ForexSpirit

One of the very first statistics that most people come across as they start out on their trading adventure is that 95% of traders lose money. I’m sure that each and every one of those people thought to themselves, “I’m going to be one of the winning 5%”. I know I certainly did.

Another revealing statistic that people might not be so familiar with comes from a study of the 1980 U.S. Department of Labor Statistics and Mortality Tables as to what happens to people between their twenty-fifth and sixty-fifth birthday: only seven percent of them became financially secure enough to retire comfortably. That leaves 93% who achieve poverty.

95% of traders lose money; 93% of people in the U.S., the most successful and prosperous nation this planet has ever seen, end up broke at the end of forty or fifty years of work. An uncanncy parrallel don’t you think?

What should these figures tell you?

To me it signifies that the commonly held wisdom on how to make money is wrong. Similarly, the commonly held wisdom on how to trade is wrong. If the commonly held wisdom was right then every trader would be rich, and 93% of the US population wouldn’t be retiring in the poor house.

Throw out that common wisdom and focus on what helped those who were successful get to where they are.

You don’t need to re-invent the wheel on how to become a successful trader. You could try and do it all on your own, but why would you want to go through all that hardship and struggle? Find a successful trader who you admire and respect. Someone whose methodology meshes well with your personality.

Thus the first key to trading success is to have a mentor.

We have all had, hopefully, great teachers in our life. They helped us achieve knowledge, avoided pitfalls and problems along the way, preventing us from making the same mistakes that others have made. A mentor should be able to transfer knowledge of techniques and insight that results in a much faster educational experience for the student, compared to having to learn everything on their own. The mentor can help steer the student’s progress, helping them in areas where they are naturally weak, and letting the student tackle on their own areas where they are strong.

I have learned more and gained more confidence in my own trading abilities in the one year that I have had a mentor than in the previous three or four years that I struggled on my own.

The second key to trading success can be summed up by one of Einstein’s famous quotes: ‘Make things as simple as possible, but no simpler’. When I say simple, just how simple do I mean?

Pretty damn simple. You should be able to explain your trading methodology to a six-year-old, and have them fully understand it.

Trading is not rocket science. Wall Street, and by inference your retail broker, would like to make you think different, with their huge array of researchers, analysts, quants, automated mechanical systems and other magical seeming flashy gadgets.

To look behind the curtain and see that the Wizard ain’t all he seems, all you have to do is be aware of hedge fund companies such as Long Term Capital Management, who collapsed spectacularly back in 1998, even with all the Noble-prize winning economists on their staff, or the huge loses suffered by Amaranth (another hedge fund) earlier this year. These ‘black swan’ events happen all the time, no matter how much the number crunchers on Wall Street would have you believe that that one in a billion chance will never happen in our lifetimes.

The markets are made up other people. Flesh and blood human beings just like you. Fear and greed drive those people to make their decisions to buy and sell. Simple. Keep it simple.

How do you keep your trading methodoly simple? Get rid of the fluff, so that you can focus on the important core factors. Once you are an expert on the basics then you can broaden your range.

There are four core factors that I was primarily taught to focus on by my mentor, and which are described in more detail in the book Bird Watching in Lion Country. I will go through each of them briefly, to show how keeping things as simple as possible is to your advantage.

One currency pair
In the world of investing, diversification can be a very good thing. On the other hand, when you want to actively trade and make your gains through speculation, then you need to specialize as much as possible to start with.

Since I focus my trading pretty much exclusively on the arena of forex trading, all my examples will deal with this area.

Working with just one currency pair allows you to focus on just the factors that affect that pair. You are able to learn the ins-and-outs of the two currencies that make up that pair.

With the US dollar still as the world’s reserve currency, the vast majority of foreign exchange transactions that take place on any given day are US dollar denominated. This is why the majority of forex liquidity is found in the following three pairs: EUR-USD, GBP-USD and USD-JPY.

Pick one of these three main pairs and get to know it like the back of your hand. There will be nothing stopping you from trading multiple pairs in the future, when you are more experienced and knowledgeable. Working with multiple pairs to begin with only increases your workload, when what you need to be doing is minimizing your workload so that you can focus on the other aspects of your trading approach.

One direction
One of the main factors that will make up your trading edge (the core reason or rationale of how you are able to take money from the market) is derived from picking the long-term directional trend that your chosen currency pair is currently in. The rational for this is again to simplify things as much as possible. Forex markets are well known for being well-trending markets, where price moves in the same direction for long periods of time. The reason for these one directional moves over such a sustained period of time is generally driven by the economic fundamentals of the countries whose currencies make up the currency pair.

In the more short- to medium-term, the currency will do one of three things: move up, move down, or move sideways.

When you know what your one direction is you are then only allowed to place trades that are in line with that direction. For example, if your one direction is long on the EUR-USD pair, then you will only ever place buy (long) orders.

