The Path to Profitable Trading

 

 www.gotcredit.com is the source of this image.

 

The path to profitability

  1. Commit to doing the work required to be a successful trader.
  2. Create a trading system that captures trends in your time frame. A trader has to be on the right side of the trend in their time frame. The path of least resistance is where you will find the best odds of profitability.
  3. Trade with a plan so your decisions are made before the markets open, and your emotions put you at risk.
  4. Trade a position size that enables you to stay disciplined with entries, exits, and stop losses. Trading too big will lead to errors in judgement.
  5. Your entries should put the probabilities of profits on your side. Backtesting, pattern recognition, and chart studies will give you an edge over those that trade based on opinions.
  6. A trade must have a favorable risk/reward ratio. Your stop loss should be close, while your profit target is farther away.
  7. A trader can only be profitable with either a high winning percentage or big wins and small losses. Combining the two is the path to profitable trading.
  8. A trader has to limit their maximum account drawdown to a level that eliminates their risk of mental ruin. A successful trader stays away from their financial and mental breaking point, and never quits.
  9. Your system should ensure that you will have the right position when huge moves take place.
  10. A trader’s methodology, plan, and system must match the trader’s personality, risk tolerance, and belief system.

Discretionary Versus Systematic Trading

The difference between traders that rely on their instincts and chart reading abilities and those who are pure system traders.

Discretionary Traders…

  • …trade information flow.
  • …are trying to anticipate what the market will do.
  • …are subjective; they read their own opinions and past experiences into the current market action.
  • …trade what they want and have loose rules to govern their trading.
  • …are usually very emotional in their trading and taking their losses personally because their opinion was wrong and their ego is hurt.
  • …use many different indicators to trade at different times. Sometimes it may be macro economic indicators, chart patterns, or even macroeconomic news. They are very “flavor of the month” in that regards.
  • … generally have a very small watch list of stocks and markets to trade based mostly off the time on their expertise of the markets they trade.

Systematic Traders…

  • …trade price flow.
  • …are participating in what the market is doing.
  • …are objective. They have no opinion about the market and are following what the market is actually doing, i.e. following that trend.
  • …have few but very strict and defined rules to govern their entries and exits, risk management, and position size.
  • …are unemotional because when they lose it is simply that the market was not conducive to their system. They know that they will win over the long term.
  • …always use the exact same technical indicators for their entries and exits. They never change them.
  • …trade many markets and are trading their technical system based on prices and trends so they do not need to be an expert on the fundamentals.

While discretionary traders are busy trying to digest what fundamental news and information mean, systematic traders are taking the signals they are getting from actual price movement in the market. Systematic traders are not thinking and predicting what the market is going to do, they are reacting to what the majority is doing based on their predetermined system’s entry signals.

For the average trader being a 100% Mechanical System Trader usually maximizes the chance of success in the markets, especially if you are using a historically proven profitable system. If you are removing the emotions and ego out of your trading and are controlling your risk of ruin with proper trade size and stop losses, then you have probability on your side of joining the consistently profitable traders in the market.

Now what sort of trader do you want to be?

The Power of System Diversification

Are You Diversified?
Investopedia describes diversification as “A risk management technique that mixes a wide variety of investments within a portfolio” that “strives to smooth out unsystematic risk events” “so that the positive performance of some investments will neutralize the negative performance of others.”

I personally think of it as the process of combining multiple non-correlated strategies together in an effort to smooth out your long term equity curve. Every strategy has a weakness somewhere and will have a bad hair day, month, or even year from time to time depending on market conditions.

Once you begin to accept and even embrace this fact your probability of long term success increases dramatically. If you allocate the majority or all of your funds to a single strategy because of past performance or any other reason you will likely struggle to be successful over the long term because of the human tendency to not stick with something as soon as a drawdown of almost any size occurs.

Unfortunately, the majority of investors discovered in 2008 that the traditional diversification model pitched by most of the financial industry failed miserably as correlation among most asset classes rose to historic levels. There is an old Wall Street adage that says “the only thing that goes up in a down market is correlation.”

