As seen in this month’s Master Investor Magazine
Following up from last month on my series of lessons that I believe are essential for any trader or investor to keep in mind, I am offering the next and final part of my “trading bible”. I firmly believe that these bits and pieces of hard-earned wisdom – if I may say so – are equally important to studying technical analysis or understanding the principles of macroeconomics before one trades the markets.
It’s like learning to drive a car: it’s not just about reading the car’s manual or taking the test; it’s about the driving instructor conveying his years of experience while we’re learning. It’s an interpersonal experience, but it’s the most important part of learning how to trade the markets. So here we go again.
Don’t underestimate the psychological aspect of trading
Trading is as much about psychology as it is about technical patterns and trading setups. It is important that trading decisions are made without fear, doubt or anger. If you like the look of an opportunity and you believe in it, go ahead and take it.
This is especially true since trading as an activity can sometimes go against our own human instincts, and our brain is not always wired to perform well when dealing with facts and emotions at the same time. In an ideal scenario trading should be done without any emotional factors taking effect, but we’re human and this is not possible.
What is possible however is to develop a system and a set of rules to rely upon and make trading decisions part of this process, of this system. And again, trading decisions should be kept simple and fast. Make sure that you have followed your decision-making rules and just go with whatever conclusion they add up to.
If your system indicates a buying opportunity with set parameters for your target and your stop, then go for it without doubts.
Keep it simple and repeated. If you result in more losses than you’d expect then you might need to tweak your rules or tactics. But always follow them religiously so you find out as quickly as possible whether they’re the wrong ones and actually need that tweaking.
Trading involves losing money as well as making it
Let me blunt here: you will lose money when trading; we all lose and this is a fact. However this is an important thing to digest and it amounts to two principles essentially: first, if you can’t afford to lose any money from your trading account then you shouldn’t risk that capital at all; and secondly, if you can’t get over the fact that you will be wrong numerous times and lose money as a result of that, then maybe trading is not the right thing for you.
The first lesson should really go without saying but people sometimes don’t understand the simple truth that losses are inevitable. And they will be frequent – that’s inevitable too.
No one can be right all the time, not even more than 7-8 times out of 10 consistently. And usually when it comes to trading, being able to be right just a bit more than you’re wrong is enough and most times is the best you can hope for.
So if you can’t afford any losses to your capital, then that capital shouldn’t be part of your trading account. Find an amount of money that you can comfortably put at risk and trade with that.
And don’t ever think that you can trade profitably if what you’re looking to get out of the markets is an ego boost, a confirmation that you can be right more times than not.
Losses are to be loved; losses teach us valuable lessons and improve our tactics; losses when cut to a sustainable amount prove to us that we’re badly positioned in the markets and maybe we should reposition accordingly.
So losses are not to be feared or fussed over. Losses are to be loved and treated as helpful signs along the road.
Be informed, trading is all about making informed decisions
Find a reliable source of information, a website or a newsletter that can quickly and effectively let you know what the conditions of the market are and base your decisions on facts and not on instinct or luck.
There is an abundance of news and information sources out there. News and analysis websites like Bloomberg, Financial Times and Reuters can provide a stream of news 24/7. Technical analysis and ideas websites can be found by the dozen and even social media platforms like Facebook, StockTwits or even Twitter can provide crucial insight on the social aspect of trading.
One should be mindful though of two potential pitfalls: one is the credibility of the source and the other whether this source has an agenda or not. More reputable and independent sources can mostly be relied upon whereas market-makers and/or brokers sometimes have their own goals in mind.
And secondly, one should also keep in mind that too much analysis leads to paralysis in the end, meaning that you should look to have as much information as necessary to make an informed decision but no more than that.
Keep it simple, find a source that you understand and that suits your style and give it a fair chance. My site InvestingBetter.com offers a selection of newsletters and reports, which are worth taking a look at.
Get educated and receive proper training from proven professionals
This is an absolute must. Education should be one of your first concerns. If you skip this step you will run out of money or patience before you get the hang of trading. And that’s the number one factor that leads people to abandon trading very quickly and paint a very bad picture of it.
In truth, they haven’t given trading a fair chance, as it involves a learning curve like every other activity in life.
The difference here is that every mistake, every bad decision literally costs money and operating capital, while taking away the initial excitement chunk by chunk and leaving frustration in its place.
So don’t underestimate this important lesson: there is an abundance of educational resources out there. Invest time and money if needed to get yourself properly educated.
It’s really an investment in yourself, and the most effective capital preservation tool.
And with that I am concluding this small series of lessons. These are mistakes and pitfalls that almost every trader falls into, so there’s no shame in being in the same position. Nevertheless we should pick ourselves up, learn our lesson and improve our trading. That’s the same thing that seasoned professionals do after years and years of experience, we evolve. The markets are never the same, but that’s the beauty – and challenge – of trading.
Alpesh B Patel
P.S. You can find my daily market commentary on InvestingBetter.com. See you next month!