Trading psychology & becoming a profitable trader over time
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Is it true that in the markets, over 90% of traders lose money? Likely! In that case, only a small percentage of traders remain profitable over a longer period. Although some people perceive trading as akin to speculating, it definitely isn’t! Over the course of years of professional trading, one thing is clear: Trading is more about discipline and psychology than drawing support and resistance lines on the charts.
The fundamental principles of a trading mindset could be categorized as follows, in their order of importance:
Is it true that in the markets, over 90% of traders lose money? Likely! In that case, only a small percentage of traders remain profitable over a longer period. Although some people perceive trading as akin to speculating, it definitely isn’t! Over the course of years of professional trading, one thing is clear: Trading is more about discipline and psychology than drawing support and resistance lines on the charts.
The fundamental principles of a trading mindset could be categorized as follows, in their order of importance:
- Preservation of capital
- Consistent profitability
- Pursuit of higher returns
Preservation of capital is the most crucial aspect of trading. Everytime we trade, we put the capital at risk. We need to be prepared with ways to mitigate the risk even before entering the trade. If the capital is lost, we will be thrown out of the markets. Winning and losing will continue to be part of the game. It is essential for us to make sure that we never lose more than we win.
To determine the viability of any trade, traders most often use a criteria called risk versus reward. This simple criteria allows one to judge whether entering the trade is worthy enough. If the risk versus reward for a particular trade is 1:3, in simple terms it means the trader would risk $10 for a potential profit of $30.
Entering unnecessary trades without looking at the risk v/s reward can be disastrous. Although there might be some winning trades, in the long-run such traders almost always end up burning their capital.
Consistent profitability as concept comes as a natural succession to the preservation of capital principle. Capital doesn’t remain static. It is either gained or lost. One needs to be consistently profitable to gain capital. In order to achieve this, one needs to preserve the gains and minimize the losses.
Assume that a trader only enters trades where the risk/reward is at least 1:3. If the trader wins 1 in every 3 trades, he still ends up being profitable. ( Take a look at the table in our chart )
By banking 50 percent of total returns each time you go from a negative to a positive return within your measuring period, you both increase the amount of available capital after each gain and increase the probability that you will remain profitable. In actual practice, you might decide to bank 50 percent of the net from each profitable trade as long as your performance was positive, but the results would not be substantially different. The basic idea is to never put all your profits at risk. It is fine to double up on a profitable position, but not if it means putting all your gains at risk.
The pursuit of superior returns
The pursuit of superior returns involves more aggressive risk taking, and only with a portion of profits, never initial trading capital.
Most people might think aggressive risk taking involves altering the basic risk/reward criterion. To the contrary, it is foolish ever to ignore or underweigh potential risk. Profits, once accrued, are essentially the same as capital, and must be preserved. But once you have achieved a comfortable level of profits, it is appropriate to increase the size of positions by risking a portion of profits. If you win', you dramatically increase your returns. If you lose, you are still profitable, and can continue to pursue consistent profitability until you reach a higher risk plateau once more.
A successful trader never lets her emotions get the better of her.
As stated by Victor Sperandeo in his book ‘Principles of Professional Speculation’, a traders' commandments should be as follows:- Do not overtrade.
- Do not take a loss home.
- Never add to a bad trade.
- Never let a profit become a loss.
- Always figure your stop loss before you initiate a trade.
- Don't be a one-way trader. Be flexible.
- Add to profitable trades when appropriate. The best time to buy or sell is after consolidations and a break above or below range prices.
Parts of this post have been referenced from Victor Sperandeo's book, ‘Principles of Professional Speculation.’
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- Do not overtrade.
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