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How to Become a More Profitable Trader

January 15, 2007

This is rather a long read but I think an important one. As New Year begins, I thought it will be a good idea to learn from past year, share experiences and by leveraging the learning develop a plan for better trades in 2007.

2006 was an interesting year. I had great wins (as high as 1200% in one night by trading straight calls on PPDI before earnings announcement) and great losses as well. During the 1st half of 2006, most of my trading was based on predicting where the market was going. This required hard work, real-real hard work vs. what some might say that it’s easy. However, still the rewards weren’t consistent. So I started my search for consistency and started to lower my expectation on returns. I met with my friend Krishna S. whose thinking made me rethink about my way of trading and transformed me into an “income trader”. Starting Sept’06, I have been trading spreads and mostly “market neutral spreads”. I no longer speculate where the market is going and don’t look for making 100% in a jiffy. This doesn’t mean one style is better than other; it’s what suits your style best. Contrary to popular belief, Options’ trading is not easy. As Dan Sheriden says, it’s a craft and it takes time. One needs to learn craft, readjust and master it before you start sailing in the sea.

Here is a compiled list based on my experience, excerpt from Real money by Jim Wyckoff, traders chat by Tom Preston of Thinkorswim. This list is in no particular order of importance.

1. Vision, Objective and Goal. Why do you want to trade options? A real simple answer will be “to make money”. However, I think if you ask yourself few more questions, you will realize that there is something else. Is it because you love numbers, action of the market, ease of liquidity, or can make “easy money”, have low capital, etc? Have an end in the mind, set your objectives and goals for the year and year after, and of course have progress measures in place.

2. Failure to have a trading plan in place before a trade is executed. Without a specific trading plan, a trader does not know, among other things, what and how to play and why, when or where he will exit the trade or how much money may be made or lost. Traders with no predetermined trading plan are flying by the seat of their pants, and that’s usually a recipe for a “crash and burn.”

3. Money management. Part of trading success boils down to proper money management and not gunning for those high-risk “home-run” type trades that involve too much capital at one time. In the trading environment, we will win and lose. However, we need to be more right than wrong and when right, be big on right. When I was winning I averaged up. But when it started losing, I didn’t cut the losses. As you may know, options swings a lot +/- 30-40% in one day isn’t surprising. Imagine if you are fully invested and if the tide turns opposite to your direction, you can lose 30-40% in one day. My rule of thumb that I learned from various seminars, option trading forums, a maximum of 5% of overall portfolio per trade/underlying. You may choose yours, but have one in place. Learn to use risk/reward measure before starting a trade.

4. Expectations those are too high, too soon. Beginning traders who expect to quit their “day jobs” and make a good living trading in their first few years are usually disappointed. You don’t become a successful doctor or lawyer or business owner in the first couple of years of the practice. It takes hard work and perseverance to achieve success in any field of endeavor — and trading is no different. Trading markets is not the easy, “get-rich-quick” scheme that a few unsavory characters make it out to be.

5. Lack of “patience” and “discipline.” “Greed” and “Fear” will test your emotions again and again and are the ones generally that prompts wrong decision, at times. While patience and discipline are overworked and very often mentioned when determining what unsuccessful traders lack, not many will argue with their merits. Indeed: Don’t trade just for the sake of trading or just because you haven’t traded for a while. Let those very good trading “setups” come to you, and then act upon them in a prudent way. The market will do what the market wants to do — and nobody can force the market’s hand.

6. “Overtrading.” Trading too many markets at one time is a mistake — especially if you are racking up losses. If losses are piling up, it’s time to cut back on trading, even though the temptation is to make more trades to recover the recently lost assets. It takes keen focus and concentration to be a successful futures trader. Having “too many irons in the fire” at one time is a mistake. Separately, just like any other business, there is a life beyond “trading life” as well.

7. Failure to accept complete responsibility for your actions. When you have a losing trade or are in a losing streak, don’t blame your broker or someone else. You are responsible for your own success or failure in trading. You make the decisions. If you feel you are not in firm control of your own trading, then why do you feel that way? You should make immediate changes that put you in firm control of your own trading destiny.

8. Not getting a bigger-picture perspective on a market. One can look at a daily bar chart and get a shorter-term perspective on a market or stock trend. But a look at the longer-term weekly or monthly chart for that same market can reveal a completely different picture. It is prudent to examine longer-term charts for that bigger-picture perspective when contemplating a trade.

9. Don’t try to make back all your losses in one trade: Everyone makes losing trades. Sometimes you get the losers in a row, one after the other, and your account is smaller than when you started. You get frustrated and angry. You decide to take revenge on the market and make all your losses back and then some. So, the next trade you make, you increase the number of contracts or shares because your rage is overpowering your discipline and you’re sure that this trade will be “the one”. And…you’re probably wrong. The trade turns out to be loser as well and your account is even deeper in the hole. Sure, it might be a winner, but it’s not worth the risk. Don’t let your anger control your trading. Just because you’ve had a string of losers doesn’t necessarily mean your due for a winner. If you’re in the situation of having nothing but losing trades, a better idea would be to review your trading plan and see if there might be fundamentally wrong with it. Then you can correct it and see if that improves the results.

10. Don’t stop trying to learn new things about trading, either by doing research reading books and articles. There are lot of free tools available on web (you can check most here) Everyone is getting smarter and more capable. The difference between the educated retail trader and the professional trader is getting smaller and smaller. That’s both good and bad. It’s good that bid/ask spreads are tighter now than they have ever been. But it also means that the industry is more competitive. Knowing what an iron condor is or how to calculate a roll value isn’t enough. There are many who already know that stuff. Making money in trading is very hard work. You have to be willing to devote the time and energy to try to find an approach to trading that might actually make you money.

A successful trading career isn’t built out of luck.

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