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Essentials of Trading

What does it take to become a consistently successful trader?  Well, there are several essentials that you must consider in order to ensure that you have a solid chance of success.  You must learn from those who are successful to calculate the risk and put the odds in your favor by identifying high probability trades and strictly following rules.  Putting the odds in your favor entails a number of essential components that need to be followed with a fierce focus.  Without these processes you will fail because the odds are stacked heavily against you.

These essentials begin with identifying a purpose for your trading; that is, a compelling reason why you are trading and putting your hard earned money at risk.  This compelling reason is most effective if it is tied to an intrinsic variable like loved ones, as in family, a cause that is dear, or some other thing that is on the what-matters-most list of your life.  When you have identified or discovered that reason it will connect the what-matters-most in your life to the what-matters-most in the trade providing positive energy to your follow-through.  Your purpose should be a part of your trading plan that includes the market or instruments that you intend to trade, goals and the strategies you intend to employ.  For instance, your strategies would include whether you will day trade, swing, or trade long term, what time frame you aim to trade, the number of trades you plan to execute in one session, indicators, and financial objectives to name a few.  Secondly, you must get market knowledge and acquire an understanding of the asset class that you wish to trade.  Next, you need a set of rules to govern your trading: the entries and exits, what type of setups will be employed, etc., and these rules all stem, in large part, from your trading plan.  Fourthly, you must have money & risk management strategies in place for every trade.  And, of course, you must have mental and emotional tools in your tool belt…honed and ready to deploy in the service of self-discipline; for without self-discipline none of the other essentials will help you.  These are all critical elements of successful trading.  Let’s briefly take a closer look at these essentials.

After you have acquired the knowledge necessary to trade, you must then develop a macro Trading Plan.  Here you will identify and formulate protocols and strategies that will increase your probabilities of getting the results you want.  On a macro level, we are talking about organizing and planning your trading; on a micro level, it is about organizing and planning your trades.  Your focus will be to figure out how to accomplish the goal and what actions it will require.  This process turns your intention into a concrete goal, further fueling the fires of positive emotion and action.  Additionally, it is important to organize both on a macro level and a micro level in order to plan effectively; in other words you must get in perspective the big picture and the details.  You’ll want to get a picture in your mind (a vision) of the outcome.  Here is where the vision of your intention is brought to life and turned into a practical process, a step-by-step action plan.  Dreams are a dime a dozen. Everybody has them. But it is their execution that is most important.  This plan, then, is a logical map showing where you want to go and how you will get there.  “When a man doesn’t know what harbor he is headed for, no wind is the right one.”

There is a tremendous amount of Fundamental Analysis and Technical Analysis involved in successful equity, futures and currency trading, which are all a part of market knowledge.  However, getting that knowledge can be a tough task; because your attitude regarding your internal stories about your ability to learn and assimilate knowledge can be either a boon or a bane.  Often, you become your own worst enemy due to those internal stories that stem from limiting beliefs.  For instance, you determine what you need to learn and to do; then you tell yourself the story about how difficult it’s going to be, or how you “flubbed” it up the last time.  Limiting beliefs will disrupt and dislodge your ability to learn and stay on course.  Limiting beliefs most often are established in childhood and built upon the negative messages you received about yourself from parents and authority figures.  These limiting beliefs proceed very much like recorded messages that have been playing and replaying in your thoughts —phrases like “You can’t do that”, “You’ll never make it”, “You dummy”, and other types of abuse language.  Statements like these are hurtful even to an adult, and may have left you with low self-esteem, and, in some cases, self-hatred.  Consequently, you react automatically when limiting beliefs are activated by external trading events pushing the button on your recorder.  However, with self-knowledge and learning how to successfully handle the negative triggers when they surface, your self-image is lifted, and the process of breaking the old limiting beliefs or programming has begun.  So, one of the important points to getting the market knowledge, is getting the knowledge of yourself as well.

Successful trading involves rules and these rules form the foundation of your behavior.  You must have a list of rules that govern your trading.  In the beginning rules are taken from books, instructors and mentors.  These rule sources can be very helpful; however what works best is to identify your rules as you trade and execute your strategies that you have incorporated in your planning.  So, identify your rules carefully and make sure that you are following effective rules.

Of course you must have a money management and risk management plans as well.  This would also include appropriate position sizing; that is, having the number of lots, contracts or shares appropriate to your trading account.  Putting on 5 contracts in a position that represents over 5% of your portfolio can separate you from your money pronto.  Additionally, you’ll want to have a risk/reward ratio that makes sense.  Most successful traders will use a 1:3 ratio, meaning that they are willing to risk $1 to gain $3 in any particular trade as a minimum; and the greater the risk/reward ratio the better the return when you do have a winner.  Additionally, it’s of critical importance to use hard stop orders as opposed to stop orders in your head.  In this way you will keep your losers small and protect your capital.  Furthermore, it’s important to limit the number of trades that you plan to take in any one session and as well you’ll want to have a limit on the amount of money you will lose in any one trading session.

Now, as an essential, self-discipline is the most important.  Without self-discipline it doesn’t matter how elaborate a trading plan you have or your amount of  market knowledge,  or how strong your set of rules or how robust your money management strategy.  The critical factor to being successful in the financial markets is the ability to follow your plan and your rules.  First and foremost protect yourself.  Effective self-discipline is about harnessing and managing your thoughts and emotions in order to remain focused on what matters most in the trade.  You’ve got to have mental and emotional tools in order to bring your “A” Game to the platform.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.