Introduction

Whether you are an experienced financial markets trader or an aspiring new trader embarked in the initial stages of trading research, there are certain basics or fundamental trading concepts and skills you will need to learn and master that will enable you to gain an edge in the market. Gaining an edge means you will have a higher probability of winning consistently in trading over a long period of time. It is well known that vast majority of traders lose and blow their trading account; including professional traders working for investment banks and trading houses. But the few that consistently win can gain great financial rewards and go and do the things they always wanted as a result of financial freedom gained by trading. There are no trading secrets or secrets of the market but the closest thing to trading secret is gaining the psychological ability and discipline to follow a trading system that suits your psychological makeup that puts the odds in your favour. You will learn in due course that looking within Yourself is the only way to improve your chances of becoming a successful trader.

Reasons for trading

There are many players in the markets, each have their own reasons for trading. The market-makers and broker-dealers trade to profit from the difference in price between the asking price and the offer price (spread) of a security. Investment managers, commodity producers and other large players trade securities such as options and futures to hedge their investment portfolio to reduce the risks of loss. Central banks trade currency to stabilise or decrease the value of their currency. Futures and options along with other financial instrument are also used by speculative traders to speculate for profits.

Private traders or retail traders as they are known in some investment circle are mainly private individuals trading from their own modest size online trading account through an online retail broker. Most retail traders begin trading with the intention of making big money, very fast, but it becomes apparent just as quickly that making big money in markets is not easy. There are traders who want to trade for fun or recognition. The successful traders only trade to win and to increase their account size. That should be your primary reason for trading. If your intention is other than that then the market will deliver what you intend, if want fun and addiction, you will get fun and addiction but it will cost you a lot, emotionally and monetarily, and your losses will be someone else’s gain. Market is a zero sum game in a grand scale.

Winners versus Losers

On average a small number of traders consistently win in their chosen trading timeframe, whether it is daily, weekly, monthly or yearly. As for most other traders, their trading result is the exact opposite of successful traders, on average they consistently lose money in the markets, occasionally they go through a series of wins but they are unable to hold onto their gains and they go bust. The cycle of boom and bust and losses seems to go on until the trader blows the account or gives up trading altogether. If you are experiencing such erratic trading result then do not lose neither heart nor despair nor give up hope. This is the first hurdle in the long process of becoming a profitable market trader. Some of the most successful market wizards in the world initially lost money and blew their trading account few times, it seems to be the norm. Very few successful traders were successful from day one. The market wizards persevered with patient, they gave themselves the time required to learn and master the trading skills. Trading should be treated like any other profession. An Olympics gold medallist trains and perseveres for many years before getting that gold medal. A doctor study’s for five years, and then trains as a junior for few more years before becoming a fully qualified professional; even then their financial rewards are small in comparison to a successful trader who may earn many millions over the course of their career. If the rewards are so great, then doesn't that mean you should give yourself at least few years to learn to become successful? Trading seems to be the only profession where people expect to be very successful from the very beginning, such unrealistic expectation seems to be compounded by the fact that due to the easy access to online trading account, where one can open a trading within a day or two with an online internet broker, fund the account and start trading without the need of any formal qualifications in trading and investment. One can call themselves a trader even after executing few trades, but to be a successful trader you will have to treat trading as a profession. That entails devoting time, energy and a lot of personal sacrifice.

A large number of less serious traders when they realise that the path to becoming a successful of trader is not as easy they initially thought, they simply give up and their trading account becomes just another dormant account. But the few that has the burning desire to succeed in trading usually work hard to educate themselves any various ways. They search the internet for trading educational material, they buy and read many trading books, they attend trading seminars, and they even seek out trading coaches online or in person. They simply invest a lot of time, money and resources to succeed in trading. Trading becomes an obsession and a passion to the extent that it remains at the forefront of their thought for a long time. But all things must be kept in perspective, and remember in the grand scheme of all things your family must comes first. Ultimately one must trade to win and enrich themselves to improve the quality of your life, most successful traders when they reach this stage they set aside a portion of their gain for charitable causes, it has been noted that the more they give, the more they gain from trading the markets, charity does not diminish their wealth, it only increases their trading fortune.

