One of the great curses of the casual trader is early success. Having won big on their first few trades without understanding why they won or what would happen if the trade went wrong, bad habits get hard-wired into their trading psyche.
Then, when a trade does go wrong, their trading style resembles a game of roulette: if the ball lands on black six times in a row, the next one has a higher probability of landing on black, so the reasoning goes (it doesn’t, the odds are still 50-50).
Translate that to the financial markets, and it’s easy to see where trading can go awry.
“Trading like a professional does not mean you have to do this full-time, but we can see from our stats that there is a corps of highly disciplined traders making consistent profits,” says Jacques de Beer, operations manager at financial services provider and over-the-counter derivatives provider QuickTrade.
“We’ve looked into this in some detail and there are some attributes that separate the professional from the casual trader. Obviously, we want all of our clients to win over the long term, so we share these insights as a way of improving their trading performance.”
Here are some of the key takeaways:
1. The professional waits for a high probability trade set-up, then enters the trade risking no more than 1% to 2% of capital. The trade may initially go against the professional, in which case further small positions are added. Should the trade continue to go in the ‘wrong’ direction, the professional exits the trade at a pre-determined stop-loss level to prevent further losses. In the case of a winning trade, the professional has enough composure to ride the profits, usually exiting some or all of the positions at the next resistance level (as defined by the charts).
The hobbyist cannot look at a trading screen without taking a trade in the mistaken belief that trading is a job that requires action (it doesn’t). This is a gambling mentality that leads to a host of associated problems: they hang too long to a losing trade until a good portion of their capital is wiped out, and they are forced to exit at a massive loss.
They also tend to double-down on losses, believing the trade will eventually turn in their preferred direction.
Many a fortune has been lost waiting for the market to turn.
2. Conservative position sizing: the professional will not over-commit capital to a single trade, recognising that their capital must be preserved. They will not risk everything on a single trade. They are in it for the long haul, taking a five- to 10-year approach to capital growth. They are prepared to accept losses early and let their profits run, understanding that this approach allows them to lose perhaps half of their trades, but still come out on top.
The gambling mentality of the hobbyist takes over when it comes to position sizing. They will risk 20% to 50% of their capital in a single trade, and will avoid exiting the trade when it goes against them, believing that the turn in the market is imminent. This can very quickly wipe out their capital. The hobbyist is also inclined to exit a winning trade too early. The result is small wins, far outweighed by big losses.
3. Over-trading: the professional may wait days or even weeks or for the right trade entry. Many focus on range-bound markets, buying a financial instrument when it hits the lower range and selling when it hits the higher range. This method has some workability but fails when markets break out of that range, in which case they exit the trade quickly before losses become too severe. Other professionals are trend-based traders, operating on the observed experience that a trend in motion is more likely to continue than reverse. Others are ‘scalpers’, taking tiny profits on small movements in the market. They do not suddenly change their minds mid-trade and become trend chasers.
De Beer points out that the hobbyist is unsure whether they are a scalper, range trader or trend-based trader. They are prone to changing their minds mid-trade, increasing the probability of a winning trade turning into a loss, or, in the case of an already losing trade, allowing the losses to deepen.
4. Professionals are students of the markets. Yes, they rely heavily on charts and use a limited number of technical indicators to guide their entries and exits, but they pay attention to the macro trends, such as employment, production and trade data (which impact economic growth and currency movements). A contracting economy, and absent fiscal and monetary stimulus, should reflect in lower corporate profits. That information will guide the trader’s overall reading of market direction.
The hobbyist is more likely to skip the hard work of studying the markets, adds De Beer.
As a reference point, there are teams of analysts and portfolio managers who do this job week in and week out, and the best of them will achieve a total return of 20% to 30% a year (there are, of course, exceptions who will handily beat this figure).
5. Conservative use of leverage. When trading contracts for difference or CFDs (a type of derivative where you are buying the movement in the price of a financial asset rather than the asset itself), traders need to understand the concept of leverage. For example, if you buy R1 000 worth of shares on the JSE, there is no leverage. With CFDs, that same down payment can buy exposure to 500 times the value of the shares (though you never own the shares). This is fantastic when you get it right, because your profits are magnified 500 times. Conversely, losses are also magnified 500 times. Most online brokers allow you to select your desired level of leverage.
“Being a successful trader is not particularly complicated, but these are the key points that separate the hobbyist from the professional,” says De Beer, adding that QuickTrade offers regular webinars hosted by professionals to familiarise traders with the dominant trends of the day or week.
“Our experience is that those who attend these webinars and make use of our extensive educational material online tend to do better as traders. Like any craft, the more you invest in terms of knowledge and education, the better you should do.”
QuickTrade is a licensed financial services and over-the-counter derivatives provider (FSP 45262).
Brought to you by QuickTrade.
Moneyweb does not endorse any product or service being advertised in sponsored articles on our platform.