With record numbers of people now trading the stock markets online and technology making it easier for them to do so, it's hardly surprising that the amount of people losing their hard earned savings has risen substantially too.
When you consider that the majority of people entering the markets for the first time have little or no market knowledge, or any kind of trading strategy, this really isn't a surprise.
With a lot of traders just after quick returns and almost treating the markets as some kind of an atm machine, or global casino, the potential for losses of a sizable nature is higher than ever.
With this in mind, and if you are serious about trading the markets successfully and safely. I've put together this list of 10 things that I consider to be absolutely essential to stock market success based on my own experiences over the last 20 years.
1. Learn to Read a Chart Correctly
I still find it amazing how many people still attempt to trade the markets with totally inadequate or no chart reading skills. This is THE most important thing you need to learn before you even think about starting to trade.
Ignoring this basic but essential skill is like jumping into your car and trying to drive to somewhere you've never been before without using a GPS or a map.
You are ultimately going to end up lost, confused and in trouble, it's as simple as that!
The chart is your road map of how a stock has performed over time, it shows you the trend direction, the support and resistance areas and the action of the smart money, if you know what to look for.
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2. Understand the Trend Direction and Trade With It.
The best piece of advice I could tell anyone who is new to the markets is to understand that "The trend is your friend". To ignore this is like attempting to swim against the tide. It's Hard work, frustrating, and you will increase your chances of failure.
If we can identify the trend direction (and it's always best to look to a larger time frame), then we can confidently buy the pullbacks or sell the spikes as they occur within the trend.
For example, if we were trading to the long side then we would look to buy at or near support levels or at the lower edges of the trend channels. It is at these places within an uptrend that the risk to reward ratios are most favorable. The opposite of course is true for those wanting to short sell.
Hopefully you can see from this, the importance of trading in harmony with the direction of the main underlying trend.
3. Develop and Stick to a Trading Plan
There is an old saying, "If you fail to plan, you plan to fail" and this is especially true with trading. Not only are you at the mercy of the markets, but you also have to be able to deal quickly with your own emotions.
This is why it is so important. The main goal of a trading plan is to provide a framework within which your decision making is pre-determined. This enables you to remain relaxed and unemotional, especially if things don't go quite as planned.
The problem with not having one is that if things don't play out as you expect, you'll make wrong decisions dictated by your emotional state at the time. Recklessness and poor costly decision making is usually the outcome.
With a plan, your trades will become more selective, you'll learn to wait for the trade to come to you, rather than chasing trades on a whim or because you feel the need to be in the market. It of course also needs to be flexible so that as you gain more experience, you are able to modify it.
These modifications are never made during an active trading session!
Examples of the kinds of things you need to ask yourself in order to frame your plan might be:
- Why am I trading?
- What are my goals? - Daily, Weekly, Monthly, Longer term?
- What type of markets am I comfortable trading?
- What time-frames will I trade?
- What is my trading method? - Be specific, entry criteria. stop loss placement, exit strategy, etc.
- What are my risk management rules?
- How will I keep a record of my trading?
These are just a few examples of what you need to put in your trading plan and it can be as complex or as simple as you like, the most important thing is that you have a plan.
If you want more detailed information on creating a trading plan I highly recommend the book Trading Plans Made Simple, which you can find on my Resource Page and I will go further into this important area in future posts.
4. Learn to Know Yourself
An awareness of the conscious and sub-conscious you and how you perform under pressure, is vital to success in the trading world. Being aware of your own mental state and how you learn to control your emotions can mean the difference between success and failure.
I'm sure that if you have traded for a while you will understand and would have experienced the emotional swings of euphoria and despair when trading.
Why does trading affect us in this way?
Invariably it comes down to one thing... money! How we react when our money is on the line is all tied into how we perceive ourselves.
If everything is going well, our confidence soars and we feel like the world is our oyster and that we are some kind of trading superman. The effect of this over confidence though is more often than not, recklessness, lack of discipline, violating your trading rules and over-trading.
When things aren't going well and we hit that inevitable string of losses, we get tested by a whole new set of emotional challenges. Despair, depression and self doubt now come into play, trades are held past their stops in the hope that they will turn around, the whole trading plan goes out of the window and of course losses multiply.
This is why it is so important to know yourself, and exactly how you will react under these kinds of circumstances. Why it is important to keep a trading journal, to be able to question yourself and look introspectively at how the sub-conscious you, reacts.
Will you be able to contain yourself when you are winning? How will you manage a losing streak?
As you will find, trading is a journey of self discovery, personal change and an all encompassing emotional and mental game.
5. Implement Effective Risk Management Strategies.
If you want to survive the markets, then having some form of risk management strategy in place and sticking to it is crucial to trading success.
This is probably the most overlooked part of the trading equation, and yet one or two bad trades can literally destroy your entire trading account in a very short period of time.
Trade the plan
The first step towards risk management is to have and follow you trading plan and many successful traders will, with good reason, often advise that you should "plan the trade and trade the plan". They know that this is the first step in protecting yourself if things don't go as you expect.
A stop loss is the price at which a stock will be sold and the trader accepts without question that he will take the loss. It is designed to prevent the trader holding onto a losing position desperately hoping that he/she will be able to sell and at least break even.
Setting the level of a stop loss can be calculated in a number of ways and a lot of the software programs these days have stop loss levels built into them. Support & resistance levels on the chart can be used, the boundaries of a trend channel, or other popular methods involve using a moving average or the average true range of the stock.
This is such an extensive topic that I will be dedicating a whole post to stop losses in the near future.
Take Profit Levels
As important as it may be to have a stop loss in place to prevent large losses, in order to make money in the markets you also have to be able to take profits.