As noted earlier only a small number of traders (whether they be equity trader, derivatives trader, Forex trader, commodity trader or trader of any other financial instrument) become successful at consistently winning in the financial market. In terms of percentage; successful traders equate to approximately 5% of all traders, which means roughly 95% of all traders are losing money in the markets in the long run, and guess who is taking their money? In the global financial markets, one traders’ gain is another traders’ loss, it's a zero sum game. Out of all the traders, successful or not, how many of them treat or approach trading as a business or profession? Just like financial market traders, most start up businesses have a very high failure rate, those businesses that succeed have a very comprehensive business plan that clearly states the products or services that is being offered, the target market, the competitors, the capital required to run the business year after year, the profit margin required to break even, the risks, the overheads etc. The business plan anticipates and lays out ground rules for what to do as and when the business goes though good times and bad times, specially bad times. Preparing and planning for the bad times will keep your business prepared for the worst and will give it a chance to survive the first few years in which most start up businesses fail.


The Trading Plan

Similarly successful trading requires a business plan too; it’s called a ‘Trading Plan’. Do you know what percentage of traders whether they be stock traders, FX traders, futures traders or any market traders have a trading plan? It’s approximately 5%. This number is similar to the percentage of traders that are successful at trading markets. Bit of a correlation you may say, whether there is a correlation between having a comprehensive trading plan and consistently winning in the market is debatable, however trading without a trading plan will almost certainly make you a losing trader. An investment bank will never let you trade a discretionary account for them until you have a solid and robust trading plan that you can follow. If you fail to follow your trading plan and make three losses in a row then you will most likely be making tea for the rest of the trading desk for a good few weeks. If you completely deviate from the trading plan and make a large loss, then you will most likely be fired.

Having a trading plan is also no guarantee for trading success; your trading plan must define what kind of trader you are. Are you a fundamental trader utilising fundamental analysis of the market or the instrument you are trading? Or are you a technical trader utilising technical analysis such as trend following technical analysis tools such as MACD and moving average cross over etc? Or are you a trader that combines fundamental and technical analysis to get the best of the both worlds?


Trading Goals

A trading plan must define your trading goals. Many new traders believe they can double or triple their account each year. That is unrealistic even for most talented professional super traders. The long term return of the stock market is approximately 8%; that is only few percent more than return on risk free government bonds and high interest deposit accounts. Average annual return from hedge funds is around 12%; that is if you have the minimum capital requirement to invest in a hedge fund. Some individual star traders trading from relatively small accounts of few millions can return around 50% or more. However if you can return 20% - 30% a year consistently then you can make a decent living out of trading and you’ll have investors’ money chasing you to invest on their behalf.

Which Market to Trade?

A trading plan must also clearly define which markets to trade. Are you going to trade the stock market, the commodities market, the Forex market? If you are a new trader it’s better to trade just one market, such as the stock market as it’s easier to understand and easier to open an account. Forex and commodities market use sophisticated derivatives instruments and also makes use of leverage. Which is more difficult to grasp and can very quickly destroy your account if you make the wrong trades. Because of the use of leverage in the commodities and forex market you can lose more than your initial deposit. This type of transaction is known as contingent liability transactions. Therefore play it safe during the learning phase and just trade the stocks and shares in the beginning. The fundamental psychological trading skills you gain trading stocks or equities is the same in all markets and it can be transferred easily to new markets in the future.


You must decide which market to trade, are you more comfortable trading stocks and shares, or do you want to trade FX market as it's a 24 hour market, or do you want trade the options and futures market to take advantage of the leveraged nature of those instruments? It's up to you to find out which market best suits your psychological makeup and your risk tolerance level. Such discovery may take a lot of trial an error, but if you really crave for it, you will eventually find it. New traders have the habit of switching between different markets and market instruments as soon as they experience few losing trade, as if the market or the stocks or futures they traded caused the loss. Look in the mirror and you will see the person responsible for your trading gains or losses, look within YOU and your trading will be enlightened.


Once you have decided which market(s) to trade, you must decide which instruments to trade. Are you going to trade shares, futures, options, CFDs, spreadbet? Again if you are a beginner start with shares and equities as it’s less risky than the other instruments. There has been an explosion of online spreadbet brokers over the last few years. If you are tempted to use spreadbet then open an online spreadbet demo account first, and trade with virtual money, this will teach you the mechanics of executing trades and familiarising yourself with trading platform or trading system. One of the advantages of spread betting over trading shares is that you can use spreadbet to go Long as well as Short Sell on financial instruments very easily. Short sellers try to profit by selling an instrument first at one price then buying it back again for a cheaper price and pocketing the difference. It usually takes a while to grasp this concept, practice this on an online virtual spreadbet account and it becomes a lot easier. Once you have gained experience on one trading platform, it becomes easier to move to a different trading platform offered by a different online broker. All trading platform essentially tries to convey the same message only in different format and layout. All trading platforms will have blotters for orders, executed trades, cancelled trades, account detail, current positions and free equity and other extras.

