Thursday, August 28, 2014

Increasing Your Odds

When something is important enough,
you do it even if the odds are not in
your favor.
Elon Musk

Trading is a profession where you can often times find yourself working against the prevailing odds. It's not like anyone can walk in off the street and start making profits on a consistent basis. Unless you take evasive action against adverse market forces, you may fall victim to overwhelming odds. Skilled traders, however, know how to put the odds in their favor, and you can too.

Trading brings out two emotions, self-doubt and overconfidence, you need to balance these two emotions carefully. Newer traders are usually optimistic at first, that is quite normal, but soon find out that trading is difficult. The markets are in many respects unpredictable and winning streaks often turn into losing streaks. The original overconfidence easily turns to disappointment and self-doubt. Avoid becoming too pessimistic or you'll never be able to pick yourself up and try again. What usually happens, though, is that you become overly arrogant to protect your ego. You may try to psych yourself up and try to beat the odds. Thinking optimistically is good, use your optimism effectively. Do not arrogantly think you know how to trade before you've built up the necessary skills. Do not take unnecessary risks and think that you can beat the markets with shear will. Persistence without the proper amount of skill will get you nowhere. Study, practice, and learn in order to build up the necessary level of skill to trade consistently. Set learning goals rather than performance goals. In other words, reward yourself for learning techniques at first, and when you are ready, you can set an overall profit goal.

Acknowledge your risks up front. Trading involves risk, learn to admit it. Traders try for the big profits, and they are ready to take the risk and the responsibility. The difference between the professionals and the amateurs is that risk is carefully managed. Since you are trying to capitalize on winning odds, your survival depends on your anticipation of a string of losing trades. That means looking at the risk to reward ratio before entering a trade, making sure that you have a large enough account to take the risk, and if you do not, reduce your position size to suit your account or stand aside and wait for a trade you can take. Risk management is a trader's secret weapon, use is to survive over the long haul.

Finally, you must use reliable trading strategies. This is so much easier said than done. You can not expect to profit if your trading strategy is flawed. But it is hard to know when it's flawed or just not working because of less than optimal market conditions for that strategy. All the trading books and experts warn "Do not abandon a trading strategy prematurely." It is not wise to jump from strategy to strategy, but what is "prematurely"? Based on probability theory, even a winning strategy can produce a string of losers and a severe drawdown, so sticking with a sound strategy too long when it's not working is going to wipe out your trading account. The best you can do is decide how much of your trading capital you will risk on the strategy up front, and if you lose that predetermined stake, move on. Trading is challenging and unless you are prepared, there are forces that put the odds against you. With the right mindset and proper risk control, however, you can move the odds in your favor, and achieve consistent profitability.

Reprint from the Prudent Trader archives

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