By Christopher Tubby
Most individuals that consider trading as a profession are unprepared for the hard work and dedication it takes to become a trader.
The second issue is not having enough capital behind them. Ideally, they already have a steady income and therefore can take the slow approach towards becoming a trader. This is important as it removes the need to make money daily. Trading is about probabilities and traders should only be considering the high probability trades, its quality over quantity!
Before you enter the world of trading you must consider the maximum amount you will invest in yourself to become a trader. Once set this should not be broken for any reason! It’s very easy for many to open a small account and then keep topping it up if they lose, however, this can lead to a massive erosion of their hard-earned capital without realising it! With a fixed amount you will track it much tighter and control it better.
Having to make money to cover bills means traders rush into trades, grab at profits, set their targets too high – which in turn leads to taking on riskier trades and disappointment when they do not reach their target.
Many begin trading without enough practise behind them to create a solid trading plan. A set of rules built to protect them from losing too much capital in any one trade on any one day! It also includes the criteria the market must meet before a trade is executed. Creating a solid trading plan helps develop consistency which is essential to a trader. It’s important to understand not just the market and the product you will trade but also its important to understand yourself!
As a professional trader when I am considering taking a trade on the first this I do once I have identified my entry price is to establish where my stop loss should be placed as this provides the potential loss should the market go against me. Once I have established that I can look at the potential profit I can make from the trade – establishes the risk/reward in the trade. Another thing to consider is something I call the three Vs – Volume versus Volatility. The higher the volatility the less volume (size) to commit to the trade as this allows for the market to go further against you without increasing the potential loss. Most trades will go against you before moving back in your favour...if they are going to!
Many traders lack discipline due to poor risk reward ratios. This makes trading more challenging as they then increase the need to win more trades. I always recommend a minimum 2:1 as this means even if you are right only 50% of the time you will still be ahead. This should not be so rigid that if you feel the market will not quite get your price you hold out as then the trade will lead to a loss. It’s okay to accept less on some trades as when you have a strong feeling it is possible to aim for higher profits. I always aim to maximise my profit in every trade and create zones rather than a single price. I will identify the price I expect the market to be rejected at and place a series of orders in front of that price. My stop loss will be either based on the average price or individual stop orders against each entry price with the loss very similar in value regardless. When the market is moving in my direction, I begin to exit the position a little at a time to gain a good average, just in case the market reverses. Zones again offer flexibility!
Another issue is traders do not understand the product they are trading. They are unaware of the fundamentals that impact the product which impacts their potential to profit from trades or cut losing ones early when fundamentals change. Correlations between various products or asset classes can also be very useful for this. If a trader is trading a contract such as the S+P its useful to know the companies that impact the index the most. I always suggest learning the top 10 companies or make a list of the top 10%. Imagine holding a long position and positive news breaks regarding one of those companies. It provides you the insight to add to your long position or r remove your sell order as there is probably a lot lore profit to be taken from that trade! Alternatively, if the news was a negative it would give you the opportunity to exit your position early or even revers it!
When trading near current highs or lows.
When day trading, if you are considering taking on a position near the day’s high or low it is necessary to analyse regarding where to place your stop loss. It may be due to your risk/reward ratio that by entering a trade too early you will be stopped out at or near the current high or low. This should be avoided as the level may continue to hold. It should require that the existing high or low to be broken to trigger your stop loss, therefore, it’s important to calculate this BEFORE entering the trade as there is nothing worse than being stopped out at the high or low of the day!!
Risk/Reward Ratio for short-term trading and how to build a position.
As a pro trader, when I am considering a trade and identified my entry price, the first thing I do is calculate where to place my stop-loss as then I can assess if I can afford to take the trade on. How much will I lose if I am wrong! Once I have established this I analyse where the market may get to in my favour and if this is at least twice as much as the possible loss then I will take the trade on, if not, I will not execute the trade as my minimum requirement is 2:1 for my risk reward. Sometimes I may have to settle for a little less and other times if I sense there is more profit in the trade, I will move my take profit higher.
I believe in building positions and exiting the position in similar manner. I deal in zones rather than an exact entry price. First, I will identify where the support or resistance is and then enter some orders just ahead of that price. If I wait for the perfect price, I may be disappointed as it may get close but then rejected before I manage to get my position on and then that is a lost opportunity. Therefore, I prefer to break my orders into 3 levels. Let’s imagine my support level is 33. I will enter buy orders at 38, 36, and 34 providing me with an average purchase price of 36 if I manage to buy all three levels. I am prepared to lose 8 points on the trade and therefore I place my stop-loss at 28. If it is $5 per point and I buy 5 contracts at each level, then I would lose $5 x 15 x 8 = -$600. If the market turns and moves into profit, I will consider exiting the trade from 52 upwards, depending on how strong I consider the momentum! I could close the whole trade at 52 or sell out by selling 5@50, 5@52 and 5@54 to lock in the same profit. Similarly, for the stop-loss I could sell 5@30, 5@28 and 5@26 which would be the same loss.
Trading should always be flexible rather than rigid as aiming for the perfect price every trade can reduce your profitability. I aim to maximise my profit in every trade and is all about taking only high probability trades, quality not quantity. Creating a trading plan, which is a set of rules that you follow every day. Helps to keep you safe by not risking too much in a trade or day and helps to produce consistency!
Candlestick Heikin Ashi
Most traders like to use candlestick charts for their analysis.
I recommend to traders using candlesticks to include Heikin Ashi in their analysis too. More so for exiting positions as the structure of the candles provides more insight into when the immediate trend has ended. Heikin Ashi has a smoothing effect as each new candle starts at the midpoint of the previous candles open/close making the colouring of the candles more consistent and flowing, thereby making it easier to identify a change in sentiment (as demonstrated in the comparison below). The candlestick chart (at the top) has a blend of red and green candles during trends whereas the Heikin Ashi (below the candlestick) shows more consistent colouring allowing the trader to have the confidence to stay in the trade longer.
Due to the fact Heikin Ashi always takes that midpoint of the previous candle it will not provide any gaps as seen when comparing the two charts around mid-September.
NOTE: Heikin Ashi should not be used for back testing.
Chris is London based and traded multi-assets on derivatives futures and options markets for over 4 decades, adding in recent years crypto. He became a senior trader at the age of 22 working for a major international physical commodity trade house. He has traded proprietary, arbitrage, and a Market Maker on various asset classes, which included four years in Milan for an Italian Bank.
Since the mid-1980s he has traded prop using his own capital and in the past decade dedicated his free time to providing education on the financial markets and how to trade them which has gained him recognition as one of the leading educators with his client base covering much of the globe. Although he offers face to face courses in London, many of his customers enjoy their courses over the internet in his virtual classroom.
Chris has consulted to the London Stock Exchange Group as well as other major exchanges, including providing some with educational content.
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