Having decided which markets to trade and which instrument to use, the trading plan must now include which timeframe to trade in. Are you a day trader who only opens and closes all the positions during the day and never carries an open position to the next trading day? Day traders try to profit from the daily fluctuation in prices of stocks, shares, FX, commodities, bonds or other instruments.

Scalping or scalp traders trade in an even shorter timeframe than a day trader, a scalper will go in a trade for few minutes and quickly get out with a small profit or a small loss. A scalper tries to minimise the time that a trade position is held in the market to avoid an adverse market move which may lead to a huge loss.

Position traders trading time frame may vary between days, weeks or months. If a trade keeps on going in your favour for few days and you lock in profit according to your trading plan then you should just sit back and enjoy the ride until your trailing stop is hit or the trend has reversed, this could keep you in a position for weeks or months. Remember big money is often made by riding the big trends. Position traders have the added benefit of doing fewer trades, which translate to fewer transaction costs compared to day traders or scalpers. Trading less also means less stress for your mind and body.

The trading plan should also specify the tools you are going to use for trading, such as which online broker you are going to use and why? Which trading platform or software you are going to use and why? Are you going to choose a broker that also has a mobile version of the trading system so that you can check your positions on the move and trade from your mobile phone if necessary? Play with the demo version of the online brokers trading system and find out if it’s easy to use and it’s intuitive. You want to be as relaxed as possible with your trading system and your trading environment; this will help you to keep a clear mind when trading. Transaction cost (spread) can slowly eat away your trading capital; look for a competitive online broker.

Risk & Money Management


The most important reason why traders go bust or large hedge funds lose billions is due to the lack of respect for Risk and Money Management. What is the difference between risk management and money management? Risk management is mainly concerned with reducing the risk of loss by analysing the market conditions and the probability of gain or loss on a trade; use stop loss orders to manage your risk. Psychologically it’s very difficult to put on a stop loss order as most traders don’t like taking a loss. If don’t have a strategy for cutting your losses short very quickly then you will sooner or later fail as a trader. It’s better to take a small loss and live to trade another day than to let a small loss spiral out of control which does major damage to your trading account. It’s often easier to take a small loss if you think of it as tuition fee for learning the art of trading. Taking a small loss is part of the trading game, you must learn to take a loss without it affecting you psychologically; you must at all cost preserve your psychological resources as well as your monetary resources. Monetary resources can be replaced but damage to psychological resources is a lot difficult to correct. As a rule of thumb you must never risk more than 5% of your equity on any one trade. In terms of probability you will have to lose 5% in 20 trades in a row to blow your account. This is possible but the probability of this happening is small and you should survive in the market long enough to learn the winning trading techniques that suits you. Risking only 2% maximum on any one trade is even better for long the term survival in the markets. Trading is a game of probability; learn to think of odds in your favour

Money management is mainly to do with maximising your profit by the use of trailing stops and optimum position sizing. Use and adjust trailing stops as the trade moves in your favour; market has a habit of taking away the profit it gives very quickly. Use of trailing stop will make sure you keep part of the gain. Never be too greedy and always be content with part of the market move in your favour, it’s simply not possible to capture the maximum market move each time.



Position Sizing


As for optimum position sizing: it’s the maximum return you can gain with the least amount of risk. High gains in the market come with high downside risk to your trading capital; low gain comes with low risks. But there is a trade off point at which optimum gain is expected with least down side risk. If you are a new trader, trading CFD’s, options and futures contract then stick with just one contract in the beginning until you increase your account size, then slowly add one contract at a time as the market moves in your favour. As for Forex traders, stick with one lot and increase gradually as your account size increase. Also for Spreadbet traders start off with the minimum bet per point move in the market instrument or market index, this is usually a £1 per point move in shares or market index such as ftse100 offered by most online spread betting companies.

An oft cited statement in the trading world is ‘cut your losses short and let your profit run’. The first part of the statement ‘cut your losses short’ refers to Risk Management. The second part ‘let your profit run’ refers to Money Management.




