Trading is much like playing baseball. Or better said, traders are much like baseball players.
There are those players always looking to hit it out of the park. The greatest home-run hitters in history had a couple of things in common: they had more strike-outs than anyone else, and they got on base less than everyone else.
Then there are the players that focused on simply getting on base. Rather than trying to hit it out of the park, they patiently waited for the right pitch and would pick their spots on the field for a base hit, or they would get a walk. These players got on base more often, and on occasion they might get the home-run.
In trading, the vast majority of traders are like the home-run hitters in that they try to catch the big moves. Unfortunately, unlike the home-run hitters, they rarely catch the big move and more often strike out. After depleting the trading account and a large chunk of discouragement, they are pronounced "out".
Professional traders, those who make money at trading regularly, look to simply make a profit each time up. The goal is to patiently wait for the right time to enter, then to strategically manage the trade to where risk is little and profits, perhaps small, are not turned into a loss. Periodically, these trades that were originally planned for a short-term move may turn into a much better gain (the home-run). But that is not the original goal nor the plan, but simply icing on the cake.
When traders allow greed to be their guiding light, they aim for the sky and more often get dirt. In hopes of making the big score, they lower their odds for success to nothing more than pure gambling. Trading itself is not gambling, since the trader sets the odds and can do so well in their favor, as we will discuss shortly. Gambling, on the other hand, is when the house sets the odds and it is always against you.
Consider the following example. Suppose you are deciding to go LONG in some Stock or Futures contract. You've done your homework and it looks pretty good that prices will likely rise shortly after you enter.
Now, which do you think has the highest odds of being successful; looking to make 50 points or 500 points?
If you answered "50 points", you are correct! The odds are much higher that your trade will go into profit 50 points as it is a much smaller target price. The further way your target is, the lower your odds are of achieving it.
The lesson here should be clear. In order to put the odds more in your favor, be sure that you start off with a price target that has very high odds of being reached. It is always better to win small profits 99% of the time than to hope to win big profits by taking trades with odds that are 50/50 or less.
These smaller profit goals, while alone may not seem like much to shout about, have an amazing ability to compound over time. And this is what keeps the Professional in the business of trading for the long haul, creating a nice pile of profits over time.
Putting the odds in your favor does not stop there. To go along with a lower profit target requires that you also learn how to properly manage your risk stop. While your win ratio is high in the 85-90% realm due to making trades with a small profit target, you can afford to take trades with a 1:1 risk/reward ratio. In other words, if you are aiming for $300 minimum profits for a single trade, your risk exposure should be somewhere around $300 as well. The problem with using your profit target as your way of determining risk is that your stop-loss placement becomes nothing more than arbitrary at best.
Part of your planning on any trade is to determine beforehand how much risk you may have to take on if you enter the trade. Since it is often better to place the initial stop-loss below the last low (if looking to buy), if this will result in too much initial risk, it is best to not take the trade at all. This is part of putting the odds in your favor. The biggest mistake amateur traders make is that they feel they have to be in any and all trades that look really good. This is simply a bad idea! The wise trader patiently waits for the right time and market to make the trade, and will not make a move until one is available. The goal is to make money, not to be playing a game. If you need to play a game, go pull out the Parcheesi and spend time with the family. Leave trading for your business of making money.
Risk management, which is important for keeping the odds on your side, is an important part of keeping your few losses small. Once you have found a trade with an acceptable risk exposure, once you are filled into the trade, allow the market perhaps 30-minutes to an hour to prove you right. If you entered, say off a breakout, and the market is acting docile even after 60 minutes have gone by, something is likely wrong and you should consider getting out at scratch or with whatever little profit or loss there is. Your goal is to enter a trade you believe is ready to go your way. If it goes into some profit and just wallows around there for some time, better to take it than let it turn into a loss.
One final tip on risk management and putting the odds in your favor for consistent profits, is to get your initial stop-loss to breakeven as quickly as you can. When the market hits your entry price and moves into profit, after perhaps 15-minutes or 30-minutes, get your stop-loss to breakeven and make it a free trade. By doing this, you have essentially freed your emotions from the equation, and you can now let the market do its thing without concern of loss.
Remember, trading is a business like any other, to make money. You must think in terms of probability (odds), and make sure your actions put the odds in your favor by a very high amount. Take unnecessary chances because you feel that the trade "is a sure thing" is a formula for failure. So think like a Professional and work to accumulate small profits a higher percentage of time rather than the hope of large profits, once in a while, and watch your account grow!
Rick J. Ratchford has been trading since 1989 and since 1996 is an Analyst for ProfitMax Trading Inc., a membership for traders specializing in the advance forecasting of market tops and bottoms for Precision Timing the Futures, Commodity and Forex markets.
