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How to be a successful trader

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So you have made the decision that you want to be a trader. Where do you start and is there some structure you need to follow to give you the maximum chance of success?

Nobody can guarantee success of course but you can move yourself much nearer that goal by adopting what I term the three S's, Strategy, Setup and Strength. All three are intertwined and rely on each other for support in your quest to become a successful trader.

Strategy - What system, what edge, what objectives?

The first thing to remember is that the most important factor in success is you! Don't believe by getting the latest and greatest things you will automatically guarantee success. Make it clear from the start what your objective is and when you will review it. It is also important to understand where your edge lies, what will make you pick successful trades above other people? You also need to decide what your particular style will be.

People who make good short term traders are often people who can make decisions quickly without having to rely upon additional opinion or feel the pang of uncertainty. Short term traders often have a fairly mechanical trading strategy at their core one that requires simple execution. Thought provoking musings are not welcome in this arena and neither are distractions. You will probably need to remain intensely focused during your trading sessions so items such as a separate study or area where you can shut out any outside distractions are essential.

Perhaps looking for more general price movements should be your style? If so then you should be happy to sit with open positions for longer time periods. When positions for these types of traders do not immediately work out they tend not to fret as they have already worked out their optimum exit position in the market and will manage their position based on that. Styles such as swing trading are less frantic than short term trading such as scalping but require a more intuitive approach.

Setup - What do you need?

Once you have decided on what basis you will trade, you need to ensure you have the right set up to execute against that. By setup I mean two key things. First, your trading hardware and software, but also the amount and type of money you have available to trade.

It is important to know how much starting capital you are you going to use and how will you deploy it. The old adage is only 'play' with money you can afford to lose. That is correct but you will need enough to make it worth your while. Also doing imaginary or paper trades is nothing like doing the real thing so make sure you have a sufficient level of capital to practice with that ensures the weight of your decisions will be felt. That is what it is like in the real world. Make sure you don't commit so much that it stops you from performing well or creates the potential for an unbearable loss. On the other hand losing runs are inevitable so ensure that your total trading capital and average capital per trade is set at a sensible level or else that inevitable losing run will wipe you out.

The equipment you use should also be appropriate for your style and level of market risk. Standard equipment is normally defined as a modern personal computer with plenty of speed and storage capacity. Most modern PC's are plenty able to cope with the demands of most software but a lot do not come supplied with that pre-requisite for trading the dual or quad headed graphics card. These graphics cards enable you to have a screen the size of a small planet by spreading your PC desktop across more than one screen. This means you can have your trading software on one screen and price information on another and move seamlessly between them. Optionally you could have email or some other application running while you keep an eye on the market.

Just stopping at a good computer is not enough and you need to ensure that you have a high speed internet connection. If you are investing a serious amount of money in the market it is worth making sure you have plenty of redundancy in your system also. Most serious traders have an uninterruptible power supply and various levels of back up just in case their system goes AWOL at the same time as the market.

A serious set up would be at least a dual headed PC with broadband and UPS. You may consider a spare dial up line in case of broadband failure. I also have a phone, a mobile phone with GPRS and a laptop with a long battery life and connection to my mobile phone in case everything else fails. When you are committing large amounts of capital into the market you need to ensure that everything is covered.

Choosing the right software is going to be dictated by your trading style but for sure the most professional, stable with functionality to suit your style is most important. Don't skimp by underpaying for software. It is an important part of your work and you will rely upon it a lot so make sure you find something suitable.

Strength - The hidden but most important tool

Psychology

You need to be aware of your emotions all the time and attempt to cast them out and be cold and hard. If you learn how to do this, then let me know! In psychology, the illusion of control refers to people's belief that they have influence over the outcome of uncontrollable events. People will often let a position run rather than cutting for a loss in the belief that they know more than the market. Typically, once a position has been stated, most find if very hard to move away from it. When movement does occur is does so only very slowly and usually in a financially painful manner. Psychologists call this effect conservatism bias. Remember, never fall in love with a position; because it will never love you back.

Quite a few years back I read an excellent book called 'Influence' written by Robert Cialdini. It was the sort of book I had been searching for, for years. This confirmed that the human world tends to anchor itself to a framework significantly influenced by things other than logic. Having recently re-read 'Against the gods" by Peter Bernstein, which also delves into these murky depths; you learn that while markets are generally considered to be efficient they can also be totally irrational.

This field of study has attracted a lot of attention in recent years and this branch of psychology is called behavioural finance. Behavioural finance looks at historical phenomena that contradict the efficient market hypothesis. It argues that people are not nearly as rational as traditional theory makes out and that psychology, not rationale, often drives a market and in both directions. Researchers have regularly reproduced market behaviour using very simple experiments.

Losses versus gains

Offer someone a choice of £50 or, on the flip of a coin, the possibility of winning £100 or nothing. The chances are that the person will go for the sure thing. Offer a choice of a sure loss of £50 or, on a flip of a coin, a loss of £100 or nothing. The person will probably take the coin toss. In absolute expectancy terms the scenarios offered are exactly the same. There is no benefit to choose one over the other in the long term; yet people tend to go for the coin toss to save them from loss. People tend to view the possibility of recouping a loss as more important than the possibility of greater gain.

Social proof

Social proof highlights why people tend to imitate others. When a market is moving up or down, people are subject to a fear that others know more or have more information. As a consequence, people feel a strong impulse to do what others are doing using outside views (the market) as a reference point. I regularly see this repeated in a number of markets. People see a trend developing and rush into join that trend but only succeed in forcing the price away from true value before arbitrageurs nip in to take advantage of that deviation. People panic, close out their positions and the normal trend resumes.

