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8 Essentials for Trading Success
In This Week’s Issue:
- Market Outlook – Buyers Fail to Reverse February Weakness
- This Week’s Market Minutes video – SURPRISE! THE MOST PROFITABLE DAY TRADES
- What’s Working Now – Short term focus
- Trader Training – 8 Essentials for Trading Success
Market Outlook – strength on Friday looked good for the start of a March rally as it marked a short term break of pessimism but the sellers took back control Monday and Tuesday of this week, putting the trend reversal on hold. The trend going back to the start of February remains down. While downward momentum has slowed, we still need to be very cautious with longer term trades on the buy side.
This Week’s Market Minutes video – SURPRISE! THE MOST PROFITABLE DAY TRADES
There is a common characteristic of strong day and swing trades that anyone can see. This week, I show what it is and then provide my analysis of the stock, commodity, currency, and interest rate markets. The day trade of the week is on GNS.
Click here to watch on YouTube
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What’s Working Now
When the trend is not your friend, you have to play stocks that are disconnected from the overall market. These “Alpha” stocks are characterized by abnormal price and volume action. Day trading the short-term pattern breaks on Alpha stocks is about all that is working on the buy side. There are a few every day but you have to be focused on intraday activity to find them. Otherwise, it remains a good time to sit on cash and be patient until the trend turns. Seasonality is on the side of the buyers but we still don’t have evidence that the trend is heading up.
Trader Training – 8 Essentials for Trading Success
Trading is a great career. You can work from anywhere that has a reliable connection to the Internet. The financial payoff is virtually unlimited, some of the biggest traders run firms that make billions of dollars per year. Above all else, trading successfully provides a great deal of freedom. We only answer to the market.
While many are attracted to trading for the benefits, few realize all the things that are necessary to be successful. Trading is simple, but it is not easy. Here is a list of some of the critical components for success in trading:
Trading decisions need to be based on more than gut feel. Whether you are a fundamental, technical or algorithmic trader, you need information. That can be the expected earnings for a company, growth rates, technical analysis indicators or correlations between different data sets. The possible reasons for taking a trade are infinite.
I am an algorithmic trader. That means I devise a set of rules for when to enter and exit a trade and how to manage risk. I then apply those rules to a large number of stocks over a lengthy period so I can see how well the rules work over hundreds, if not thousands, of trades. I only trade those rules if I find that they are consistently profitable through different market conditions. Data is the foundation of my approach.
The rules for when to enter the trade, manage risk and identify opportunities are the basis of the trading strategy. A trader buys stocks when the earnings growth is more than two times the price to earnings ratio and sell when that is no longer the case. Another could buy when the 50-day moving average crosses above the 200 day and then sell when it falls back below. How about buying when a stock drops to a price that is two standard deviations from the average and sell when it is one standard deviation above? Some traders do that.
I am not recommending you do any of the above strategies, they are just examples of how different traders approach the market. What I do want to stress is that the best traders approach trading with a plan. That plan should be researched and tested. I find that the best strategies are also quite simple. I can write the rules for any one of my strategies on one piece of paper.
Developing a trading strategy is difficult and time consuming. I have spent years developing, testing, modifying and evolving my trading strategies. It is not uncommon for me to lose thousands of dollars in the development of a strategy as I fine tune the rules. Yes, you can test a strategy without using real money, but the real proof of its effectiveness comes when you actually trade it.
When developing a strategy, the greatest challenge is overcoming bias in testing. We humans have a way of seeing what we want to see. If bias creeps in to your strategy development process, what works in testing may not work in real trading.
Traders need a way to manage the data that feeds their strategy and initiates the trade. Most of us use a computer to look for opportunities and execute trades. We need software tools to help us find the trade in a timely way (I use Stockscores.com and Tradestation for most of my trading decision making). The trading platform software is where we execute the trades and then we should track our results and data using data management tools like Excel.
Tools for the trader are like tools for the car mechanic. Absolutely necessary but useless without the knowledge for how to use them.
Trading takes money to buy and sell and I am often asked about how much is necessary. The answer to that question depends on what stage of your trading education you are at.
I tell all my students that they should start out using $0. Whether you have millions or a few thousand, you should start out using no money and only trade in a simulated environment. Trading takes practice so why not practice where you risk is zero dollars. Once you can do well in a simulated environment, you can start to risk your capital.
Start with a small amount of risk and see how you do. Once you have made some money, increase how much you risk on each trade. Find success, increase risk again. Find losses, scale back your risk.
This way of slowly increasing your risk tolerance for each trade means that you don’t risk too much of your seed capital. If you are losing, you scale back your risk to $0 and practice more. If you are successful, you will be able to mitigate some of your risk with money you have recently made.
When day trading, brokerages will give you 3 to 1 leverage. That means $10,000 of capital gives you $30,000 of buying power. While market conditions and trading skill are very important factors, it is reasonable that this amount of capital can allow you to make $250 - $500 a day if are doing well. There will be times when it is more and there will be times when it is less. Aspiring traders have to realize that the market is your boss and it does not deliver the same number and quality of trades each day. If you are going to make a career out of trading, you need to plan for the random cash flow that it gives.
The rules of your trading strategy must be executable. Many strategies fail in the market because of liquidity, slippage and timeliness. Whether your strategy works in real market conditions is largely dependent on process.
What are the steps to finding and executing the trade and how will you use your tools to make the trades happen? This is process and it is as important as the strategy itself. Two traders applying the exact same strategy can get very different results if one has a better process.
As traders, we are following the rules of our strategy. If we get emotional in their application, the performance of our strategy can really fall apart. Having the discipline to trade the strategy that you have tested and not break your rules is essential.
This is especially true with the risk management components of your strategy. Capital preservation is our number one goal.
At the top of this article, I said that trading is simple, but not easy. The market wants to give profits to the smallest number of people as possible (and that small number makes a lot of $). To be part of the successful group requires an almost obsessive persistence to win.
The stock market is cruel because it gives the test first and the lesson afterward. It will teach you lessons every day and some days it will feel like your teacher is kicking you in the head. Your greatest challenge is overcoming your human self. It can be done by anyone as long as they are persistent.
This is the most important component for trading success. To beat the market, and the millions of people participating in it, requires an edge. How does your approach to trading allow you to beat other traders?
My edge relates to the experience that has gone into my trading strategies as well as the tools I use to have an efficient process. I have developed my own indicators and tools that allow me to find hot stocks before most other traders. When the crowd catches on and sends the stock higher, I am usually already in the trade and looking for the exit door.
I hope this helps aspiring traders organize their thoughts and expectations in the pursuit of their trading goals. To learn more about how I trade, and how you can learn my approach, visit www.stockscores.com/learn or check out the videos on the Stockscores YouTube Channel.
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