Trading is easy; anyone with a few bucks can do it. Making money, however, is a whole different ball game. A simple fact of trading is that almost 90 percent of all commodity traders and those who day trade equities lose money. Investing in stocks, by contrast, was always looked at as a safe long-term play, but as I write this, I have to say that may not be the case anymore. So why is there such a high percentage of losing traders? Do they all have something in common that makes them lose continuously? Why do a select few traders repeatedly make money while the masses lose? What are the common traits that winning traders possess that losers don’t, and vice versa? Can losing traders become winning traders? What do bad traders do that good traders avoid? More important, what do winning traders do that is different? With such a high percentage of traders losing, there have to be some things they all do that cause those results. Throughout this book I will try to answer these questions as I detail how successful traders behave differently and can consistently make money by making high probability trades and avoiding common pitfalls. As important as learning how to trade successfully is learning how to
avoid losing. People who are not clear on this will have trouble turning the corner and becoming winning traders. I won’t just point out what traders’ weaknesses are; I will help readers overcome and avoid those common mistakes while showing how a successful trader would react in the same situation. The goal is to teach all traders to have the mindset of a successful trader.
There is no easy recipe for becoming a winning trader, but hard work, experience, capital, and discipline are some of the basic ingredients. Although most people will lose money, by learning to trade with the percentages, I believe the average person can become a successful trader. Most of the best traders started out on a frustrating note but were able to turn it around. Sure, some traders may get lucky at first, but trading is a learning process that takes years to master. Much of that learning consists of being able to tell the difference between high and low probability situations.
By doing this one can begin to filter out trades that have a low probability of working while being more aggressive on others. Many trading books I’ve read make it seem that trading is a piece of cake and that anyone can do it after reading the book.
That’s not the case. Reading will help, but experience is a much better teacher. One of the best ways of improving, in my opinion, is by correcting past mistakes. It’s easy enough to tell a trader how to trade and to teach him that the trades offering the highest potential reward for the lowest risk offer the highest probability of success.
Yet there is nothing a book can teach that a $1000 loss can’t amplify.
No book can teach you how to handle losses mentally or how emotions affect one’s trading. Only having real money on the line will make you feel the pain and exuberance that can cause traders to behave erratically. Paper trading can help with some things, but one needs to risk actual money to learn how to handle emotions and
risk. People follow their rules to a T in paper trading, but as soon as real money is on the line, they begin to ignore those rules.
As a trader trades, the first few years will be filled with countless mistakes. These mistakes are important because only when traders realize what they are doing wrong can they start to concentrate on not making those mistakes over and over again. By weeding out the bad trades, a trader becomes an overall better trader. It is important to show why some trades are bad even if they turn out to be winners, simply because they have a high risk/reward ratio.
Some trades are not worth the risk and should never be done. To trade successfully one needs to consistently make trades that offer low risk compared to the reward. I may tend to repeat main points throughout the book; this is not because my editor wanted a bigger book but because these things are important and repetition will make them stick in the reader’s mind.
After reading High Probability Trading one should be able to distinguish between different types of opportunities and take the winning approach. If you are currently trading and have lost money, this book will help you uncover why while leading you to overcome those faults. It will help you learn when to trade and when not to trade. It
will help you realize the importance of and how to write a trading, game, and money management plan, without which one should not be trading. A trading plan need not be elaborate, but every trader should have one.
Having traded both stocks and commodities, I will talk about both throughout this book and will use the term market to refer to both. This book was originally planned to focus on commodity traders, but I expanded it to benefit equity traders as well. Trading is trading whether one is trading IBM, Yahoo, pork bellies, or S&P 500 futures; it’s all basically the same. There are some differences, such as margin, leverage, software, expiring contracts, and limit locks, but for the most part if you can trade one, you can trade the other. The book does have
a bias toward the short-term trader, but its overall goal is to help all traders, from beginners to seasoned vets, whether they are short-term day traders or position takers.
WHAT IS HIGH PROBABILITY TRADING?
I define high probability trading as trades with a low risk/reward ratio that are backtested to have a positive expectancy with predetermined money management parameters. The best traders always trade when the odds are in their favor, not just because the market is open. They trade for a reason: to make money, not to amuse themselves. For the most part high probability trades are made only in the direction of the major trend. If the market is uptrending, a trader will wait for a dip and test some support level before entering. Dips are just waves in a trend, and though shorting them can be profitable, these are low-percentage trades and should be avoided. High probability traders know how to cut their losses and let their good trades run. You cannot come out ahead of the game if you lose $500 when you lose and make only $200 on the good trades because you are too eager to take a profit. As important as letting profits ride is knowing when to take a profit. Many bad traders let winning trades dwindle into losers because they don’t know when to get out of a good trade or have no exit rules. Exiting a trade is even more important than making it, because that’s what determines whether you win or lose. If a trader randomly put on trades but knew how to exit them properly, he would probably be a winning trader.
Though going with the trend always offers the best success rate, trying to pick tops or bottoms can have a high degree of success if the right pattern is prevalent and the trader is quick to realize when he is wrong. When trying to pick the end of a trend, traders will be wrong often, and so they must be able to quickly accept the fact that
they are wrong. When one is correct in picking a top or bottom, the reward can be substantial, so cumulatively these trades can have a high probability of success. It doesn’t matter what one’s trading style is: If a trader is disciplined and has a solid trading strategy and money management plan, he can make money.
To be a high probability trader one needs to have a trading plan. This includes trading strategies and, more important, knowing how to manage risk. This book will help a trader develop all the skills and tools needed to make a proper trading plan. As each person has a unique style, there is no perfect trading plan that will work for everyone. Each individual has to make a plan that best suits his trading and psychology. Once a plan is set up, most of the hard work has been done, yet many traders fail to spend the time to develop a plan and instead jump straight into trading.
WHAT MAKES A TRADER GOOD?
In a nutshell, a trader who makes money is one who works as hard during nonmarket hours as he does when the market is open. These traders know in advance what markets they will trade and what their actions will be. They patiently wait for the market to give them an opportunity to enter and are agile in getting out when they are wrong. They look for markets or stocks that are in a trend and wait for a retracement in order to get into the trade. They do not try to outguess the market or think they are better than the market; they take what the market gives them. They have full control of their emotions, are always focused, and do not spread themselves too
thin or overtrade.
A Trader Who Has a Good Chance at Success Has the Following Attributes Is properly capitalized
Treats trading like a business
Has a low tolerance for risk
Trades only when the market provides an opportunity
Can control emotions
Has a trading plan
Has a risk management plan
Is incredibly disciplined
Has backtested his trading methodology
A Trader Who Has a Good Chance at Failure Has Any of
the Following Attributes
Does not understand the markets
Rushes into trades
Chases the market
Is afraid of missing a move
Is stubborn and marries a position or idea
Is always looking for home runs
Lets losers get too big
Takes winners prematurely
Takes trading too lightly
Takes large risks
Has little control of his emotions
THE BUILDING BLOCKS
The Tuition of Trading
Setting Realistic Goals
Leveling the Playing Field
USING THE NEWS
Trading the News
Increasing Your Chances with Multiple Time Frames
Trading with the Trend
Breakouts and Reversals
Exits and Stops
Making the High Probability Trades
TRADING WITH A PLAN
The Trading Plan and Game Plan
A Little about Backtesting
Employing a Money Management Plan
Setting Risk Parameters and Making a Money Management Plan
Discipline: The Key to Success
The Dangers of Overtrading
The Inner Side of Trading: Keeping a Clear Mind