Our natural response to risk and uncertainty is excellent at keeping you away from harm in many real-world situations. It is what has kept the human race alive for millennia.
But it’s not so good when it comes to working with risk as a tool to make money, like we need to when trading from a computer screen.
And so, for example, when we talk about the natural tendency to want to be right on as many trades as possible – aiming for as high a strike rate as possible – it’s not really YOUR bad habit we’re shining a light on, it’s simply the way we’ve evolved to think as a species.
But once you’ve identified the hard-coded bits of your brain’s operating system that hold you back you CAN get to work on overriding them!
Now this process will obviously differ from trader to trader depending on your own approach, and it’s something we’ll look at in more detail.
But today, let’s identify the underlying drivers of good trading practice. You can then decide which particular areas you might focus on personally.
Here we go…
The 7 drivers of effective trading
1) Realise that the market is never wrong. Just because a nice candlestick pattern pops up on the chart it is no guarantee that the market will subsequently move in any given direction.
You can take indicator patterns as a clue for what might happen next, but nothing is guaranteed. So you MUST break out of any habitual thinking that has you blaming the market, or your strategy, for ‘failed’ trades.
Remember it’s all about probability. A really good pattern might give you profits 6 times out of 10 but it still means it’ll give you a loss on 4 of those 10 trades.
So get into the habit of thinking in probabilities. And treat trading results simply as feedback from the market.
2) Trade for consistency instead of accuracy. I could write an entire volume of books on this one habit alone! So, so, many traders come into the markets with a wonky idea that they must win as many trades as possible, but it’s not the case. Not if you’re trading to actually make money anyway.
You simply need to make more money from the trades that win than you give up on the trades that lose.
To take it to an extreme level here’s an example: imagine you had a strategy that ‘wins’ one trade out of 10, and from that one trade you tend to make around £1000. On the losing trades you give up £50 each, so across the set of 10 trades you’d expect to make around £550.
Not bad, right? It means an average profit of £55 per trade.
But, shock! That system has a strike rate of only 10%.
It means many traders would kick it into the gutter because it doesn’t ‘win’ enough trades.
And that’s a mistake.
Look, I know it’s tempting to want to win as many trades as possible, that way our egos would not have to suffer the indignity of being ‘wrong’. But to find the consistency that trades crave you must be prepared to trade probabilistically. Keep looking for scenarios that mean more MONEY instead of more winning trades. And do it on a habitual basis!
3) Have realistic expectations. Be mindful of what you have been conditioned to expect from trading. It’s easy to run away with notions of making a vast fortune from your small starting account, and doing so within the next 6 months, especially after hearing stories of other people doing it.
But the odds of everyone achieving this are long. It’s why those stories of success are overnight success are so appealing.
I had a trader write to me who was trading with an annualised return of almost 40%, yet he felt frustrated with his results.
But where else can you get returns of 40% from a few minutes ‘work’ per week clicking the keys on your computer?
Get into the habit of comparing your trading performance to ‘real world’ benchmarks. Checking the interest rates on deposit accounts at the bank is always a good starting point. It can help you see just how much harder your money is working for you in the markets.
4) Stick at it. Sometimes things don’t go as expected. All strategies go through purple patches (see trading for consistency instead of accuracy above). And when the soles of your feet are being held to the fire it’s easy to quit.
But the nature of the build up of emotional stress that creates those feelings means it often coming to a peak right at the extreme point of a losing period. And you can guess what happens next… you throw in the towel just as conditions change and your strategy delivers huge positive results.
Trust me. I’ve seen it happen too many times!
Work on the habit of grinding away through challenging periods. As long as your strategy has a proven positive edge your job is to simply keep pulling the handle on the trades.
5) Know when NOT to trade. This one is all about trading with restraint i.e. only doing the things you already planned to do in advance.
So that means not jumping into a trade just because the market ‘looked like it was going up’, or firing off a quick order because you hadn’t had a signal all morning and felt bored!
I find it helps to actually write down on a piece of paper EXACTLY what you’ll be doing in advance of any live session at the screen:
“I’ll only take valid SELL entries in EURUSD and ignore BUY signals because the market is in a longer term downtrend.”
“I’ll scalp GBPUSD to the upside only until the market reaches resistance at 1.2500.”
Get into the habit of pre-planning your actions. It can save unintentional trades being taken in the heat of the moment.
6) Always position-size. Get into the habit of ‘weighing and measuring’ risk before you pull the trigger on a trade. Make sure each trade has an equal proportion of your account equity allocated to it. Remember, a trade risking 100 pips staked at £1 per pip is TWICE the risk of a trade risking 50 pips.
Most brokers offer staking from 10p per pip these days so the level of flexibility is available. It just needs a quick double-check before you fire off your order. Think in terms of £ risk to your account rather than in terms of pips or points.
7) Be like water – take the path of least resistance. When the market is strongly trending strategies designed for rangebound markets will underperform, and vice-versa: when the markets are stuck moving sideways, trend-seeking breakout strategies aren’t going to find much joy.
The habit we need to install here is keeping a degree of flexibility in our outlook. It’s tempting to expect a strategy to perform exactly the same under all market conditions, but does that sound realistic, or even possible?
TIP: You might keep a selection of strategies working inside your portfolio and look for the most appropriate ones to outperform the others depending on prevailing market conditions.
So those are the 7 meta-habits we need to work on getting in place. It can be a challenge, so don’t expect it all to drop into place overnight, but do make a conscious effort to start correcting any habits you recognise are holding you back.