10 Steps to Profitable Trading

The secret to winning big in the market is not to be right all the time but to lose the least amount of money possible when you are wrong. As long as you win larger than you lose, you will be a profitable trader at the end of each year. Pride, ego and stubbornness prevents a trader from reaching the levels that very few can master.

To become a profitable trader, you must:

  • 1. Manage Risk: Learn to trade a manageable portion of you portfolio (I recommend to risk less than 2% of you overall portfolio equity on each trade). Always establish a risk/reward ratio before making a trade. Without the ratio, how do you know your risk?
  • 2. Understand Position Sizing: All traders must learn to know “how much” to trade on each position. Do not overtrade or you will runt he risk of ruin. Position sizing is rule number one of managing risk.
  • 3. Cut Losses: Do not allow losses to run wild. You must learn to cut losses and understand that losses are a part of the game, a large part of the game. Check you ego of winning at the door. We are here to make money, not go undefeated. Play sports if you want to keep score with a record rather than your bankroll.
  • 4. Learn when to Sell: You must learn when to sell. Selling is more important than buying as it ties directly to risk management. Use stops if you haven’t yet developed the discipline to get out at your predetermined stop or profit goal.
  • 5. Average up in Price: I will never hesitate to add shares in a stock that is moving higher (see Mastercard) but I always avoid averaging down. Remember, cut losses and never throw good money after bad because we know that’s a quick way to the poorhouse.
  • 6. Have Patience: It takes years to master trading as an advanced skill; even then, you are never done learning or adapting.
  • 7. Buy 52-week Highs, not 52-Week Lows: Don’t be afraid to buy stocks making new highs. The garbage sits at the bottom of the market along with poor earnings, weakness and further downward pressure. Buy strength and the momentum moving higher. Stocks are typically priced at the levels they trade for good reason. This applies to most premium items in life.
  • 8. Ignore the Talking Heads: Do not listen to the stories, gossip and rumors flying around on network television, stock forums or the major financial newspapers. It a surefire route to bad information and clueless advice. Do your own research; you’ll come out much further ahead. This applies to crappy blogs and internet sites as well.
  • 9. Understand Technical Analysis: Fundamental analysis is a solid part of my trading system but technical analysis brings in the dough. You must learn, understand and use technical analysis on a daily basis. Fundamental analysis tells me what and technical analysis tells me when, where and how.
  • 10. Control Emotions: Enough said – You must control your emotions or the game is over! Understand you!

Comments

  1. An excellent article.
    If I might add one more rule – a trader needs to let his (few) real winners run and avoid the temptation to take profits prematurely.

  2. Good summary of rules you have here, In Rule 1, you recommend trading with less then 2% of your overall portfolio. What about the other 98%? Perhaps invested with professional money managers? It doesn’t leave me with a confident feeling when somebody only puts 2% of their money into their own system. Something like 10% I feel would be reasonable. 100% would be crazy.

  3. Random,
    I see you misunderstood the statement and don’t read the blog often. I risk 2% max on each position. For example, a $100k account would only risk $2,000 at MAX on a position. The position coule be for $20,000 but the risk is only $2,000 or 2% of the entire portfolio.

  4. Random commenter says:

    Did it say “on each trade” earlier today, if so, then my error, I should read more carefully. If not then I think it’s a good revision for you to make.

    And you are correct I don’t read the blog often. I just read your ‘position sizing’ page yesterday and now that the “on each trade” has been clarified, then I agree. Don’t want to risk too much on each trade. I see some coworkers ‘betting’ it all on 1 or 2 stocks then wonder why they get wiped out. They don’t have any money management rules.

    Anyhow, nice blog, added your RSS feed to my reader.

  5. It was a revision I made after reading your comment. You made me realize that it may not have been clear to new readers. I must be more careful when assuming who reads the blog.
    Enjoy.

  6. Hi Chris,

    Great post! I want to include you in the new book. Could you email me; I seem to have misplaced your contact info. Thanks–

    Brett

  7. Brett,
    Thank you – I sent you a private e-mail.

  8. Justice Nature says:

    Excellent article, thx! I’m fairly new to the investing game. I’ve dabbled in the past – without any strategy. Of course, I lost out.

    This time around I want to arm myself with technical and fundemental analysis knowledge (and possibly trading strategies). I’ve searched online and am overwhelmed with information – I have no idea what I should buy/study and what is a load of hot air. I would appreciate any recommendations with regard to DVD’s or books that people have found useful (possibly enough material so I can get started in trading small amounts). (i’m thinking about short and medium term trading – I’ve heard 95 % of day traders fail – any opinions onday trading?)

    Thanks for taking time with a newbie.

    Regards
    Justice

  9. Just came across your blog – very impressive,added you to my blog roll as you have excellent advice for new (and old) traders -

  10. Good advice! I’m a newbie trader.
    I’ve been following your blog for quite a while now. Something I have learned is that no matter how much I learn, read, or know the theory of how I ‘should’ trade and ‘when’ I should trade, in practice it’s a whole different game. You really learn about yourself and see how you will react in different situations.

    I have a question about taking losses…if I enter a position and in a few days the stock drops to my set loss% It would be beneficial for me to exit right away because it shows that I have chosen the wrong entry point? (That is if I know the stock is not volatile for example.)

  11. KM,
    If it hits the stop: sell. You can always get back in. No questions asked.

  12. Great post!
    I find that of all the 10 points, the last point is the most difficult yet the most important for all traders to master.

    Regards,
    Options Trading Beginner

  13. Good content. One should strictly follow the rules. Stumbled!

  14. Excellent blog and excellent advice – espacially the bit about selling and stop losses – a ten per cent loss, a fifty per cent loss can be a disaster, especially if you repeat the experience a number of times (blush) !

  15. Nice list. I would however disagree with the premise that it’s ok to average up but not average down. I would suspect that you are a trend trader rather than a contrarian trader. When the market moves opposite to the fundamentals (and especially to some of the indicators like the Tick) it can mean there is an edge and a reversion to the mean is imminent. Many a time I’ve bought in (long or short) too soon and when I see that but I also see that my reasons are still valid, I will add to my position even if it’s moving the wrong way.

    Case in point. Thursday I saw the indicators showing a market in the process of topping out. The buzz was all about the GDP but underlying it was a decelerating economy. I went short after the early move higher and then kept adding to my position even as the market moved higher.

    Friday I made a small bundle and am happy. I didn’t “let it ride” too long and I didn’t buy the big move on Thursday.

    How many would have bought the rising market on Thursday, adding to their position as it rose only to see it evaporate the next day?

    Following the herd usually leads you off a cliff…

  16. Marc,
    Point well taken but I don’t day trade so the intraday and short term daily movements don’t mean anything to me. I won’t put good money after bad if the trade is moving against me.

  17. When I first started investing, I just could not get myself to believe that buying at highs was better than buying at lows. However, over the years, I have come to realize that every winner I buy into keeps on winning and every loser I buy into keeps on losing. That isn’t to say you can’t pick up bargains or get burned on overpriced junk, but everyone said Apple was overpriced when I picked them up at $30 per share four years ago. They were firing on all cylinders and have continued that trend ever since.

    Heed #7. Buy winners…not losers!

  18. Just wondering what your thoughts are on investing solely in an Index 500 fund. I question whether anyone really can beat the market year in and year out. The amount of research it takes to make an educated investment decision is mammoth. How can one expect to be diversified and still do all that research?

    Your thoughts?

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