How to succeed in trading (by really, really trying)

Key Points

• The majority of Sentimentrader.com subscribers are traders and/or investors with some degree of real-world experience in the markets. But maybe you are new to the markets. Or maybe you've been trading awhile but have never achieved the kind of success you had hoped for. Or maybe you've been successful in the past, but have faced a "crisis of confidence" more recently
• Oftentimes in the markets it is good to go back and revisit the basics
• Trading success comes from a "reality-based" approach.  It is NOT about "all the money I am going to make!"  It IS about "formulating a plan" (see the questions below) AND "doing the right thing over and over and over again" (no matter how uncomfortable or unsexy those "things" may be)
• The bottom line: "Hopes and dreams" don't mean diddly. Success follows adherence to a "process"

A focus on "trading"

First, note that I define "investing" and "trading" as two different - albeit very similar - activities. My definitions:

• "Investing" means putting money to work in the markets in hopes that it will grow over time
• "Trading" means buying or selling something short in hopes of making money right (freaking!) now

Much of what follows below does apply to investing. But simply note that everything that follows is written with and for a "trader's mindset."

Steps to Trading Success

Trading success comes from a two-step process:

• Formulating well-thought-out answers to the questions below
• Remembering - and applying - the answers through all of the inevitable ups and downs that will follow

What vehicles will you trade?

Will it be stocks, ETFs, mutual funds, futures, options, or something else?  If you plan to trade futures or options, understand that you will need a different account and/or approval from your brokerage firm.  Likewise, note that you will need to learn about the unique quirks of futures and options BEFORE you start trading them.

How much money will you commit to your trading account?

Whatever that amount is, be sure to put the entire amount into your account.  DO NOT make the mistake of saying, "I only have x$'s, but I am going to trade it as if it were y$'s." One good drawdown, and you will pull the plug.

How much will you commit to a single trade/position?

We are NOT talking here about how much of a loss you are willing to endure.  We are simply talking about how much (whether a specific dollar amount or a percentage of capital) you will commit to entering a given trade.  If you put 10% of your capital into a given stock or ETF, that doesn't mean you are going to risk the entire amount.  This question has more to do with determining how diversified you will be.

How much will you risk on a given trade/position?

Think in terms of percentages.  I will risk 1%, 2%, 5%, 10%, whatever, of my trading capital on a given trade. Note that there is no magic or correct number. But think of it this way - "if I experience five consecutive losing trades, how much will my account be down?"  If you can't handle that number then you need to reduce your risk per trade.

How many different positions will I hold at one time?  What is my maximum?

Buying and holding a portfolio of stocks is different than actively trading. For active traders, holding a lot of positions at one time can be very psychologically taxing - much more so than you might expect going in.  Don't learn this lesson the hard way.

Do you understand the mechanics of entering trading orders?

Placing orders online has gotten much easier and much more streamlined over the years.  Still, each brokerage firm has their own websites/platforms, and each has its unique characteristics.  "Paper trading" can be disastrous if you come away thinking you "have the touch" when it comes to making money.  However, when it comes to learning the ins and outs of order placement BEFORE you actually start trading, it can be invaluable.

Think of trading as skydiving and think of paper trading as watching virtual skydiving on your laptop.  You get the general feel and can learn the mechanics involved - but the actual experience is going to be, ahem, different.

What criteria will cause me to enter a trade?

There are roughly a bazillion and one ways to trigger a "buy signal".  Some are great, some are awful, but the majority are somewhere in between.  Too many traders spend far too much time looking for "that one great method" of triggering signals.  The truth is that if you allocate capital wisely and manage your risk (more to follow), then the actual method you use to signal trades is just one more piece of the puzzle - NOT the be all, end all.

How will I enter a trade?

This sounds like the same question as the one above, but it is different.  For an active trader, a buy signal may occur, but he or she may wait for "the right time" to actually enter the market.  For example, if an "oversold" indicator triggers a "buy" signal, a trader may wait until there is some sort of price confirmation (i.e., a high above the previous trading day, a close above a given moving average, etc.) rather than risking "trying to catch a falling safe."

What criteria will cause me to exit a trade with a loss?

The obvious one is a loss that reaches the maximum amount you are willing to risk per trade, as established earlier.  But there can be other factors.  In some cases, if the criteria that caused you to enter the trade in the first place no longer is valid, it can make sense to "pull the plug" and move on to another opportunity.  A simple example: you buy because the price moves above a given moving average. The price then drops back below that moving average without reaching your "maximum loss" threshold. Thus, your reason for getting in in the first place no longer exists.

What criteria will cause you to exit a trade with a profit?

This one is easy to take for granted and to not plan for.  Too many traders think, "Oh, once I get a decent profit, I'll just go ahead and take it."  But a lot depends on the type of methodology that you are using.  If you are using a short-term trading system that looks for short-term "pops" in the market, then it might make sense to think in terms of setting "profit targets" and getting out while the getting is good.  On the other hand, if you are using a trend-following method, you will likely need to maintain the discipline to "let your profits run" in order to generate the big winning trades that virtually all trend-following methods must garner in order to offset all of the smaller loses that virtually all trend-following methods experience.

The problem comes when a short-term trader decides to "let it ride" or when a trend follower starts "cutting his or her profit short" by taking small profits. Only a well-thought-out plan and the discipline to follow it can alleviate this problem.

Different Types of Trading Require a Different Mindset

Putting money into a mutual fund or a portfolio of stocks is far different than trading futures or even options.  While you can be "hands-on" with funds or stocks, it is not necessarily a requirement.  With futures or options, you MUST be - and must be prepared to be - hands-on.

Also, big percentage swings in equity are more of a way of life in futures and options.  I like options because they give you the ability to risk relatively small amounts of capital on any variety of opportunities - bullish, bearish, neutral, hedging, and so forth.

I also like futures, but it does require a different level of emotional and financial commitment than most other forms of trading.  Many years ago, I wrote about the following "Litmus Test for Futures Traders".  It goes like this:

To tell if you are prepared emotionally and financially to trade futures, follow the steps below:

1. Got to your bank on a windy day.

2.  Withdraw a minimum of $10,000 in cash

3. Go outside and start throwing your money up into the air until it all blows away

4. Go home and get back to your routine like nothing ever happened

If you can pass this test, then you are fully prepared - financially and emotionally - to trade futures.  If you cannot pass this test (and let's face it, most people cannot), it simply means that you need to go into it with your eyes wide open regarding the potential risks (with the knowledge that something similar to what was just described can happen at any time).

What the research tells us...

In a perfect world, a trader will have well-thought-out and detailed answers to all of the questions posed above BEFORE they risk their first dollar. And in a perfect world, they will stick to their process.