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What makes a successful trader?

By Dan Atkinson

12:08, 31 October 2018

As a novice trader, you’ll have heard all the clichés about what makes a winner in financial markets. The successful trader has to be a cool-headed poker player, an iceman or woman with, to mix metaphors, nerves of steel. In the markets, it is a case of kill or be killed (financially speaking, anyway). Every moment is make-your-mind-up time. Deal, or no deal?

All very exciting, no doubt. But extremely misleading. The novice trader may be better advised to ignore all this high-adrenalin action talk and, and, as a starting point for discovering the secrets of trading success, contemplate the Greek aphorism, author uncertain: “Know thyself.”

For the would-be trader, this self-knowledge takes two forms. The first is having sufficient self-awareness to be able to select the right trading style for them. No two styles are exactly alike, any more than are two people, and the right style for one person may well be the wrong style for another.

No guarantee of success

One trader may focus on one or two assets – a commodity, perhaps, or a particular index or individual company stocks– and research them deeply, giving themselves a significant edge in terms of making the right calls as to the next price movements. Another may trade opportunistically, perhaps using chart analysis to inform their judgment as to when a rising security is due a correction or an oversold asset is likely to bounce, known as a “status change” in relation to stocks.

There are traders who take no view on future price movements and decide in advance what will be their reaction should a security rise, fall or move sideways. There are traders who try to spot, in advance, major events that can have a big effect on a price or prices, such as a conflict in the Middle East or a political crisis.

Once they believe they have identified such a pending event, they would back their view with significant funds.

No trading style can guarantee success, but a shortcut to failure is likely to be the result of adopting a style that is unsuitable for the individual concerned.

The second vital aspect of self-knowledge relates to the biases inherent in the human condition, biases that, left unchecked, will make loss more likely than profit. One of the most widely-understood of such biases is known as the endowment effect, which steers people to value things that they own more highly, for no other reason than they possess them.

Think like a trader, not an investor

One immediate result of the endowment effect in financial markets is to bias traders towards taking long rather than short positions. Trading, by definition, involves a willingness to stand on either side of a trade, long or short, depending on where the best opportunities lie.

Another bias is known as loss aversion. Experiments have shown that people feel loss more acutely than gain.

Thus turning £10 into £15 generates, let us say, one “pleasure point”, but turning £10 into £5 generates two “grief points”, despite the magnitude of the change – £5 in both cases – being the same. Loss aversion can bias traders into excessive caution in their trading.

Another such bias is the erroneous belief that a trading strategy, or any other financial-market position, “owes” the trader and will inevitably “come good”. There are several others grouped under the heading “cognitive biases”.

All this leads us to a key principle of successful trading, which is to remember at all times that you are a trader, not a long-term investor. Light-footedness and a nimble approach mark out the best traders.

US100

18,286.90 Price
+1.410% 1D Chg, %
Long position overnight fee -0.0262%
Short position overnight fee 0.0040%
Overnight fee time 22:00 (UTC)
Spread 7.0

BTC/USD

62,131.25 Price
-0.830% 1D Chg, %
Long position overnight fee -0.0616%
Short position overnight fee 0.0137%
Overnight fee time 22:00 (UTC)
Spread 106.00

Oil - Crude

79.49 Price
+1.850% 1D Chg, %
Long position overnight fee 0.0266%
Short position overnight fee -0.0485%
Overnight fee time 22:00 (UTC)
Spread 0.030

XRP/USD

0.63 Price
+4.530% 1D Chg, %
Long position overnight fee -0.0753%
Short position overnight fee 0.0069%
Overnight fee time 22:00 (UTC)
Spread 0.01168

A sub-principle here is that traders should never “stay married to their mistakes”, to use a striking phrase. Cutting losses, and doing so ruthlessly, is an essential aspect of trading.

Don’t forget the luck factor

On a related subject, traders ought to always remember that they are playing a zero-sum game. There are two sides to each trade, and it is impossible for both sides to win. Nor is an honourable draw likely.

This is shown in sharp relief in trading contracts for difference (CFD), a classic example of the adage that “two views make a market”. The trader takes one view of future price movements, the broker or other CFD provider takes the other view, and a contract is signed.

Both can’t be right.

The stark win/lose nature of financial trading leads to another absolutely fundamental principle of trading, risk management. Putting in place a risk-management framework, which, again, will differ from one trader to another, is more than simple common sense. It is a recognition that the market owes you nothing and can wipe out your brilliant, sure-fire trades in a moment.

In a sense, proper risk management shows the market the respect it is due. It was said of Captain William Bligh, of “Mutiny on the Bounty” fame, that he regarded the sea as an implacable enemy. It may sound a little extreme as a description of financial markets, but it is not a bad frame of mind for the trader.

Two final principles may appear opposite, but are closely linked. The first is that superstition is a no-no for the successful trader. By all means they can touch wood, cross fingers and avoid the number 13 in their private lives. But all that has to be left at the door during trading hours.

The second is not to disregard the role of luck in trading. Here we come across what is known as the primary attribution fallacy, under which the successes of people of whom one approves – oneself especially – are entirely the result of hard work, or innate genius, or some other praiseworthy feature of their personality, while their failures result from the sort of ill fortune that could happen to anyone.

There will be times when a trader’s successes were, quite simply, lucky. In keeping with the first of these two final principles, they ought not to seek such luck, through superstitious practices, but neither should they pretend it does not exist.

Which ties neatly with our first principle. Self-knowledge, in all its aspects, is the indispensable bedrock of successful trading.

Sometimes a right strategy is the key for successful trading. Have a look at one of them.

 

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