Archive for September, 2009

Turning Into a Profitable Trader

During my trading and mentoring career I regularly encounter very interesting people from all fields. What they have in common, however, is their unprofitability in trading which is why they are seeking advice. They seem unable to reap consistent profits off the stock market despite having been involved since years. I assert that this is due to the lack of a fundamental understanding, so my approach is to teach them about the movements in the market and how price action is interpreted correctly. I personally had the luck to be taught by a mentor and was able to forge a trading strategy on top of this precious teaching.

Basically that is all you need to significantly boost your chances of becoming profitable. Let us think back to our childhood when we got our first bike. Our parents might not be particularly good cyclers but they knew one thing: to ride the bike we must be able to balance. Hence they do not bother teaching us which gear to use, or how to do dirt jumping. But this is precisely what aspiring traders venture into. They start off with the most challenging stunts like scalping and picking tops without knowing anything about chart reading. Seeking answers in indicators is one of the mistakes they succumb to.

Whenever an aspiring trader comes to me I will ask him to turn off all indicators and misleading entry signals, then give him the basics he needs to start trading profitably. This includes among others price action, understanding the battle between bulls and bears, and trends. After that we go into more details such as using stop loss orders and risk management. To my surprise they are able to find entries and manage positions all on their own within a few weeks, or have developed a totally new strategy with the help of the basics I provided. Most importantly, they do this without looking at any indicators that they used to love.

Understanding Price Action in the Stock Market

How do markets move and why? When should I be in a trade and in which direction should I be trading? Trend following is a concept that requires only little effort coupled with big profits once the major trend has been identified. Here is an excerpt from The Book of Five Rings by Miyamoto Musashi:

The way to do battle is the same whether it is a battle between one individual and another or a battle between one army and another. You should observe reflectively, with overall awareness of the large picture as well as precise attention to small details.

The large scale is easy to see; the small scale is hard to see. To be specific, it is impossible to reverse the direction of a large group of people all at once, while the small scale is hard to know because in the case of an individual there is just one will involved and changes can be made quickly. This should be given careful consideration.

If you imagine the market as a place where two crowds gather to battle, the price action which we observe day by day can be understood in a much easier manner. It is very similar to a tug of war where two opposing parties pull on a rope with the aim to drag the competitor over a border line. Once a party has gained some degree of advantage it will be very difficult for the opposing side to end it. The losing side eventually gives up fighting this influence.

For instance, if prices have been moving down in the broader picture, bearish investors must be possessing greater power while the bullish investors are countering against their influence. This explains the minor swings up while the price is overall falling and thus forming a downtrend. Buying becomes a more challenging proposition than simply going with the major trend—or ignoring the stock altogether if you do not like shorting. Having this concept in mind greatly enhances the probability of a successful trade.