The following is an excerpt I wrote for Bob Lang’s new book “Know Your Options: How to Build Wealth Using Proven Options Trading Strategies and Technical Analysis.”
What is a trader?
Traders are often misunderstood. While investors are more mainstream, traders are viewed as risk takers or as having ulterior motives. There are some significant differences between investors and traders, but the notion that serious and profitable traders are gamblers is far from the truth.
Investors grow their capital by investing in a company’s stock. Traders increase their capital by trading a stock’s price action. Some traders may be undisciplined or inexperienced enough to be perceived as gamblers, but the most profitable traders are entrepreneurs operating a business. Gamblers risk money when the odds are not in their favor, but good traders only take risks when the odds are on their side. Likewise, the differences between gamblers and traders are mirrored by the disparities between gamblers and casinos. Casinos take bets from gamblers that have the odds in their favor over the long term and set table limits to manage their risk exposure. A profitable trader resembles the casino more than a gambler because they always keep the odds in their favor, play the long game, and manage their risk of ruin.
Profitable traders should be viewed as entrepreneurs that take calculated risks for the opportunity to make profits. Most businesses buy and sell products based on supply and demand; they buy wholesale and sell at retail to earn a profit. A trader makes money by buying low and selling high or buying high and selling higher. It is always based on supply and demand. Most experienced traders find success during a market trend, just like a business will profit by finding and selling the hottest merchandise.
The greatest opportunity when it comes to trading is also the biggest danger. Unlike other professional fields there is a low barrier for entry. It’s easy to open up an account and start trading alongside seasoned professionals. You can’t practice law or medicine without spending years of study and having practical experience, and trading and investing is no different. It is all too easy for a new trader to enter the market unprepared and quickly lose their trading capital.
The prepared trader will reap the benefit of their less educated adversary. A trader’s profitability comes from being on the right side of the market when it makes a move. When you are on the right side money goes into your account, and when you are on the wrong side the money leaves your account. A trader’s education process involves learning how to be on the right side of the market the majority of the time. Profitability comes from maximizing your time in winning trades and minimizing the amount of time in losing trades. Focus on making large profits when right, and strive to lose a small amount of money when you’re wrong. That is the key to profitable trading.
Another important element of a trader’s education is to understand the importance of risk management. Most traders struggle because they trade too big and take on too much risk. Trading is as stressful as we make it. One single trade should never carry the threat of a large emotional or monetary loss. Each trade should only be one of the next one hundred trades. This is accomplished by trading enough capital that you can handle losing, while risking enough to make the trade worthwhile. One way of accomplishing this is through asymmetric trading vehicles like options. Options allow a trader to risk a little for the possibility of making a lot. These contracts allow traders to define their risk and limit their losses, while keeping the upside potential unlimited until expiration. Options are an important tool in a trader’s toolbox.
While investors look at the current value of a company versus the future potential for price appreciation, traders analyze the future potential of trending prices based on the current supply and demand of the stock. Higher highs and higher lows day after day on the daily chart tell a trader that a stock is in an uptrend. If a stock is unable to get through an overhanging price level on the chart, that tells traders that there are no buyers at that price level and the stock has hit resistance. Volume on a chart is a voting system; the higher the volume, the better the odds that the price will stay at the new levels and continue to trend. Try to go in the direction of least resistance with a trend until it becomes extended from short term moving averages, or its price becomes too volatile. This is where the trend can bend. Always look for the easy money by going with the flow as long as possible.
Trading can be an enjoyable and profitable way to spend your time if you trade in your comfort zone. It can also be a nightmare if you risk too much and trade too often. Remember that the only reason to trade is to make money. I love trading but I hate losing money. I have had some great experiences over the last 20 years. Like most, I benefitted from the Dot Com boom and had enough money in my account to pay off my first home in March of 2000. That was an amazing feeling at age 28 and it hooked me for life. There are a lot of business opportunities out there, but it’s hard to envision them having a better upside than trading. Professional trading has a low entry cost, offers great profit potential with minimum risk in an environment that you control 100%. Best of all, there are no employees, no leases, and no boss.
My many years of learning things the hard way led me to start NewTraderU.com as a way to help and inspire new traders. I blog, publish books and create e-Courses on the dynamics of trading psychology, risk management, and trading methodologies. They are designed to give new traders a shortcut to profitability by sharing what I wish I had known twenty years ago.
Best Wishes on your Trading Journey,
Bob Lang’s new option book is packed with useful, educational, and informative information for trading options and technical analysis. I highly recommend it and was honored to be included in this great new contribution to trading education.