Simple trading principles for success
The difference between success and failure in trading is simple:
Successful traders:
Develop a clear trading objective.
Establish an iron-clad trading process.
Practice discipline and humility.
Control their emotions in any market situation.
Make no mistake: trading is hard work. No one wakes up one day and proclaims that they are going to be a wildly successful trader. It’s the same as waking up when one day and stating that you will take on a new profession. There is no easy button.
Just like any new skill – you have to learn, practice, identify your mistakes, correct, and iterate. If you put in the effort – your account will reap the benefits.
Below are a series of simple perspectives and guidance from our trading journey. This isn’t a complete guide - it is meant to give you a jumpstart in understanding the basics.
We have separated this article into three sections:
Trading basics
How to manage wins
How to control losses
A. Trading basics
1. Never confuse investing with trading
Investing for the long term and trading for the short term are two very different approaches to growing your account. They should never be confused.
See the image below – long-term investors and short-term traders have completely different growth objectives, views towards a stock, routine, investing timeframe, and risk management.
This is why we always ask the question: Are you investing for the long term? Or are you trading for the short term?
If your focus is primarily short-term – make sure you have a specific trading plan and a methodology that will allow you to be successful (we go into these details below).
On many occasions, we have met investors who want to become traders and apply the rules of investing to trading.
STOP! That does not work! Step back and assess your objectives before getting into trading.
if 2020 has taught us one thing - it’s that investors who had never traded before got cocky and thought they could become traders. After 2021, it’s unlikely that they will make this mistake again.
2. Never invest and trade in the same account
You ideally should PHYSICALLY SEPERATE your trading portfolio from your investing portfolio.
Separating portfolios allows you to establish a clear boundary between your strategies. If you co-mingle strategies within the same account, you risk confusion and failure, especially on your trades. Comingling strategies also limits your ability to truly assess if you are performing well as a trader.
The only exception to this rule is when investors want to trade around a core investment. This is a slightly advanced strategy where an investor may hold a core position and sell an intermediate top, and buy back a dip to reduce their cost basis. While this is an acceptable practice…not everyone can execute it with discipline. In order to do this correctly, you will need to sharpen your trading skills and have excellent mental discipline first.
3. Understand your starting point and your growth objective
Every single trader has different starting points and growth objectives. Be realistic about your growth objectives as it will dictate how much risk you need to take in order to grow your account.
For example – you are starting with a $10K account.
What is the purpose of your trading account? It could be used to generate living income or to buy a car, or a house. Establish the goal.
Identify a growth target and a timeframe. Do you want to grow it to 20K or $50K in 1 year?
Growing your account to $50K in the same timeframe will require you to take significantly more risk than growing it to $20K.
If you are unable to stomach that risk, then you need to revisit your growth objectives.
Don’t fool yourself into thinking that you can obtain significant results without taking risks.
Pro tip: Never compare your growth objective to someone else. In fact, don’t compare yourself to anyone else - period!
4. Develop a trading strategy – make it your own
Once you have identified your growth objective and timeframe – you need a strategy to get there.
Successful traders always develop a few strategies to make money. The strategies don’t have to be complicated. However, you need to WRITE DOWN what you are going to do to grow your account and determine if this approach will help you achieve your intended outcome.
There are a TON of trading strategies out there:
Trading in and out of 3x Leveraged ETFs
Trading weekly options on highly liquid momentum names
Selling covered calls or cash-secured puts over a period of time
Swing trading momentum names
Swing trading crypto names
A combination of the above
…
At SMA Pro – our primary trading strategy is swing trading momentum names using our industry leaderboard. When the markets are healthy, we layer options on top of our swing trades for additional juice.
If you don’t have a strategy and a plan…how will you consistently grow your account?
5. Establish a trading rhythm
Your trading strategy will dictate your rhythm for each day and week. Identifying and following this rhythm is the first part of developing discipline as a successful trader.
