In today's article, I would like to share with you all the trading lessons that I have learned over the years of my trading. Let's get started.
Consistent actions lead to stable results
I remembered my first trading system. This was a strategy to return to the middle Bollinger Band . You buy when the price is in the lower band and sell when it is in the upper band. The first few trades I made were profitable, then the losses started and I decided that this trading strategy was not working.
Then I stumbled upon harmonic patterns . I spent half a year learning how to draw these patterns. At the beginning I had a string of profitable trades, but gradually the losses grew and I lost all my profits. Again, I said to myself, “This trading strategy is not working. We need to try something else."
This led me into the world of price action trading , support and resistance levels , candlestick patterns , etc. And again, the same scenario repeated itself. I had profitable and losing trades, and I abandoned the next strategy.
One day I asked myself. "Why does this always happen?" "Why am I not achieving consistency in my trading?" "There's always a streak of winning trades, and then the losses pile up and take it all." Do you know what I understood? The problem was with me. I moved from one trading strategy to another.
My actions were inconsistent. And because my actions were inconsistent, I got inconsistent results. So don't make my mistakes. If you want to get consistent trading results, you must follow a consistent path. Stick to one trading strategy, master it - and only then move on.
Your trading strategy must have an advantage
In trading, it is important to be consistent in your actions. But that's not all, because you also need to have an edge in the markets. You're probably wondering, "What does that mean?" Everything is simple.
This means that your trading strategy must be statistically positive in the long run. If it doesn't, then no amount of consistency will help you because you end up constantly losing. Don't believe me?
Then send to the nearest casino and constantly bet. You can be consistent with your risk management, betting size, games you play, etc. In the long run, you will still lose all the time because you don't have an advantage over the casino. Do you agree? The same is true for trading.
You must have an edge in the markets because without it, no amount of consistency, risk management, trading psychology, etc. will help you.
The most important formula in trading
You are probably wondering, “How do I know if I have an advantage?” That's a good question.
You cannot tell if you have an advantage based on chart analysis, risk management, psychology, etc. Instead, you should be able to quantify your advantage. The following formula works for this:
E = (average win x win rate) - (average loss x loss rate)
Now don't panic because the formula is easy to understand and even a 10 year old can do it. Let me explain.
Suppose you have the following indicators of your trade:
- Average win = $500
- Average loss = $400
- Win percentage = 60%
- Loss rate = 40%
Then plug those numbers into the formula and you get:
E = ($500 x 0.6) - ($400 x 0.4) = $300 - $240 = $60
So what does $60 mean? Two things:
- This means that your trading strategy has a positive expectation.
- In the long run, you can expect to earn an average of $60 per trade.
Your expectation will vary from one trading strategy to another (and from trader to trader).
You may have an advantage with a low number of winning trades because your average profit is much higher than your average loss. Similarly, it is also possible to have an advantage with a higher average loss than profit because your profit percentage is high.
Look at the price first
You don't have time to process huge amounts of data, do fundamental analysis , identify key market drivers, etc. But how do you know which direction the market will go? It turns out there is a simple solution. Watch the price.
In other words, look at the chart and ask yourself, "Is the price moving up or down?"
- If the price rises, look for opportunities to buy.
- If the price goes down, look for selling opportunities.
Here is an example:
As you can see, the price is rising, so we will look for opportunities to buy - without selling.
You may be wondering: “What to do if the price moves up, but the fundamentals remain bearish. Should I buy or sell?
Based on my experience, it is more profitable to follow the price regardless of the fundamental indicators. That's why. When the market goes up on bad news, it's probably because the market is already in an uptrend and the bad news wasn't "strong" enough to cause a correction or reversal. So always focus only on the price.
Different markets behave differently
If you have read books on technical analysis , most of them tell you about market trends 30% of the time. But recently I discovered that this is not entirely true. In fact, some markets have a stronger trend than others.
Let me prove it to you. I applied a simple trend-following strategy in different markets
- We buy on the breakdown of the previous day's high.
- Hold a long position until the price hits the previous day's low and go short.
- Hold a short position until the price exceeds the previous day's high and go long.
GBP/USD: The equity curve is in an uptrend when trend-following techniques are used.
You see the equity curve moving up. This suggests that the GBP/USD is a trending market.
AUD/CAD: The equity curve makes new lows when it is traded in a trend-following approach.
Now you see that the equity curve is moving down.
So the lesson is this. Different markets behave differently. If you know the behavior of the market, you can increase the statistical odds in your favor.
Holy Grail does not exist
Why? Everything is simple. Any trading strategy is designed to profit from a certain "pattern" in the market. But, as you know, the market is always changing. It can move from an uptrend to a downtrend, from a range to a breakout, etc. This means that a trading strategy can only make a profit under certain market conditions before it goes into a drawdown when market conditions change.
Trend followers make money in trending markets but fall into a drawdown when the market enters a range. So, if you agree with what I just said, then you can understand why the Holy Grail does not exist.
But the good news is that you don't need the Holy Grail to be a consistently profitable trader. All you need is a trading edge and consistency in your actions.
Proper risk management
Imagine there are two traders, John and Sally. Both of them start with a $1,000 account.
- John is an aggressive trader and he risks $250 on every trade.
- Sally is a conservative trader and she risks $20 on every trade.
Both use a trading strategy that gives a win rate of 50% of the time with an average risk to reward ratio of 1:2. Over the next 8 trades the results are: loss, loss, loss, loss, profit, profit, profit.
Here is the result for John:
— $250 — $250 — $250 — $250 = deposit drain
Here is Sally's result:
- $20 - $20 - $20 - $20 + $40 + $40 + $40 + $40 = + $80
Do you see the power of risk management?
