Keys to success in trading

[The following is extracted from p.87-91 of the ebook Master Trader by Jens Clever. The book is available at: http://www.daytradingcoach.com/mastertrader.htm]

I believe that the right state of mind is by far the single most important key to successful trading. Yes, a solid strategy is an absolute necessity too; but without being in the right state of mind it won't make you successful either. I state in the “philosophy” section of my website that I don't think trading needs to be complicated and that keeping it simple is the way to success. The most successful traders I know only use a few basic strategies. What made them so successful was their confidence in their strategy, their ability to stay neutral and to execute according to what they see. Other people I met had very sophisticated and complex approaches using several indicators. And guess what, a lot of them were successful too. I doubt that the indicators themselves made them successful though; more important was their confidence in their strategy. Some people can only work with very sophisticated approaches just because they don't believe that simple things work. They say: “it can't be that easy”. My point is that there are many approaches. I don't want to judge whether one is better than the other. As long as they work for you the goal is achieved. No one holds the Holy Grail to success. Personally I don't like advanced technical indicators too much. The reason is that there are too many variables that can be adjusted. I like to get clear entry signals based on absolute prices (i.e. highs and lows), which I am not able to alter. This gives me less room for personal interpretation and more clear signals.

Going back to the mental aspects, I would like to point out some of the key traits of successful traders:

1.They stay neutral:

Staying neutral means to be emotionally detached from your trading decisions. You probably know guys for whom the world sucks if they take a loss of $100 and if they make $1000 they are on top of the world. They are definitely not neutral.

If you are like that, then your trading will definitely be driven by fear and greed; if you are down $100 you probably don't want to take a loss, just because you know that you will be emotionally suffering. If you are up $1000 you might want more, even though you should take profits. Or you might end up taking profits way too early because you are afraid that the position might turn against you. The professionals don't let the day-to-day oscillations in their account faze them. The results of one week don't matter much, not even the monthly results. It's just a small blip of time in their career, so the day-to-day oscillations don't really matter. Emotional ups and downs are pretty normal for beginners. If they influence your trading decisions too much, then I would strongly advise you to go back to paper trading in order to gain the confidence you need to not let those oscillations affect you too much.

Staying neutral also means to see the price movements like they really are, not how you want them to be. You might all know the situation where a trade is going against you, and you start looking for other reasons why it is still a good trade and you should hold it. This is very dangerous since it leads people to breaking their stops and to lose big. Your entry and exit criteria has to be absolutely clear before you make a trade. Switching strategies while you are in a trade is one of the worst things you can do. You can always find a reason for your position to go up or down, but you don't see the actual price movement anymore. You are shifting from reaction to prediction! A day trader should under no circumstance try to predict future price movements. As traders we have to play the actual price movement, not what we think the movement should be! Please leave prediction to investors. A lot of times I see traders taking positions in stocks they know very well fundamentally. They mix trading with investing. This is very dangerous too. While there might be reasons to enter a position for a short-term trade they often end up holding it as an investment if it goes against them. Just think about Enron.

Yes, there were points during the Enron sell off where a trade would have been justified. Even I held Enron for a short recovery from about $8.5 to $10. The problem is, that if you base your entry on the belief that the company is cheap and it has to recover, you will be more and more inclined to hold your position or even add to it once it goes lower. The stronger your opinion on a stock, the harder it is to make decisions based on the actual price movement. I would strongly advise you to have a separate account for fundamentally based trades. A day trading account gives you too much leverage, making it very tempting to take risks that are way too high!! I am not saying that it is not good to have expectations; everyone should know what his potential trades are most likely going to do. Should those expectations be wrong though, then we have to accept that and react according to what is really happening.

2. Successful traders have confidence in their trading decisions:

Confidence in your trading decisions is the key to everything. A lack of confidence can lead to fear. Fear or a lack of confidence in your trading decisions makes it hard to enter trades in the first place. You will often find yourself letting good opportunities pass by, or you are waiting for additional confirmation that the stock is going your way, which makes you enter trades too late and you end up chasing the stocks; often getting in at the end of the movement. Fear of losing money makes it harder to take losses. To much fear will either make you not take losses at all and cause significant draw downs, or it will make you take losses to soon, before the actual stop price was hit. Confidence in your ability to make good trading decisions will help you to be patient since you know that eventually there will be good opportunities. Traders with a lack of confidence tend to look for different trading strategies every time something goes wrong for them. They are therefore never able to focus on one strategy and master it. Even if you are a experienced trader you might lose some confidence once in a while.

Go back to paper trading or to trading small shares in order to get yourself back on track.

3. They only use risk capital for trading:

If you are trading with all the money you have without having another income you will be way too scared in order to make any neutral decisions. There is a saying that scared money never wins. I have yet to see a trader who was able to live off a 5K trading account without any additional income.

4. They focus on a few strategies that suit them well:

Many traders try to implement too many strategies at once. They think they have to make money every day. The most successful traders I know only have a few strategies that they are highly successful with, sometimes only one. The goal is to find a strategy that YOU are comfortable with and to master it. This won't come overnight. Of course you need to have a look (and try) different strategies until you find something that you are comfortable with. Keep in mind that no strategy works in every market. Therefore it is normal to sit on the sidelines every once in a while. You don't have to make money every day. The key is to only trade when the odds are in your favor and to stay in the game. Once you have established a “bottom line” strategy you should slowly move on and implement other strategies.

5. They are patient:

This starts with patience in your learning process. Take time to trade on paper for a while. You will make mistakes and it will take time to get comfortable with your trading decisions. Please make your mistakes on paper; this will keep you in the game. If you absolutely want to trade live right away please do so with a very small amount of shares. You can make a lot of mistakes if you are trading a small amount of shares. If you use your full buying power though one blown stop can wipe you out. I have yet to see a trader (including myself) who didn't blow a stop at least once!!

Patience to wait for trading opportunities is very important too. As stated above, not every strategy works every day. You might have to wait a while to find a good trade. It can also happen that you have a loosing streak. A good trader will not worry too much about that and will do something else. Sitting in front of your computer trying to make back losses is the worst thing you can do. I would strongly advice you to set maximum losses per day, week and overall. Stop trading immediately if your maximum losses are hit. Remember, as long as you stay in the game there will always be another day with new opportunities.

6. They are great money managers:

A good trader will never risk more than 2% of his trading capital on a single trade. This means that if he has to take a stop, the amount of money he is wiling to lose will be no more than 2% of his capital. 2% is the absolute maximum. You should attempt to risk less than that. The reason why this is so important is that even if you are right 99% of the time you can still lose 10 times in a row. Every once in a while this might happen to you. Only if you risk little money you will be able to survive such a drawdown.