What is a Trader
Once again, Wall Street retailers have done a job on shaping our view of what investing is all about. The average investor is not a trader but they are taught to invest for the long term, diversify and only buy or sell when your broker says so. There is nothing wrong with that and most investors are happy if their portfolios are near the index benchmarks. It’s a fairly low risk way to invest if done over the long-long term. But there are is growing number of investors who are becoming more interested in trading.
A trader makes short term trades-from several minutes up to holding a position for several months. Traders thrive on stock, bonds, ETFs, options, futures-you name it. If it moves-or doesn’t move (options can make money on stagnant stocks!)-it’s fair game for the trader. The basic concept being that even small gains can add up to big annual returns if done frequently. As a matter of fact, in terms of probability, the more trades the better.
The philosophy behind trading is that if a trader can have a win-loss ratio of above 50-50 (chance) and have a system that requires profits to be at least twice the margin of losing trades, the math comes out favorably over a number of trades over time. In other words, if half your trades have a losing margin of 6% and the other half (your winners) have a margin of 12%, you will come out a winner-over time. If this happens on multiple short term trades, even a 6% profit margin can add up to an eye popping annual return.
But, losses will happen…and pretty often. The key is to pull the trigger quickly on losses (have tight stops) and play the probability. Even the best traders are happy campers if their trading system has a win-loss ratio of over 65%. But they know how to take the loses in stride and stick with the system. Knowing how to lose is the real hooker. How do traders get over the emotional issues of losing that are deep seated in all of us? The answer is: practice and confidence.
First, a trader develops a system which incorporates a methodology to analyze and pick high probability winners. They also have a strict set of rules as to how much money to trade (usually a small percentage of their trading capital) and procedures to be followed regardless of what their ego and hearts tell them. They develop the confidence in their system first by paper trading for months until they get a feel for the win-loss ratio over at least hundreds of trades. Once they have a system, confidence using it, and a strict set of trading rules that they adhere to regardless of sentiment, hunch or peer pressure, a trader is born. This is where the rubber meets the road. Above all else, a trader must have iron discipline.
More on becoming a successful trader in subsequent articles.