit.

Trading in actual mechanics terms is simple.You buy, you sell, you put a stop, you risk a certain % of capital. Those are the basic elements common to all trades. All trading decisions fall in to five "controllable" categories which I call Trading Mix:

  1. What time frames to trade (trade frequency)
    1. Day trade
    2. swing trade
    3. position trade
    4. macro trade
    It is your choice as to which time frame to trade. This is a very critical decision and it dictates your rest of the trading mix elements. If supposing you decide to be a day trader, the entry, exit, risk strategies and market you decide to trade are very different. For the Working People site my strategy is to Position Trade and hold trades for long term. That means I have to look at completely different kind of stocks when looking at making a recommendation on that site. My stops and risk management strategy is different.
    Unless you are clear about what time frame you want to trade you will be confused and in Brownian motion. If you have full time job , can you realistically trade on daily or swing time frame?. You can try but it will be very difficult. If you are day trader, you will find holding positions for longer duration very difficult. It is difficult to switch time frame. If your mindset is capturing 25 cents to 50 cents move, trying to capture 20 to 50% move is different game. Only very experienced traders can do it. If you are beginner, in the process of trying to do both you would get more confused. Day traders typically risk much larger amount of their capital on a single trade. So for them liquidity is critical. If you are day trader you need to understand the micro structure of the market and the motivations of major players in it very well. You have to continously update your understanding of the micro structure as strategies and technology changes. If you decide to be day trader the kind of databases, news sources, and other feed services and software is very different from someone wanting to swing trade.
  2. What markets to trade (equity selection)
    1. equity
      1. growth
      2. momentum
      3. value
      4. technical analysis
    2. futures
    3. options
    4. currencies
    5. etf
    Once you decide your trading time frame then which market to trade becomes a critical decision. Supposing you want to trade the daily time frame then the futures market are better than stock. They have high liquidity and offer high leverage. So many day traders focus on them.
    Each market has its own peculiarity. It takes months or years to perfect strategy in most markets. The reason I trade equities is because in stock markets there are every year situations where some stocks will make very big moves. Moves of 1000% plus can happen in the markets. ETF cannot have those kinds of moves. That is the reason I do not focus on them.
    I do once in a while trade futures and working on developing strategies on both futures and currencies market and that is one of my focus areas for next year. But I have definite edge in equities and so I focus on them.
    Within stocks I primarily focus on growth and momentum. Why because growth and momentum stocks historically makes biggest moves on shorter time frames. I have spent significant efforts in understanding these two kinds of stocks and very confident of my methods and understanding.

  3. When, where, and how to enter them (entry selection)
    1. When to enter at open or after open etc
    2. How to enter : market order, limit order, basket order etc
    3. where to enter: channel break, pullbacks, breakouts of support, at resistance etc
  4. When , where , and how to exit them (exit selection)
  5. How to manage risk (risk management)
    how much to risk per trade
    where to put stops
    how and when to use margin
    All these decisions are under a traders control. These are the variables you need to work with to design a profitable method. This is where a trader should spend bulk of his time. If you do a good job of controlling what is under your control then you will be in charge of your trading and the market will not be. You should focus your area of study on these controllable variables. People have studied various entry strategies, various exit strategies, various stop strategies , various risk management strategies. What works and why on these controllable variables is easily available and is in public domain.

    This is the basics of trading. If you master this then you can apply the same principle to any market and market time frame.
This is very basic trading decision. You must think through this. If you don't enter or exit at right time it is difficult to make money and manage risk. Entry is critical if you are trader. The whole idea behind being a speculator is to "time the market", to "time the entry" , to "time the exit", and to "vary risk depending on situation". Those are the core skills of speculators as against investors. Many times I get emails asking, whether they should enter a position or increase size on open positions , at that time I am thinking of exiting the position. Essence of speculation is "timing" . Don't speculate unless you understand that.

The profit opportunity is in the market if you get the mix of above elements right the result is profit. Each of these five variables are completely under your control. If you change these variables your profit increases or decreases. So for a same size of profit opportunity in the market two traders using two different set of trading mix will have completely different profit outcomes. Controlling your trading mix is the key to profitability.


Unless you have these basics in place, no amount of trading psychology is going to help you. Because your problem is not mindset or discipline at that stage but it is ignorance. Unless you educate yourselves on the controllable factors the market will remain a big mystery to you.

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