By trading in only the direction of what we have identified as the long-term trend direction, we are able to make money on moves that move up or move sideways. We will only have to sustain loses when price moves down.

Your mentor can certainly help you in deciding what your one direction should currently be. As the economic reality of the countries that make up your pair change, you have to decide if your current one direction should change or stay the same. You must use your brain in making this decision, and keep using your brain to re-evaluate it on a constant basis.

Another added benefit of only trading in one direction is that you won’t keep constantly second guessing yourself if you allow yourself to enter both long and short positions at any given moment. The constant, random tick price movements that exist at very short time frames will only cause you cause you undue anxiety and stress.

You will also learn to be patient if you restrict yourself to only trading in one direction. If price is currently moving against your one direction, then you have to learn how to exercise restraint, and wait until price has retraced to where you think it will bottom out before moving back in your one direction again. You soon come to learn the huge importance and advantage of how not trading is part of a successful trader’s arsenal.

Low gearing
Gearing is a term used to describe how much money you will use on any given trade. It is a core factor in understanding how you will manage your money.

Since, as part of our simplification process, we have chosen only one direction in which we are allowed to place trades, and that the direction is based on the long-term trend we foresee, we must prepare ourselves for large price movements that go against our one direction. All price movement involves retracements that occur frequently during any trending move. To withstand such adverse price movement, while at the same time allowing our trades time to mature into positive territory again, we must only allocate a small amount of capital to each and every trade. This will allow us to ride out such retracements.

It is imperative that you preserve your trading capital at all costs. The longer you can stay in the trading game the more chance that you will have of learning the necessary skills and techniques to survive and thrive.

Don’t get greedy! Trade using low gearing, prefereably through a broker that allows you to use micro lots, so that you can allocate the correct lot size to each trade entry based on how much available equity you have in your trading account.

Cut profits short, let your losses run
This core factor flies against most of the teachings that you will come across from other traders. While at the same time, it is a successfully used technique in the world of stock and mutual fund trading.

All you have to do is remind yourself that 95% of traders lose money. I’m sure the vast majority of those traders did some research and came across the mantra of ‘cut your losses, and let your profits run’. It didn’t save them from losing money, and more than likely, it won’t help you either.

Trading can be a fickle game; you have to take your profit whenever you can. Remember the ryhme you heard as a kid: ‘An apple a day keeps the doctor away’. In the trading arena it’s: ‘Profits every day keep the bailiff away’.

Of course, what this means in practice is that you will end up taking small, frequent profits. Since loses are a fact of trading life you must also know when you are going to take them and why. You take loses when the fundmental reasons why you are entering trades in your one direction begin to no longer hold true.

To be profitable you only need to have your numerous small profits exceed your rare larger loses. If price is rangebound or moves in your one direction then this scenario will hold true and you make money. In cases where price makes a sustained move against your one direction you will experience loses. Since loses are an everyday part of a trader’s life, you have to learn to take these loses in your stride as you continue be forward looking, focusing on the future direction of the market. Again, the process of preserving your capital is paramount, which is why using low gearing will result in relatively minor losses compared to what you might experience if you utilize the full leverage that many brokers provide.

In the long run (i.e. over the months and years), if your reading of the market is correct, and you have been able to keep on the right side of the long term trend more often than not, you will have achieved what 95% of traders are unable to: profitable success.

Having such mental fortitude to handle all the various emotions that are part and parcel of a trader’s every day activity is paramount. The third key to successful trading that I want to cover is how to achieve this mental strength.

A trader’s psyche has a huge influence on their ability to make decisions and perform to the best of their ability. Every person is different, and thus every person has their own mental strengths and weaknesses.

It is important to make an effort to discover what your mental weaknesses are, and to try and either eradicate them or else to turn them into strengths. This can only be achieved by pursueing a journey of personnal development. This is one of the most rewarding aspects of being a trader; being always on the lookout on how to better yourself.

The importance of a trader’s psychology can not be understated. Once you have been trading for a while, you really do begin to see how vital this aspect is in becoming a successful trader.

If you’ve always dismissed how much impact your own psychology has on your performance as a trader, I urge you to take active steps to at least learn the basics. Especially on how the mental programming that we have acquired throughout our lives can be impacting on our thinking and decision making processes.

While there are many different roads to trading success, there are a few key points that can help us to get there without having to experience misfortune and misadventure:
1. Find a mentor and learn from their experience. The easiest way to be successful is to emulate that success.
2. Keep it simple. The marketing glitz put out by Wall Street and other trading marketers is just a smokescreen. You don’t need to know or understand everything to make money trading. You just need to know enough, and if you keep things simple you have a better chance of figuring what that is. Examples of using the four core factors discussed above can be found throughout my Journal postings.
3. Be self-aware. Don’t allow self-sabotage to ruin your chances. Always be on the look-out to improve yourself. In time, you yourself and those around you will thank you for it.

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This post was submitted as part of the 48th installment of the Carnival of Investing.