If somebody says his profession is a trader, what will you immediately think of? I believe most people would immediately flash across thoughts of fine dining, fast cars and effortless work. Is this really the life of a trader? If it is so easy, why don’t we all jump onto the “trader” bandwagon?
In my opinion, trading or punting without consistent profits and plans is easy but it is not recommended. It is akin to gambling. If we are referring to trading as a consistent means of earning our keep, it is not easy. Ask any professional trader and nine out of ten traders are likely to say that it is as difficult as any other profession such as doctor or lawyer. This is because we are dealing with the market which is the collective behaviour of all market participants, be it speculators, traders and investors of different horizon and different nature (i.e. retail or institutional).
In this article, I will outline some of the basic requirements of being a trader who aims to earn consistent profits. Most professional traders would recommend the following things to be done before “newbie” traders engage the market. Although I am not yet an expert in trading, I do broadly follow their points with some amendments to suit my risk profile, returns expectation, holding period, competencies etc.
1. Psychology – most important component
The most important element in being a good, consistent trader is your psychology. Traders have to understand themselves thoroughly as trading involves a confluence of feelings such as uncertainty, risk, greed, fear etc. All of these emotions will have an impact to your trading performance. In order to understand your psychology well and be mentally prepared for the market, it is critical that one has to have a written trading plan.
Below are some of the points which I will consider / evaluate in my trading plan.
a) Return objective: What is your return objective? Do you expect to get a 10% net gain in a couple of days by trading Singtel? Is this realistic and consistent?
b) Trading tools: Consider the tools such as trading system, internet connection, access to analyst reports, fundamental information etc which you require for your trades and get them ready before you commence your trade.
c) Trading horizon: Decide whether you want to trade with a horizon of 1 day, or up to a week, or up to a few months. This decision will also have an impact on your trading routine and lifestyle (i.e. the number of hours you have to stare at the trading screen per day or per week). Some retail traders may initiate the trade with a time period of one week but in the end, as the trade is a losing one, they change their mind (usually by substantiating with other reasons to attempt to convince themselves) to keep it over the long term.
d) Trading methods i.e. Basis in trading: This is your system which alerts you to trades and whether to enter the trades based on the criteria set up in the system. Different systems work in different kinds of markets and for different types of people. For myself, I have two broad trading methods, viz. i) buy stocks with potential near term catalysts; ii) long or short stocks with wide analyst coverage which are near all-time overbought / oversold.
e) Trading indicators: Understand that there are different types of indicators for different purposes. For example, some indicators such as Stochastic are better at measuring momentum than moving averages. By knowing this, there will be less chance of an error of using highly correlated indicators together for analysis.
f) Risk management: This is especially important which will be elaborated in the subsequent article. Suffice to say that risk management is the main area which you have control over the market. It includes how you initiate a trade with a position sizing methodology and how the trade is managed using proper stop losses and profit targets etc.
g) Paper trade – boring but essential: For novice traders, they should do paper trades to test out their above strategies. Although some readers will contend that paper trades will differ from actual trades and hence, a waste of time, it is a fact that paper trades should be easier than actual trades with less emotional baggage. Thus, it is logical that one should be consistently profitable in paper trades before he risks his capital on actual trades.
h) Trading performance: It is critical that you should appraise your trading performance either on a monthly, quarterly or at least annual basis. This is important as it puts things in perspective. If you continue to have losing trade after trade, your current trading strategy may not work for you and you may need to tweak it.
i) Keep a record of your trades and evaluate them according to your system: Professional traders typically keep a trading journal where they record the reasons why they initiate a trade and how they manage the trade. They should review these trades (both winning trades and losing trades) regularly and take responsibility to correct any mistakes. This would also be covered in the subsequent article.
Conclusion – psychology is key
Trading is an exciting and (sometimes brutal) game where there are significant rewards, as well as, pitfalls. According to statistics, about 90% of people who engage the market lose money over time. Thus, it is imperative that traders, especially newbie traders should understand their psychology first by having a detailed written trading plan before they engage the market.
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