Exit strategy

The exit strategy is one of the most important aspects of trading. You must have an exit strategy for any given market situation. It must be clearly stated in your trading plan. How and when will you exit a winning trade? Even more important is how and when will you exit from a losing position? As a trader you should mentally rehearse exactly what you will do if the trade does not go as anticipated, you must expect the unexpected in the markets. Otherwise the shock of seeing a loss will result in confusion of your mind and you will not be able to think clearly, your objective analysis of market will be severely impaired. Your mind will be hijacked by your emotion of fear and greed; you will only see the market patterns and trends that you would like to see; that will only reinforce your erroneous belief about the position. You will be hoping that the loss will reverse and turn into a profit, but on the long run a loss only becomes a bigger loss and your emotional dent gets bigger and bigger. After a series of large losses, the fear of loss takes over your mind at which point onward it will be difficult to pull the trigger to execute a trade. Your fear of loss will bring about further losses from the subconscious level of your mind. With such a mindset set you will be trading to not-to-lose rather than trading to win. A successful trader trades to win, psychologically this trader is prepared if the unexpected happens, he or she will just exit the trade and take a small loss and look for the next opportunity. The losing trader will be absorbed by the loss and lament the losing trade over and over again. A psychological anchor will be placed at his subconscious, and fear of loss and actual loss becomes second nature. A trading plan is designed to be followed without failure or hesitation with absolute discipline. You must put all your thinking and intelligence in creating your trading plan. By thinking about all the pit falls of trading and writing it all down on your trading plan, you save yourself from hesitating and panicking in front of a losing trade. If your trade plan states you must exit a trade if it shows a loss of 5% of total equity. You must exit your position when this happens. If you do not, then your trading plan is no use to you. Your trading plan should be designed to prevent you going down the path of failure and make you treat trading as a profession or a successful business.

The bottom line is that most traders will lose money in trading very quickly because they do not have an exit strategy. If you want to stop losing, then simply exit the losing trade. It sounds simply, but very difficult to implement. The trader that can exit a losing trading quickly and cut his losses short will get a chance to develop into a very successful trader. On average professional traders have close to 50% losing and 50% winning trades, what differentiate a professional trader is their ability to cut the losses short and let the winners run. By keeping the winners they are able to pay for the losing trades and also make an overall profit.

If you find it difficult to physically exit a losing position, then just put a stop loss order every time you put a trade on. Most online trading system has the ability to execute stop loss orders, if your broker does not offer stop-loss order facility may be you should think about changing your broker.


Trading strategies

What are trading strategies and why do you need your own trading strategy? A trading strategy is a set of detailed rules that describes exactly under which market condition you will open a trade, what to do when in the trade and what will signal you to close an open position. Fundamental and technical analysis tools are employed in creating trading strategies. When creating a trading strategy you must be certain that it gives you an edge in the market in terms of probability before you trade a lot of money on it. The strategy when employed for a large sample of trades should make you an overall winner at least on paper. You should back-test your strategy or test it in a demo trading account. There are few online brokers that provide back-testing data going back 10 years or so as part of their trading platform. When satisfied with back-testing or demo trading then trade with small amount of money on a real trading account for a reasonable number of trades to see if it's an winning trading strategy. A lot of traders do not have the patient to stick with their trading strategy after a series of losing trades, they abandon their strategy and move to another one or even worse they start putting on trade randomly. You must give enough time for your trading strategy to have a chance to exploit the edge it has in the market. Every trading strategy will have series of losing and winning trades, wins and losses will be random. Just because your trading strategy showed a series of losing trades at the beginning does not mean it’s a bad trading strategy.



Keep It Simple (KIS)

When creating a trading strategy keep it simple. Do not over complicate it with too many technical indicators, the more indicators you add the more contradictory signals you will receive. There is no need to add multiple Trend Following indicators such as Moving Average, MACD, On Balance Volume and Directional System in your strategy. Likewise there is no need to add multiple Oscillators such as RSI, Momentum, Stochastic, Force Index and Willams %R. Profession traders trading for investment banks deceptively use very few technical indicators for their trading strategy setup. Some only use a trend following indicator such as MACD to keep track of the trend and use an Oscillator such as stochastic to get an idea of when the current trend is likely to reverse. Over use of too many technical indicators will only lead to confusion. There is a saying in the trading world which states too much analysis leads to a condition called 'analysis paralysis', so avoid such condition.