For example – if you are trading momentum names, your daily rhythm could include:
Identifying the market direction
Identifying potential strong momentum stocks in outperforming industries (using fundamental/technical analysis)
Defining the setup, entry, and exit ahead of the next trading day
Setting alerts in your trading platform
Placing the trade when an alert hits
Documenting the trade in your journal
On a weekly basis, you may analyze your won/lost trades and adjust your process
Depending on your growth objectives and your trading strategy, you may not have to sit around your desk and monitor the market all day.
6. Get the right trading tools
Trading is a business. It is your business. You need the right resources to help run your business effectively. Don’t overcomplicate it – use only what you need to support your trading journey.
For example, I use the following tools (We are not paid to promote any of these tools. We just like them):
SMA Pro Industry leaderboard: Identifying the strongest momentum names in the strongest industries
Stockcharts: Technical analysis, Sector analysis
Finviz: Quick technical analysis, portfolio development, futures
Koyfin (beta): News, Advanced market dashboards, and portfolios
CML Viz: Pivot points, Stock profile, pivot points, Insider buy/sell information
CML Trademachine: Stock and option backtesting
7. Never start trading on day one
This is obvious, but worth repeating over and over:
Just because you have established a trading account, you DO NOT have permission to trade on day one.
If you purchased a car but didn’t have a driver’s license, would you drive the car on day one? You will most likely lose.
Listen: you need to earn the right to trade. Learn and internalize these rules first.
8. Practice makes perfect
If you are new to trading, you may have heard that paper trading is a great exercise to test your strategy and rhythm. This is true – but you need to quickly get your trading on a platform. You need to be comfortable hitting the “buy” and the “sell” button.
Two suggestions:
Try out a tool called tradingsim. This tool allows you to test your strategy in a safe environment and track your gains and losses
Start trading small amounts. If you have a $10K account, start trading only 2-5% of the entire account. That is the MAX risk you are placing on your entire portfolio. As you gain confidence and nail down your process you may increase your portfolio exposure.
9. Successful performance is NOT just about the percentage of wins!
The number one question we get asked all the time is “What’s your performance?”
And almost always – they want to see an equity curve and the percentage of wins. However – winning in trading is not just about the percentage of wins.
There are different formulas out there - here is one example:
Winning = (Number of winning trades x $ gained per trade) – (Number of losing trades x $ lost per trade)
Below is a simple example:
Let’s say you start with a $10K portfolio.
You place 10 trades.
You win on 5 of those trades at an average of $200/per trade. That gives you a $1000 gain.
You lose on 5 trades at an average of $50/trade. You were able to control your losses. That gives you a 250 total loss.
Your win % on 10 trades is 50%…however, you are now up a net of $750.
In reality - 1/3rd of our trades will be winners, 1/3rd will be flat and 1/3rd will be losers. flat trades are okay - they aren’t losses!
Being a successful trader is not just about your win percentage. You can potentially place the same number of winning and losing trades. However, If you control your losses, or come out flat, you can still come out on top as a trader. This is why there is so much written about risk management and loss control.
Start by winning small, and losing smaller.
10. Keep a journal of your trades
You cannot improve what you cannot measure. Keep a simple journal of your trades. A journal will help you assess your performance over time, and adjust your strategy and your tactics.
A sample journal is below. Add a column for trade notes (when you scaled in, out, and any exit/escape notes). Don’t overengineer your journal.
B. How to manage wins
1. Aim for consistency, not home runs
Your intent on every trade is to win, consistently.
Start by winning small. Small wins over time give confidence in your skill/ability and give your permission to trade in bigger sizes. Don’t show up to the trade expecting to hit a home run. Stay true to your process, show up each day and rinse/repeat. You will be surprised how quickly you can grow your account with a consistent set of smaller wins.
