4 Things I Wish I Knew When I Started Trading. A popular saying in trading is that “90% of traders lose 90% of their money in the first 90 days of trading”. I want to share with you the mistakes I have made in my trading career so that you don’t have to make all of these mistakes that I have made. Let us look at some simple ways to avoid this disaster while still in the learning curve.
Trade Small
Learn from your mistakes.
The New traders should learn from their mistakes with a small account. The dream of making big money with big trade is always a path to failure. Start small and grow as you develop a solid trading system with an edge that you can execute with discipline.
Keep losses small to stay in the game.
Trading is a game of probability, and nobody is right 100% of the time. So, you will be wrong, and the trading system is when you are wrong, your losses should be as low as possible. To minimize your losses, you should exit the trade quickly instead of keeping false hopes for recovering the loss.
Even if your winning ratio is more than % and if wins are small and losses are big, you will ultimately lose all your money in trading. The single biggest mistake of unprofitable in trading is big losses. Letting winners run and cutting losses short is an edge in profitable trading.
Let me give a simple math of the above paragraph.
X is an aggressive trader who risks 20% of his account on each trade. Y is a conservative trader who risks 2% of her account on each trade. Both adopt a trading strategy that wins 50% of the time with an average of 1:2 risk to reward. Over the next 10 trades, the outcomes are Lose Lose Lose Lose Lose Lose Win Win Win Win-Win.
- Here is the outcome for X: -20% -20% – 20% – 20% -20%= BLOW UP
- Here is the outcome for Y: -2% -2% -2% -2% +4% +4% +4% +4% = +8%
Risk Management in Trading could be a deciding factor in whether you are a consistently profitable trader or a losing trader. Remember, you can have the best trading strategy in the world. But without proper risk management, you will not be successful in trading.
All your trades should end in one of four ways:
- A small win
- A big win
- A small loss
- Break-even
Risk Management
“The key to long-term survival and prosperity has much to do with the money management techniques incorporated into the technical system.” -Ed Seykota.
Risk management includes Stop losses, position sizing, and trailing stops. The main aim is to limit the loss and stay in the game.
Stop Loss and Position Sizing
A stop loss means stopping your loss. A stop loss sets the predetermined risk for each trade with respect to a specific price level. You know at what price level you get out when you are wrong in your trade.
A stop loss has to be given enough space for you not to be shaken out prematurely with normal price fluctuation against you. Nobody can be right 100% of the time in trading. So, you will be wrong sometimes, and the method is that when you are wrong, your losses should be as small as possible.
How to place a proper stop-loss order?
Step 1 =Identify the structure of the markets
Step 2 = Place your stop loss beyond the structure
Let me explain…
Step 2 = Place your stop loss beyond the structure
These are important points in the market because that is where most traders will place their stop loss.
Why?
Because if the price trades beyond it, it will invalidate their trading setup as they know they are wrong on their trade. But, the problem with placing your stop loss near these levels is that it gets triggered easily by smart money.
Why do they do this?
Smart Money is paid to collect VOLUME (where Liquidity is found). He only targets places with higher Volumes, and he collects them.
How do they do?
The spikes in one direction or the other hit the stop losses of either sellers or buyers.
Risk-Reward Ratio Focus on Risk and not on Profit (PS)
Risk is defined as the amount a trader is willing to lose on a particular trade if it hits the stop loss level. Calculate risk on trade (size of a stop loss) by measuring the distance between the entry point and stop-loss level.
The reward is defined as the price distance between our entry point and our profit point. The risk-reward ratio determines the potential loss (risk) versus the potential profit (reward) on any given trade.
4 Steps to Determine Maximum Position Size
- Step1 = Establish the maximum Risk amount per day based on a percentage of account size
- Step2 = Divide the maximum Risk amount per day by the average number of trades per day to calculate the risk amount per trade.
- Step3 = Calculate risk on trade (size of a stop) by measuring the distance between entry and stop-loss.
- Step4 = Divide the maximum risk amount per trade by risk-on trade to determine the maximum position size.
