Trading - Some Simple Rules to Keep You Solvent
In recent years there has been something of an explosion in tools and services that let people trade the financial markets making what was once the preserve of the few the option of the many. The option to trade in micro lots has meant that anyone can set up with a minimal amount of money and start trading immediately. This has drawn many people into trading, many hoping to make easy money. But ease of access should not be confused with ease of success.
When you first start trading, your head can be full of dreams of bazillionairedom, private yachts, holidays in the Cayman Islands/ You read case studies of people who went from zero to millions with their special strategy and hope to be like them. But all too frequently it ends up with a blown account and dreams shattered. The winners are few, the losers are many.
I have been trading for over three years. Whilst this is not a long time, and I’m not claiming to hold a magic ticket to success, I have learned a few things along the way which might be helpful to others just starting out that help to prevent you losing everything before you get to profit.
Here are my tips to finding success in trading:
1. Choose a system that suits you, and stick with it.
There are so many different ways to trade, so many different systems. Each system will be marketed to you as the one and only system that works. I can assure you that none of them work in isolation. If they did, why would anyone sell them? Surely they would just use them and clean up on the financial markets.
There are technical systems, fundamental systems, mixed technical and fundamental systems. Automated systems, set and forget systems, there are magic indicators which will guarantee you success every time etc etc.
No system will work without proper application. You need a system that suits your personal style. For example, do you like higher or lower risk? Are you more drawn to technical/ numerical information or do you prefer to look at fundamentals like economic and political drivers? It needs to be something that interests you sufficiently.
Once you have a system, stick with it and work at getting better with it. Amateur traders spend time hopping from system to system hoping that the next one will really bring home the bacon. But it’s getting good at a system rather than the system itself that really counts. In his great book “Trading in the Zone”, Mark Douglas emphasises that a trader should spend time “Sharpening their tool” rather than constantly looking for another tool.
Trading in the Zone
2. Don't Overtrade
One of the most common mistakes made by newbies is trading too much. Linked to the previous point, only trade when there is a trade that meets your system. Don't try to find trades that 'nearly' fit. If you are searching for a trade it's blind luck if it's successful.
Overtrading can also come from just finding the whole thing exciting and wanting to get experience. It’s a good idea to start with a practice account whilst you are learning. That way you can overtrade and learn to your heart’s content without actually losing any real money.
3. Trade for yourself
This is common now with the option to copy other traders, who, on a micro scale, are acting as your hedge fund. The internet is full of gurus with only a short history of trading. They have all the answers and the results to prove it. Yet on closer inspection all they did was get lucky on one idea. Recently the EURUSD produced a number of these traders. They were experts when the dollar went up up up and the euro went down down down. Some making many 1,000%s on their account in one year. Unsurprisingly, when this trade faltered, so did they and like so many before they ended up with blown accounts. If you must follow or copy other traders, look for people with a demonstrable long term record. It is best to look for people who have lower annual returns, anyone with anything above 20% is probably at risk of blowing up, or at least not achieving consistent annual profits.
4. If it's exciting, you're doing it wrong
There should be no excitement in trading. It should be mechanical and rules based, with a high probability of success. If you are on tender hooks about the outcome of a trade, it means you are gambling, like betting on a horse. In which case, bet on a horse, the odds are probably better.
Trading is a probability business. Good traders are able to make judgements on the probable outcome of their trade based on their experience and their consistent application of their system. This means there is little need for emotion as they can be certain that they will make money over time.
5. Money management is as important as choosing the right trade
Warren Buffet famously said “Rule No 1 Never Lose Money, Rule No 2 Don’t forget rule number one”.
Because trading is uncertain, any trade can go against you no matter what system you have. You need to account for this by having strict money management rules that prevent one trade from wrecking everything for you. You can limit your losses by limiting the amount you risk on any one trade. Only risk between a half and one percent of your portfolio on any trade.This will of course mean that the upside is potentially limited, but don’t forget what Warren Buffett said. I think he knows a thing or two about this business!
There is an old adage that we are all aware of. “Don’t put all your eggs in one basket”. The same applies to trading. Don’t put all your money into one market, or one commodity. Diversify across currencies, indicies, individual stocks, bonds and commodities. The ups and downs and shocks in the market will be balanced out by diversification. Ray Dalio outlines a very useful outline diversified portfolio in Tony Robbin’s book “Money, Master the Game.”
Money, Master the Game
7. Don’t trade to prove something
Trading can be a very humbling experience. You go into it thinking you know how many beans makes five and come away discovering your answer was actually somewhere around 3.6. The purpose of trading is to earn money, nothing else. Yes it can be enjoyable, but don’t try to get validation from it, it will beat you into the ground if you do. If you want validation go and work with homeless people or build a school in Africa. If you want money, learn to trade carefully and consistently in a way that people barely notice.
So those are the rules that I try to apply to my trading. All of them are easier said than done. Remember I don't claim to be a great trader, but I have made plenty of mistakes prior to getting some consistency and I'd like others to benefit from that. Let me know what you think to these rules. Is there anything else that should be included?
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