There is no simple and easy secret to trading success. The production of substantial trading profits is a function of focusing on several major skills and then working on them consistently for a long time.
If there was some simple approach to great trading, then it would not be so potentially lucrative. Like most things in life, good results require effort.
The foundation of market success is comprised of five pillars.
- Money Management
- Stock Selection
- Conviction and Aggressiveness
Before you can effectively trade the market, it is important to understand what sort of market you are dealing with. Every market environment is unique in some way, and before you can navigate effectively, you have to understand where the opportunities lie.
At the most basic level, there are bull markets and bear markets. Obviously, it is tougher to make money buying stocks if there is a bear market and they aren’t going up. However, simply recognizing that there is a poor market environment and that it is a good time to sit on the sidelines and wait will put you ahead of the vast number of market participants that don’t have an understanding of what is going on.
Market timing goes well beyond bull and bear markets. There are always rotations taking place like we have seen recently between value and growth. There are also major themes that develop, and that is where the best opportunities tend to develop.
Some markets have highly correlated action where all stocks are moving in tandem. Other environments favor stock-picking or momentum stocks.
Once you understand the market environment that you are dealing with, then you can develop the best strategy for profiting from it.
One of the greatest things about the stock market is that as long as we have cash, there will be another opportunity to produce a profit. Capital is our most precious possession when it comes to trading and has to be protected.
The heart of money management is to minimize losses and maximize gains. But that is far harder to do than it sounds.
Money management systems can be highly subjective. What works best will depend on styles, time frames, emotions, market timing, and numerous other factors. The ultimate goal is to keep account balances as close to highs as possible. That allows for the compounding of gains and avoids the unproductive work of recouping profits.
If your money management is solid, you can handle stock picks that don’t work with minimal damage. More importantly, good money management will keep you in the best trades and prevent you from selling prematurely.
Designing a good money management system is extremely difficult. We could devote an entire book or two solely to that topic and even then, what works will vary based on the market.
The most important thing about money management is to simply have some sort of plan. Any plan is typically better than emotional reactions. Plans force you to contemplate both success and failure, and that has great value. Too many traders fail to consider that their trades may go bad and when it does happen, they end up freezing and doing nothing.
Picking the right stocks makes the hard work of trading much easier. For many, the search for the next big winner is one of the most enjoyable aspects of trading. Finding something exceptional that is still largely unknown is how you make big money. But many traders don’t know how to find good ideas, and they tend to gravitate toward familiar big-cap names instead. That can work very well depending on market conditions, but if you really want to produce good results, you have to develop ways to produce a steady flow of new ideas. The shorter your time frames, the more new ideas you will need to have.
Astute stock-picking will offset a multitude of other mistakes, but mistakes, disasters, and bad luck are inevitable, which is why money management is so important.
The only way to produce exceptional returns is to take some risks. Risk and return are inseparable. When we feel we have an edge, it is important to press. Good traders who are afraid of volatility and refuse to take a higher level of risk cannot grow and prosper. The trick is to control speculation so that you aren’t just some random gambler acting on gut feel.
If you are going to be aggressive, you need to be able to state clear reasons why and use a money management system. Too often, aggressiveness is a function of frustration rather than careful planning, and that can lead to disaster.
The most successful traders take risks. They are constantly pushing themselves to find ways to produce bigger gains in the context of an effective money management system. Learning to deal with routine volatility is one of the most difficult things for many traders to do, but it is at the heart of becoming a more successful trader.
Without persistence, the previous pillars of trading success I’ve outlined are meaningless. It is necessary to work on these skills every day.
Great trading is not a home run derby. It is a daily slog through good markets and bad. Just like the stock market, traders go through cycles of ups and downs, and you have to be able to take that in stride and keep pushing.
Half the battle of being good at something is knowing what you need to work on. For traders, that means money management, timing, stock selection, conviction/aggressiveness, and persistence. Each of those must be balanced to some degree, but when you put them together in an effective manner, trading success is nearly inevitable.
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