Out of the Box Trading Systems

There has been a prevalence of software vendors selling computerise trading strategy or system claiming such trading program can trade for you and make money. You see them exhibiting their software in trading exhibitions or trading fairs. They show you statistics of how their software would have made money in the markets in the recent past. If you optimise any software to fit past data you can easily show a profit. The real test of their claim would be to show consistent profit trading with live data for a reasonable length of time. If such money making software existed, do you think the software vendor would sell it to anyone? For the sake of argument, even if such trading system existed, the vast money of the traders will not be able to follow it due to the psychological nature of trading. Each trader needs to find a system that works for him and is confidently able to stick with it during bad times.


Develop Your Own Trading System

If you want a computerised trading system that uses your own trading strategy then create one. Learn a computer programming language or hire a programmer to develop a trading program according to your specifications. Some of the online brokers' trading platform comes with an inbuilt basic programming language that traders can use to write their own trading strategies, which also enables you to incorporate risk and money management.

The advantage of using a computerised trading system is that it takes emotion out of your trading. The subjective emotional bias that most traders are prone to is best eliminated by a computerised trading system.






Trading Systems Expectancy

The expectancy of a trading system quantifies the probability of making money per pound risked. The mathematical formula for Expectancy is as follows:

Expectancy = (Probability of win * Average size of win) - (Probability of Loss * Average size of Loss)

For example:
If you trading system have a 55% probability of a winning trade and 45% probability of a losing trade on average. Each win on average is £100.00, and average loss £50.00

Then plug in the numbers in the formula:

Expectancy = (0.55 * 100) – (0.45 *50)
= 32.50

That is a positive expectancy; one average for every £100.00 risked in the market the system would make £32.50 profit. Putting it another way, for every £1 risked in the market the system would make £0.32 profit. Expectancy is just a good way of quantifier the profitability of your trading system.

If you switch the average win and loss in the above formula, it would give you a negative expectancy. That means this system would lose money in the long run. It would be pointless trading a system that would lose money in the long run. The higher the expectancy the more profitable your system is on average.



Before the Market Opens and After the Market Close

The trading plan should also include guidelines regarding what you will do to prepare yourself before the market opens. Likewise, how you will review your trading activities after the market close. Most successful traders keep a trading journal or a diary of all their trading activities and thoughts. Writing down thoughts and ideas generally shows commitment and assist in learning. Therefore write it all down and teach yourself by the Pen.



The Disciplined Trader

Having a detailed trading plan is a step forward towards becoming a successful trader in comparison to the vast majority who do not have a trading plan. But a trading plan is a waste of time if you do not implement and flow it doggedly. Following a trading plan is easy if you are in a winning streak, however you should not abandon it as soon as you hit a losing streak. You must see your wins and losses as a large sample of numbers; you cannot predict your next series of wins or losses. Only after you have traded for a long time that you will see the edge built into your trading plan materialise in your favour. When trading you must not sit in front of your trading platform and think about what or whether to buy or sell. All the thinking should have already been implemented in your trading plan. Your trading plan should give you the trading signals and you must not hesitate to implement those signals even for a second. Take the signal and put the stop loss order predefined by the trading plan. You know your maximum loss if the trade does not work out, but if you fail to take a trading signal for the fear of loss then you will never win.

Investment banks instil discipline on their traders by punishing them when they deviate from their trading plan. In an investment bank if you fail to follow your trading plan three times in a week then you will be making tea for the rest of the team for the whole month. Fail to follow it once a day then there will be no trading for you for the rest of the day. However, there is no one to enforce penalties on private or retail traders. That is one of the reasons why they are so poor at following their trading plan. You must enforce penalties on yourself when you repeated fail to follow your trading plan. If you fail to follow your trading plan once on any day, then stop trading and reflect on strengthening your discipline. If you fail follow it three times in a week then stop trading for a whole month and do some research on how to improve your trading psychology.

It is relatively easy to create a trading plan that puts odds in your favour. A trader who is well disciplined can use a mediocre trading plan and make consistent profit. However a trader who lacks the discipline to follow a trading plan will consistently lose even when trading a superb trading plan.

If there is one thing that you want to concentrate in improving your trading skills then let it be the discipline that comes from honing your market psychology.




The Golden Rules

Many successful traders have Golden rules that they have on their trading desk, easily visible at all times. Here is an example of my Ten Golden Rules:

#1: Maintain psychological discipline with patient at all times

#2: Protect and preserve my capital.

#3: Always set a stop loss!

#4: Cut the losses short and let my profits run!

#5: Trade what I see – Not what I think I see!

#6: Never ever chase my losses!

#7: Never ever average down!

#8: Keep excellent records!

#9: Keep it simple (KIS).

#10: Plan the trade – Trade the plan!