Let us do it in an example
Account size=100000
Maximum Risk percentage per day=2%
Maximum Risk amount per day= Account size* Maximum Risk percentage per day =10000*2%=2000
Number of trades per day=2
Risk amount per trade= Maximum Risk amount per day/ Number of trades per day =2000/2=1000. Calculate risk on trade (size of the stop) =5
Maximum position size= 1000/5=200 shares. The larger the size of your stop-loss (risk), the smaller your position size (and vice versa).
How do measure the risk-reward ratio?
Risk Reward Ratio (R: R) = Total Risk on each trade / Total Reward on that trade. The higher the reward versus your risk, the less winning percentage must be to make money. Let me give a simple math of the above paragraph.
X is an aggressive trader who risks 20% of his account on each trade. Y is a conservative trader who risks 2% of her account on each trade. Both adopt a trading strategy that wins 50% of the time with an average of 1:2 risk to reward. Over the next 10 trades, the outcomes are Lose Lose Lose Lose Lose Lose Win Win Win Win-Win.
- Here is the outcome for X: -20% -20% – 20% – 20% -20%= BLOW UP
- Here is the outcome for Y: -2% -2% -2% -2% +4% +4% +4% +4% = +8%
Risk Management in Trading could decide whether you are a consistently profitable trader or a losing trader. Remember, you can have the best trading strategy in the world. But without proper risk management, you will not be successful in trading.
What is the maximum percentage of our account we are willing to risk?
- Only risk a small amount of your total account per trade, perhaps 0.5 to 1 percent.
- Only risk a small amount of total account per day. This is called a daily stop. Perhaps set a rule that if you lose “X%” percent of our total account in a given day, you will stop trading for that day.
- Only risk a small amount per week. This is called a weekly stop. Perhaps set a rule if you lose “X%” percent of your total account in a given week. you will stop trading for that week
Focus on your process, not the outcome.
The more you focus on the trading process and becoming a good trader, the more the profits will attract you over time. Trading discipline involves following your own trading rules like right position sizing, stop losses, and trailing stops.
Discipline traders have a defined trading system. A trading system means pre-defined rules to guide them. Discipline traders know where they will get in a trade based on entry signals, trailing stop loss based on trend, and where they will get out based on exit signals. They go with the flow of rules, not the flow of emotions.
Let me give some ideas. Different types of entry methods are breakout. Breakout test, pullback, and reversal. This entry depends on different market conditions, like in the trending bull market, buy on dips, or any pattern breakout. In the range market, buy low, sell high. Now define, what are the probabilities of all entries based on past historical price data and charts.
Focus on developing your own trading edge.
The biggest mistake beginners make is jumping from one strategy to another and looking for the Holi grail strategy in trading. When one strategy used to fail, I used to think that strategy did not work and used to jump to another strategy. As long as one strategy used to give me profits, I used to think it was a good strategy, and the day it hit my Stop loss, I used to think that strategy didn’t work.
There is no holy grail strategy in trading. Any strategy can fail at any time. If 50% of trades are profitable, you are still profitable if you follow Risk Reward. Here is how:
Suppose you win%= 50
R: R=2
The outcome of 10 trade +2 -1 +2 -1 +2 -1 +2 -1 +2 -1 = +5
Creating a low-risk, high-reward ratio through the use of trailing stops and stop losses is the foundation of profitable trading. The only biggest reason the majority of the traders are profitable is due to big winning trades and small losing trades.
What does it mean to have an edge in trading?
Many traders don’t understand the meaning of an edge in trading. It is simply an advantage in the markets that, over time, leads to your profitable trades adding up to more than your losing trades.
“Let winners run and cut losers short.” This means Developing a trading strategy where the wins are bigger than the losses on average. How big do the winners have to be, and how small do you have to keep the losers for the trading system to be profitable?
Back-testing trading strategy and developing a discretionary rule-based strategy based on the back-tested result that creates big wins and small losses can give a trader an edge.
Here are some edges that a trader develops in the markets:
- A positive expectancy model.
- A profitable mechanical trading system
- A discretionary rule-based strategy.
- A positive risk/reward ratio.
- Cutting losses short and letting winners run in trade management
- Back-tested trading strategy that has wins on average that are bigger than the losses.
- Discipline to follow the trading system
- Risk management and position sizing that allows survival during losing streaks
Post a Comment