For all of its numbers, charts and ratios, trading is more art than science. As in artistic endeavors, there is talent involved, but talent will only take you so far. The best traders hone their skills through practice and discipline. They perform self-analysis to see what drives their trades and learn how to keep fear and greed out of the equation. In this article we'll look at nine steps a novice trader can use to perfect his or her craft. For the experts out there, you might just find some tips that will help you make smarter, more profitable trades too.
1. Define Your Goals and Choose a Compatible Trading Style
Before you set out on any journey, it is imperative to have some idea of your destination and how you will get there. Consequently, it is imperative to have clear goals in mind, then ensure your trading method is capable of achieving these goals. Each trading style has a different risk profile, which requires a certain attitude and approach to trade successfully. For example, if you cannot stomach going to sleep with an open position in the market then you might consider day trading. On the other hand, if you have funds you think will benefit from the appreciation of a trade over a period of some months, you may be more of a position trader. Just be sure your personality fits the style of trading you undertake. A personality mismatch will lead to stress and certain losses.
2. Choose a Broker Who Offers an Appropriate Trading Platform
Choosing a reputable broker is of paramount importance and spending time researching the differences between brokers will be very helpful. You must know each broker's policies and how he or she goes about making a market. For example, trading in the over-the-counter market or spot market is different from trading the exchange-driven markets. Also make sure your broker's trading platform is suitable for the analysis you want to do. For example, if you like to trade off of Fibonacci numbers, be sure the broker's platform can draw Fibonacci lines. A good broker with a poor platform, or a good platform with a poor broker, can be a problem. Make sure you get the best of both.
8 Tricks Of The Successful Forex Trader
3. Choose a Methodology and Be Consistent in Its Application
Before you enter any market as a trader, you need to have some idea of how you will make decisions to execute your trades. You must know what information you will need to make the appropriate decision on entering or exiting a trade. Some people choose to look at the underlying fundamentals of the economy as well as a chart to determine the best time to execute the trade. Others use only technical analysis. Whichever methodology you choose, be consistent and be sure your methodology is adaptive. Your system should keep up with the changing dynamics of a market. (For related reading, see: 4 Investment Strategies to Learn Before Trading.)
4. Choose Your Entry and Exit Timeframe Carefully
Many traders get confused by conflicting information that occurs when looking at charts in different timeframes. What shows up as a buying opportunity on a weekly chart could, in fact, show up as a sell signal on an intraday chart. Therefore, if you are taking your basic trading direction from a weekly chart and using a daily chart to time entry, be sure to synchronize the two. In other words, if the weekly chart is giving you a buy signal, wait until the daily chart also confirms a buy signal. Keep your timing in sync.
5. Calculate Your Expectancy
Expectancy is the formula you use to determine how reliable your system is. You should go back in time and measure all your trades that were winners versus losers, then determine how profitable your winning trades were versus how much your losing trades lost.
Take a look at your last 10 trades. If you haven't made actual trades yet, go back on your chart to where your system would have indicated that you should enter and exit a trade. Determine if you would have made a profit or a loss. Write these results down. Total all your winning trades and divide the answer by the number of winning trades you made. Here is the formula:
E= [1+ (W/L)] x P – 1
W = Average Winning Trade
L = Average Losing Trade
P = Percentage Win Ratio
If you made 10 trades, six of which were winning trades and four of which were losing trades, your percentage win ratio would be 6/10 or 60%. If your six trades made $2,400, then your average win would be $2,400/6 = $400. If your losses were $1,200, then your average loss would be $1,200/4 = $300. Apply these results to the formula and you get E= [1+ (400/300)] x 0.6 - 1 = 0.40, or 40%. A positive 40% expectancy means your system will return you 40 cents per dollar over the long term.
6. Focus on Your Trades and Learn to Love Small Losses
Once you have funded your account, the most important thing to remember is your money is at risk. Therefore, your money should not be needed for regular living expenses. Think of your trading money like vacation money. Once the vacation is over, your money is spent. Have the same attitude toward trading. This will psychologically prepare you to accept small losses, which is key to managing your risk. By focusing on your trades and accepting small losses rather than constantly counting your equity, you will be much more successful. (For related reading, see: The Art of Cutting Your Losses.)
Secondly, only leverage your trades to a maximum risk of 2% of your total funds. In other words, if you have $10,000 in your trading account, never let any trade lose more than 2% of the account value, or $200. If your stops are further away than 2% of your account, trade shorter timeframes or decrease the leverage.
7. Build Positive Feedback Loops
A positive feedback loop is created as a result of a well-executed trade in accordance with your plan. When you plan a trade and execute it well, you form a positive feedback pattern. Success breeds success, which in turn breeds confidence, especially if the trade is profitable. Even if you take a small loss but do so in accordance with a planned trade, then you will be building a positive feedback loop.
8. Perform Weekend Analysis
On the weekend, when the markets are closed, study weekly charts to look for patterns or news that could affect your trade. Perhaps a pattern is making a double top and the pundits and the news are suggesting a market reversal. This is a kind of reflexivity where the pattern could be prompting the pundits, who then reinforce the pattern. Or the pundits may be telling you the market is about to explode, hoping to lure you into the market so they can sell their positions on increased liquidity. These are the kinds of actions to look for to help you formulate your upcoming trading week. In the cool light of objectivity, you will make your best plans. Wait for your setups and learn to be patient.
9. Keep a Printed Record
A printed record is a great learning tool. Print out a chart and list all the reasons for the trade, including the fundamentals that sway your decisions. Mark the chart with your entry and your exit points. Make any relevant comments on the chart, including emotional reasons for taking action. Did you panic? Were you too greedy? Were you full of anxiety? It is only when you can objectify your trades that you will develop the mental control and discipline to execute according to your system instead of your habits or emotions.
The Bottom Line
The steps above will lead you to a structured approach to trading and should help you become a more refined trader. Trading is an art, and the only way to become increasingly proficient is through consistent and disciplined practice. (For related reading, see: Forex Trading: A Beginner's Guide.)