Fear of regret

Make an error and you will feel an emotional reaction. Gamblers who make errors on betting markets have a tendency to chase their losses. Often they will get away with it but they only stop when they chase one too many losses and face a catastrophic drawdown. Faced with the prospect of selling, traders become emotionally affected by the price at which they took a position. They tend to avoid closing out the position as a way to avoid the regret of having made a bad decision. This is rarely a good move especially in the long term. This is why stop losses have been created!

Over Reaction

People get optimistic when the when doing well become pessimistic during downturns. This appears to be because people place too much importance on recent events. People have a tendency to extrapolate recent trends way off into the future when in reality, that is rarely going to be the case.

The topics I have touched on here are just a few of the topics covered in Behavioural finance. Hopefully that have given you a clue as to how you should approach a market. I have practiced and got better and better over time and have a cold heart, I believe, gives me an additional edge in the market. Edges come in all shapes and sizes.

Record keeping

Keep good records. This is how you can figure out which markets and strategies are poor or did not deliver the returns you predicted. You can then cast out that strategy or the assumptions behind it. If your return is falling then go on to explore why that may be the case. Markets and its participants change, you need some measure of being able to keep an eye on that change and good record keeping is it. Make sure you allocate time to do it. Sometimes taking a day out will do you good and allow you a fresh set of eyes for the next day. Regardless of what setup you use to enter or exit a trade, record keeping has to be a key priority. As your trade record grows, your metrics for success will be clearly defined. Again another edge. I can tell that I have an edge in the market and because I can clearly define it I know if moves I make to improve it are working or failing. Without good record keeping you don't stand a chance.

Money management.

Money management is critical. It key to ensuring you are taking the right level of risk in a market. Money management will define how much money you put into each trade. It will also tell you when to cut your losses. Each market and strategy has its own risk/reward structure and volatility. It is for you to find a process that works inside this structure. If you know what your total downside is then your profit target is automatically defined. If you are unable to find a system that will deliver this potential target then you are doomed from the start. Try to construct your money management around how often it will fail rather than by how successful it is. This will focus your mind.

If you have to close a position 90% of the time losing you £100 each time you can work out quite easily what upside you need per winning trade. If I assume my average stop loss loses me £100 per trade then I know that in 100 trades it will be fired 90 times (90%). Therefore I need the remaining winning trades to net me profit of at least £9000 (90 losses multiplied by £100). Therefore £9000 divided by the ten successful trades means my average profit on a trade needs to be at least £900. Trading without any form of money management will ensure you end up on the rocks before you even started. Get a grasp on it extensively before you start to trade.

Making mistakes

Every body makes mistakes. Mistakes can come from over-confidence, forgetfulness, internal or external influences or just plain bizarre quirks. Try to minimise them as much as you can. Structure your trading so that any possible mistakes will be minimised.

Computers can be quirky beasts, so minimise the load on your computer system to enable your trading software to run at the best possible pace without unexpected interruptions or potential to crash. Because of the size of my trades, I run three screens and two computers at the same time to minimise any possibility of error. I have a land line and mobile phone so I can phone through an order in case of a catastrophe. When I use one click or automated software I pull the mouse away from the screen and run my email on a separate screen just incase I accidentally click something. When entering a market if I am late switching to it and the market activity is lively I don't rush in even if I think an opportunity is there I take time out to carefully asses what is happening before I get involved.

When I leave my 'trading den' I lock the door. Why? My wife once asked me to move the car and after repeating the request she finally make it clear that the car should be moved immediately!! So I dashed out to move it only to find on my return my three year old son busying backing and laying the odds on favourite for me using some automated trading software. I managed to escape a severe loss but it was still an unpleasant one. As always in these situations that horse went on to win and my loss came in, Ouch. The most expensive car move in history, maybe. But hey, lets look on the bright side. At least I have a scapegoat.

You can also make stupid mistakes when trading. Everybody makes mistakes, whether it is taking a profit, or cutting loss rather than letting it run. Don't kill yourself if you do the same. Accept it and move on. You will make mistakes and a lot of these are likely to be due to your logic and strategy being over ridden by your emotions. Make sure you learn from your mistakes and reduce your errors over time. My favourite trick is to print them out and blu-tack them to my wall, an impossible reminder to ignore.

Practice makes perfect

When you enter a market or start a new strategy, start with small stakes and practise a lot. Putting smaller stakes into the market will give you a feel for how things are going. Also you will need a large sample size. Some of my favourite strategies actually got off to a terrible start. But it was only with time and a lot of repetition that I learnt how and why things were happening and how I could refine them.

Sometimes you may just be in a bad market or a bad run. Remember that over time things WILL average out so try and avoid any immediate feelings that you have failed (or succeeded) and make sure you have enough data to hand to make a decent judgement. The opposite can happen too and you can find yourself doing fantastically well, too well in my opinion. This tends to lead to over confidence and you raising your stakes too quickly too early, only to face the inevitable set back. This can be crushing, especially when you have been doing so well and may have just raised the bar in terms of risk. Sometimes losing can actually be good!

AND FINALLY

And finally, if I had to name the top three things it takes to be a successful trader it would have to be discipline, discipline and not forgetting of course discipline. Adhere to some basic principles and there is no reason why, with a decent strategy, you should not be a successful trader. I wish you the best of luck in your future trading career.

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