Component of Successful Trading

Component of Successful Trading

We believe that there are three essential components for successful trading;

1. Money Management

2. Risk Management

3. Forecasting ability

We know of too many cases of traders who have lost everything on a single trade. It is only possible to lose everything on a single trade by risking everything on a single trade. A trader may make big money a few times by doing this, but as a policy it is a recipe for disaster. Conservative money managers will never risk more than 5% of total capital on a single trade. The market is very efficient in transferring money from the impatient investor to the patient investor.

Concerning risk-management, protective stops are a powerful tool for self-discipline in day trading. Stops should never be below round numbers on long positions and above round numbers on short positions -- to reduce the chance of being stopped-out at the same time as other investors (who have a fondness for round numbers). Round numbered stops typically increase slippage, i.e. extra loss beyond the stop due to a bad fill of the stop order. Fast price movements increase slippage.

Stops are also a way to get yourself cut to pieces if they are too close to your current position. The market must have some slack to make excursions up and down on the way to your desired destination. More often than not, when we are worrying about what the stop should be, it is a sign that it should exit position (sell-out if long, buy-out if short). We always prefer to be in control of when we exit position. Stops have probably cost more money than they have saved because of sudden & temporary spikes in price. (There was a significant exception.)

Excessive confidence in one's forecasting ability is dangerous. A good forecaster who is right more often than wrong, who always knows how much money she/he has available and who does not risk too much money on any one trade is most likely to succeed.