As a trader, you will regularly take losses. But with proper risk management, you can contain those losses until they feel like an “ant sting.”
Trading is a get-rich-quick scheme
You are probably thinking, “Then what is the point of being a trader? I want to make money fast so I can quit my job." "I've heard of traders who take a few thousand dollars and turn it into millions."
Yes, you can make big profits from your trading in a short period of time. How? All you have to do is risk all your capital on one trade. And if the risk/reward ratio is 1:1, then you can double your trading account.
But this is not rational. Because if you face one loss, it will mean the end of your deposit. So how do you approach trading?
Use the "get rich slow" scheme. If you stick to this principle long enough, you can increase your score to 7 digits or more.
Let's say you have a trading account with $5,000. You deposit $5,000 into your account annually. You earn an average of 20% per year Now if you do this consistently for 30 years, do you know how much money you will have?
$8,278,170. Yes, you read that right, $8,278,170. In other words, when you think about the long term, any amount is not the limit. Unfortunately, most traders are fixated on the moment when they lose sight of the big picture and want to get everything at once. Don't be one of them.
Use diversification
I wrote that there is no holy grail because market conditions are constantly changing. But what if I told you that there is a "secret" technique that allows you to make a profit even in various market conditions.
So here's how it works. You must diversify different trading strategies. Thus, if one trading strategy is ineffective, another profitable trading strategy can "soften" the loss (and possibly even keep your portfolio in the black).
“But what if both trading strategies fail at the same time?” That's a good question. The key here is to trade multiple uncorrelated trading strategies you are using. Let me explain.
Here you see the result of testing the trend following system from 2000 to 2020.
As you can see, there were 3 unprofitable years here in 2009, 2012 and 2018. This is a decent trading strategy, and it has its drawbacks.
So how can we improve this? By adding another uncorrelated trading strategy. So, let's add another trading system to the portfolio - a stock reverse trading system.
Here is the result of the rollback of the stock trading system from 2000 to 2020.
For this trading system, we had 3 losing years in 2008, 2011 and 2018.
Now, what if we assign 50% of our equity to a trend-following system and 50% of our equity to a reverse stock trading system, what would be the performance of our portfolio?
As you can see, we have only 1 unprofitable year (instead of 3, which were earlier). Now do you see the power of diversification?
If you want to achieve higher returns than risk, you can diversify between 3, 4 or even 5 uncorrelated trading systems.
It is important to have another source of income
No matter how good you are as a trader, you will experience losing streaks, weeks and maybe even years. If you don't prepare for this, you will run into financial difficulties. And in a situation like this, it's hard to make good trading decisions because you're trading money you can't afford to lose.
You can average out your losses hoping to get them back quickly or widen your stop loss so you don't lose your money.
So what can you do about it? Well, here's where another source of income helps. It could be a job, an online business, affiliate marketing, etc. The more sources you have, the better.
You should focus on digging the well until there is enough water in it before moving on and digging another well. Otherwise, if you dig many wells at the same time, you won't have any water left because you haven't dug deep enough. The same is true for creating multiple streams of income.
Indicators are not evil
Often I have seen traders lose money and blame the indicators for it. They say things like, "Indicators are lagging tools, so they don't work."
However, price action, candlestick and chart patterns are also lag tools.
The daily timeframe candle is formed only after the market closes. A chart pattern can only be formed after a series of candles. Isn't it a lagging tool?
So my point of view is this: Yes, indicators lag the market, but that doesn't mean they're useless.
How to use trading indicators correctly? Here are three things you can do.
#1: understand how the trading indicator works
You need to know what causes the indicator to go up (or down), how the value is calculated, and what its concept is. For example:
How does the moving average indicator work? Well, this is an indicator that calculates the average price for a certain period and is displayed on your chart as a "wavy line".
#2: Know the purpose of your trading indicator
Once you understand how an indicator works, the next step is to learn its purpose. In other words, what can it be used for?
So, using the moving average as an example, it can be used to identify the trend, define your value area, manage your trades, etc.
#3: Use no more than 1 indicator from one category. This means that you should not have multiple indicators with the same target.
If you are using a moving average to determine the trend, don't add the ADX indicator because it serves the same purpose. Or, if you are using the RSI indicator to identify overbought/oversold areas, then don't use the Stochastic indicator because it behaves in a similar way.
Know your trading timeframe
Most charting platforms allow you to trade on multiple timeframes such as 5-minute, 1-hour, daily, weekly, etc.
Just because you have access to multiple timeframes doesn't mean you have to use them all.
If you are trading on the 15 minute timeframe, then the monthly timeframe doesn't matter because it is too "far" from your trading timeframe.
“So how do you know what timeframes to pay attention to?”
- Determine your trading timeframe.
- Determine the higher time frame using a factor of 4 to 6.
In other words, you must know the time frame that suits your trading style. Here are some recommendations:
- If you are a day trader, you can trade on timeframes from 5 to 30 minutes.
- If you are a swing trader, you can trade from 30 minutes to 4 hours.
- If you are a long-term trader, you can trade from the 4-hour timeframe and up.
Determine your higher time frame using a factor of 4 to 6.
If you are trading the 15 minute time frame, then the monthly time frame is irrelevant because it is too far away. How to find out which timeframe is more appropriate?
This is where the 4 to 6 ratio comes into play. Take your trading timeframe and multiply it by a number between 4 and 6.
Your trading timeframe is 15 minutes. If you multiply it by 4, you get 60 minutes. This means that your higher timeframe is the 60 minute chart. Now you can also use a factor of 5 or 6 if you prefer. But whatever multiple you choose, be consistent with it.