Experience has taught me to define success by having a well-defined and diversified plan that I execute with rigid discipline and flexible expectations for the month by month outcomes. Here are a few bullet points in my personal trading plan that I like to review on a regular basis to maintain a healthy and realistic mindset of MY personal beliefs about the markets.
• The markets are capable of anything. Expect the unexpected. Without risk there is no reward.
• Losses are ok and they are part of the plan. My focus is flawless plan execution and respecting stops/max loss. This is what creates discipline and confidence. The objective is to make money, not to be “right” on every investment or every trade.
• There is no holy grail. There will be drawdowns, losing trades, and losing months. Focus on execution and long term results and even the tough times can be low stress. Nothing works 100% of the time.
• When monitoring open trades focus on plan execution, not current P/L. Professional traders feel pressure when a trade is going against them, amateurs impulsively act on it.
• Executing my plan is boring and monotonous. Ignore the noise and impulse of everything else. Patiently wait for my setups to occur and my adjustment points to be hit.
• Emotions are real, so be aware of them. The person screaming at the computer will be the guy on the other side of my trade if I’m flawlessly executing my plan on a daily basis.
• Nobody knows exactly what the markets will do next. Stay disciplined and focus on risk management and execution.
• Seeing the next big move coming is always easy in hindsight. For this reason I will always have long puts on to protect the extreme outlier downside Delta and Vega risk.
The additional benefit of diversification is that when your portfolio isn’t overly dependent on the performance of any particular strategy you will have a chance at actually sticking with that strategy WHEN its next drawdown occurs instead of being part of the mob of performance chasers out there who become a statistic in the next Dalbar study. Analyzing individual strategies as “better or worse” based on something like a few recent months or years of past out or under-performance is often missing the big picture. Nobody knows what market conditions might occur in the near future that could be optimal for one strategy while more challenging for another. But blending together multiple non-correlated strategies gives your portfolio the highest probabilities of providing long term satisfactory performance with acceptable drawdowns.

Kim Klaiman is a full time options trader and has been trading stocks and options for more than 10 years. Kim is a founder of educational blog and forum steadyoptions.com. He likes to trade a variety of non-directional trades with low correlation to limit the total portfolio risk.

Kim Klaiman
Founder and Editor
SteadyOptions.com
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10 Great Technical Trading Rules

 

 

“We learned just to go with the chart. Why work when Mr. Market can do it for you?” – Paul Tudor Jones

Only price pays. In trading, emotions and egos are expensive collaborators. Our goal as traders is to capture price moves inside our time frame, while limiting our drawdowns in capital. The longer I have traded, the more I have become an advocate of price action. Moving away from the perils of opinions and predictions has improved my mental well-being, and my bottom line.

In developing a trading system of your own, you must begin with the big picture. First, look at the price action and then work your way down into your own time frame. You need to create a systematic and specific approach to entering and exiting trades, executing your signals with the right trailing stops, setting realistic price targets and position sizing, and limiting your risk exposure. Relying on fact, rather than being tossed around by your own subjective feelings, will insure your long term profitability.

Here are 10 great technical trading rules that will help you build a systematic approach to trading:

  1. Start with the weekly price chart to establish the long term trend, and then work down through the daily and hourly charts to trade in the direction of that trend. The odds are better if you are trading in the direction of the long term trend.
  2. In Bull Markets, the best strategy is to buy the dips. In Bear Markets, the best strategy is to sell short into each rally. Always go with the path of least resistance.
  3. Support and resistance levels can hold for long periods of time; the first few breakout attempts usually fail.
  4. The more times a support or resistance level is tested, the greater the odds that it will be broken. Old resistance can become the new support, and the old support may become the new resistance.
  5. Trend lines are the easiest way to measure trends by connecting higher highs or lower lows, and they must always go from left to right.
  6. Chart patterns are visible representations of the price ranges that buyers and sellers are creating. Chart Patterns are connected trend lines that signal a possible breakout buy point if one line is broken.
  7. Moving averages quantify trends and create signals for entries, exits, and trailing stops.
  8. Moving averages are great tools for a trader to use, but they are best used along with an overbought/oversold oscillator like the RSI. This maximizes exit profitability on extensions from a moving average.
  9. 52 week highs are bullish, and 52 week lows are bearish.  All-time highs are more bullish, and all-time lows are more bearish.  Bull Markets have no long term resistance, and Bear Markets have no long term support.
  10. Above the 200 day is where bulls create uptrends. Bad things happen below the 200 day; downtrends, distribution, bear markets, crashes, and bankruptcies.

Originally posted on www.seeitmarket.com