This may sound absurd but it is amazing how many novice traders get into a winning trade, succumb to the emotions of greed and ride the stock to its peak and down the other side into a losing position. It is a very common occurence.
With this in mind it is essential that you identify the areas on the chart in advance, where you are prepared to potentially sell and take profits.
These take profit areas might be at key resistance areas, overbought conditions, signs of weakness like a selling climax, or a major event like an earnings report where expectations appear to have gone too high and its better to take the money off that table until volatility dies down.
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Calculate the Expected Return
To ensure that you aren't taking unnecessary risks on trades that aren't worthwhile it's important that potential future returns be calculated before taking any trade. This at least gives you the ability to compare a number of trades against each other to determine the best risk/reward ratio per trade and make the best decision.
A simple formula for this is:
[ (Probability of Gain) x (Take Profit % Gain) ] + [ (Probability of Loss) x (Stop Loss % Loss) ]
The gain or loss probability % can be calculated by looking at previous similar setups where the stock has broken out or down out of historical support or resistance levels.
6. Learn to Keep Things Simple
It's very easy for a new trader to get caught up in the complexity of the markets. They can feel that they have no chance of success unless they use a multitude of indicators, a lengthy complex trading plan and a strategy that totally over-complicates any decision making processes.
It really doesn't have to be this way and the KISS principle (Keep It Simple Stupid) is always the best strategy in my opinion. If you can't explain your strategy in 1 minute or less then it's too complicated.
Trading stocks is really just a case of setting your buy criteria, executing it once it is met, managing the trade and taking profits when your sell signal alerts you to.
So simple and yet so many people fail at it. Why?
Well I think it's because they switch from one system to the next every time they fail.
Something worth thinking about next time you beat yourself up over a failed trade and that loss you had to take, is that most of the best traders in the world rarely have a win strike rate of more than 50%!
Keep it simple, declutter those indicators from off your chart and use only 2, maybe 3 at the most. Use a simple easy to follow risk management system and if things aren’t going as planned, then get out.
You can always buy back in when things look more favorable!
7. Start With a Small Account and Grow As You Learn.
There is no reason, if you are new to the markets, that you can't start off with a small account and build it into a larger one over time. Your losses will be smaller and easier to manage psychologically as well as financially, and believe me...you will have losses.
The most common mistake I see, with traders new to the markets, is that they start with a small account and then have the quick easy money mentality. This thinking attracts a lot of players to the markets, but of course anyone who has traded for a while knows that there is no easy fast track to riches unless you are extremely lucky.
It's hardly surprising then that it is this type of trader that ends up getting totally worked over by the markets, struggles and continually fails to make any money.
These types of traders have a sense of urgency about them and the pressure they put themselves under actually puts them into a position where they over trade and also take impulsive trades.
Traders with large accounts don't put themselves under this pressure of needing to trade and this is the trap for a trader with a lot less money. You therefore have to change your way of thinking to counter this, concentrate only on trading well and your account will grow naturally.
8. Don't be Fooled by Fancy Systems Promising Quick Returns.
The promise of a systematized, easy, "holy grail" approach to buying and selling stocks is obviously very tempting to people wanting to make money quickly and it is for this reason so many expensive and ultimately useless black box trading systems get sold to people.
Let's face it if they worked and everyone was making millions out of the markets everyone would be doing it and if you were the developer why would you sell it?
Most of these systems are constructed on a combination of indicators that have been back tested and then the data optimized to show wonderful outcomes for the future.
The only thing you are really being sold when buying one of these systems is the "dream" of a fairytale lifestyle and easy money without any effort or real market knowledge.
The only money to be made is if you are the salesman selling the software!
9. Never Believe the News
If you really want to trade effectively then I would highly recommend trying to ignore what you hear or read in the news as much as possible especially when in relation to stocks or financial matters.
Most of the so called experts in the media and on forums too, have very little idea and are really only mouthpieces for the news that goes out. The trouble with this is you don't know who is feeding it and what their agenda is.
I'm sure there would have been plenty of times that you may have seen on the news a great earnings result released by a company, and yet the price goes down significantly on that day and usually ends up being the start of a trend reversal for the stock.
The smart money of course would have bought up the stock a long time in advance, in anticipation of the good earnings report and then used the good news to sell into.
Lets face it, how else are you going to create a big enough market to sell into unless you create and play on the 2 strongest and most basic human emotions, fear (of missing out) and greed.
So you can see it pays not to listen to the news, rely on the chart instead.
The chart never lies!
10. Understand That There is No Holy Grail!
My last point here is a short one, but nevertheless a relevant one and has to do with something many traders and investors waste countless dollars and time on. This is the search for the "holy grail" of trading, which I can assure you doesn't exist.
There is no perfect trading system, no piece of software that you can buy that will make you the perfect trader, nothing that will help you win in the markets 100% of the time.
The only thing that works is you and how you educate yourself and handle yourself emotionally.
Being a great trader is about trading well and handling yourself properly and having control when under stress or in moments of euphoria. It's about good risk management, growing your account slowly so that you have time to learn and ultimately only believing what you see the chart is telling you.
Forget the holy grail idea, its a false promise that will detract and distract and cost you in the long run. Implement the steps outlined in this article and you will have a much greater chance of being a successful trader than you ever will trying to find something that doesn't exist.
It’s Not Easy…
It’s not easy to trade the markets and be successful but it’s a whole lot easier when you put in the time and effort to educate yourself properly.
The fact that you are reading this means you have read through the whole of this post and that you have the urge to succeed and do well. Persist at it, continue to learn and hone your skills, learn from your mistakes, and you will get there!
Thanks so much, best of luck, and if you find this post useful, please use the sharing buttons below to spread the word!