2. When you win, have rules to cash out
When you are up on trade – you can take half off over a certain percentage and ride the rest with a stop ABOVE your buy price. That way you always protect your initial capital and allow some exposure to allow your winners to run.
Once in a while, you might hit it big. A trade you put on may go up 3-5X what you expected. Congratulations. At that point, take the gains and walk away. You won. PROTECT YOUR PROFITS.
Don’t go back and trade the name. Your emotions are high at this point. Don’t give back any profits.
Go back to rule B1. We aim for consistency, not home runs.
C. How to control losses
One of the most important skills to develop as a trader is controlling losses. If you read any trading guide - you will notice a significant portion is dedicated to either trading psychology or managing losses. Why? Most traders don’t fully understand their risk appetite until it’s too late. Loss control is about sticking to a set of rules that fall within your risk appetite.
Once you can control your losses, you can focus on winning.
1. Never place a trade without a plan
When you put on a trade, make sure you understand what is the reward to risk ratio. You ideally need at least a 3:1 reward to risk ratio, otherwise, the trade is not worth it.
You can identify your risk by looking at the stocks price, conducting technical analysis of support and resistance points, and evaluating the maximum risk you are willing to accept to obtain your stated reward.
If you don’t have a plan for your trade, you will lose.
2. Limit your losses
In the journey of trading – you must accept that you will have losing trades.
It is OKAY to be wrong on a trade. Be humble. Sometimes the market may not cooperate. Sometimes the stock may move against the trade plan based on news or a binary event. That’s why you must define a clear, entry, exit, and ESCAPE price before entering the trade.
The moment you realize you are wrong – exit the trade. You limit your losses, free up capital, step back, and can reassess.
3. When you start trading poorly, take immediate action
Good traders who document their trades will understand and follow this rule.
IF you start noticing a couple of losing trades in a row, lower your trading allocation. E.g. on a $10K folio, if each position was $1000, bring the position size down to $300. This will lower your stress level while you focus on getting back to a winning trade.
If you continue to lose, stop trading for the day and take a walk. DO NOT OVERTRADE. Clear your head, spend time with your friends and family. Come back later in the day, assess what did not go in your favor, and retry with a smaller trade allocation.
This even applies to situations when the Market is choppy or not cooperating.
4. Never turn a winner into a loser
This is the opposite of rule B2. And this has happened to all of us. We have a trade that’s working well and all of a sudden, the trade that was positive has gone negative. In many cases, we have violated this rule because of greed. A stock that went up 10% was not enough – we wanted 20, 30, or 40%.
Do not let this happen to you. Follow the process outlined in Rule B2. It is only one trade, and it should not break your overall performance.
5. Never hang on to big losers. It will hurt you psychologically
A big loss is one that exceeds your risk/reward threshold. For example, what was supposed to be a 5% loss could become a 50% loss. Most traders will deceive themselves by saying that “it will come back” or “it is not a loss until you sell”.
However, a big loss can psychologically and emotionally drain you. It’s a big heavy anchor that you have to stare at every day when you open your portfolio. Your hard work to build up your track record of winners will be wiped out. You will likely never recover from the loss. You will lose your confidence to trade.
Arithmetically obvious but non-intuitive facts about recovery percentages:
60% down —> 150% to recover
50% down —> 100% to recover
40% down —> 67% to recover
etc.
When you end up with a big loss, DO NOT do the following:
Feed more into the loser – the damage is done, do not throw away good money after bad.
Blame the market – The market, while incredibly humbling, is never at fault for a loss. You must claim responsibility and be held accountable for your own trading actions.
Try to make it back later – After suffering a big loss you must clear your head and reset back to zero. Each day is a fresh start and you should not dwell on the past, all you can do is not make the same mistakes again and move forward.
Drastically change your strategy – chances are the strategy is fine. Go back and review your trades to see if you followed your setups exactly.
Protect yourself from this event. Live to trade another day.
Trade wisely gang,
Les & Stevin (#SMAPRO)