Trading is simple, although not easy. In order to become a consistently profitable trader, you first need to grasp, at a theoretical level, what makes a good system profitable. These are the three pillars of successful trading.
Pillar 1: Proper risk management
I intentionally placed this one before “a strategy with an edge”. Most traders will jump straight forward to charts and trading, and focus on entry strategy, overestimating the importance of it in successful trading and overlooking other equally important aspects, such as risk management. Big mistake.
Although risk control is the boring part, you should always start here your learning journey in order to avoid blowing your account, which will certainly happen very quickly if you overlook the risk management side.
Actually, it is quite easy and quite common to blow your trading account with a valid and potentially profitable trading strategy, just because of improper risk management. To make things worse, some traders don’t realize that their problem is risk management and may jump into a new trading strategy without fixing it. Of course the next trading system will be also self-sabotaged by the same risk management issues.
On the other hand, if you take risk management seriously, your chances of surviving the learning curve and stay in this business for the long run are significantly higher.
My risk methodology is quite simple and effective.
I always use a hard stop. Usually between 2.5 and 3.5 ES points depending on market volatility and type of entry or set up.
I always risk the same percentage of my account in each trade (R). It can range between 0.5% and 2.5% depending on how aggressive you want to be. I use 1.5%. I advise you to start with 0.5% or 1% until your edge is proven and you have consistent results for months. Click here to learn more about how R works and the benefits of this approach. This risk method is applicable to any trading vehicle or stocks.
There are other possible ways of managing risk.
Pillar 2: A methodology with an edge
You need to approach trading in a cold, statistical manner. A trading system is a large number of trades with an expectancy. A profitable trading system is one with positive expectancy, which is often called “edge” in trading jargon.
You need a trading system with positive expectancy. Without it, you cannot make money in the long run. Good risk management without a profitable system will only slow down your pace to bankruptcy.
There are numerous possible strategies that are potentially profitable, some better, some worse. Although most traders lose money, I’m sure there are a handful of traders out there making money consistently with different strategies. You also need a strategy that fits your personality and trading style. Personally, it took me a while to find the right strategy and then some time to master it. The journey paid off, however, and results speak for themselves.
One of the challenges is to build a strategy that works in all market conditions. In my view, any strategy that isn’t adaptive to the varying market conditions is doomed to fail in the long run. It’s very easy to devise a strategy that makes money in a trending market. And very easy to develop a strategy that works well in a balanced market. But either of those will make you lose a lot of money when market changes from one type to the other. So you need to factor somehow market type into your strategy if you want to build something robust.
Once you have a risk management system and a strategy with an edge, it all boils down to execution. Executing the system properly. This requires practice and discipline, but the biggest challenge when it comes to execution is dealing with psychology and emotions. That’s why, for me, the third pillar of successful trading is psychology.
Pillar 3: Psychology
This was by far the most challenging aspect in my journey to consistent profitability. Trading is difficult, markets are unpredictable and random to a large extent, and when there is money at stake emotions explode. You need to deal with fear, with greed and with frustration. You have to be patient and disciplined. Prudent at times, aggressive at times. You must be resilient to cope with the setbacks and losing streaks. By definition, nothing works 100% of the time in trading. This means that even when you are doing the right things, they won’t work at least 30% or 40% of the time, which can be frustrating.
As with anything else, you can work on this field to improve. Gain awareness of common psychological traps, learn to identify your emotions and manage them, etc.
There is only one constructive way to look at this: if it was that easy, trading wouldn’t be so profitable. So embrace the pyschological challenge. Strong psychology will definitely be part of your edge.
Once you master these three pillars, the rewards are great. You basically have a money printing machine.