There is a series of core trading skills that you will be required to develop to trade successfully. Mastering these core competencies is essential to mastering trading. The core skills start out with analysis, first and foremost. Following this the position size is determined in conjunction with your entry criteria and your stop placement. By religiously placing a stop on every position, you cut your losses, but still have to work out when to take profits. Scaling in can be used by intermediate traders to reduce the risk when entering a trade and scaling out can be used to lock in profits as they occur. And then one final skill to master is re-entry after you have been stopped out or taken profits on a position. It does not matter whether you trade shares, currency, futures, commodities or CFDs, the core skills required are all the same.
Analysis
Before you place your first trade you must decide how you will develop a trading edge. Your trading edge is your advantage that you intend to exploit for profit and is critical to your success. Your edge will come from a thorough analysis of the market you intend to trade. It is not essential for you to do all the research yourself as you can utilise analysis from a third party, but it is essential that you find an edge before you enter the market.
Methods of analysis can include a wide range of variables including economic factors, technical indicators, seasonal influences, fundamental criteria, relative performance, news releases, special events and valuation measures. It does not matter which school of analysis you subscribe to as long as the method of analysis provides you with an edge.
Position Sizing
Sound position sizing methods are critical to your trading success. It is essential to size your positions to control losses. No matter how good your analysis is, YOU WILL BE WRONG. Accepting this is important to survival when trading. The market you are trading is made up of thousands of participants all making independent decisions. No analysis available can take into account all the possible outcomes of these individual decisions, so no analysis will be right every time. If you have placed too large a position on the trade then you can blow up in spectacular fashion as the result of a strong move or gap against your position.
Low Risk Entry
Low risk entry points improve your chance of success when trading. A low risk entry point means you will lose very little if the trade does not go as planned and by keeping your losses small this can improve your risk reward ratio and your overall profitability. There are a variety of methods for determining a low risk entry point, however with all of these entries you will quickly know if your analysis was wrong. Low risk entry points not only make trading easier, they are more profitable overall, because when a trade does not work out your loss is as small as it can reasonably be.
Cutting Losses
Before you enter a position you should know where you are going to get out. This is critical to keeping your trading account intact. When you enter a trade there are only three things that can occur. Your analysis was correct and the trade moves into profit, your analysis was wrong and the trade moves into a loss, or you get lucky and it moves strongly in your favour. We prefer the third outcome and the purpose of our analysis is to identify opportunities where we can get lucky, but more importantly we want to avoid the situation where we get caught with large losses.
Develop the habit of always placing a stop loss order into the market when you enter a trade, to ensure that you control your losses on any trade.
Scaling In
Have you ever entered a trade and realised almost immediately that you did the wrong thing? Most traders have. By entering a part position, you can test the waters and if the trade moves as you expect then you can add to the position. This is known as scaling in. Most traders enter a position in one full parcel and exit the same way. However another tool you could use is adding to a winning position, maximising the returns from a good trade. Starting with a position less than your maximum you can add to the position at preset intervals. Scaling in is one of the most under used techniques by traders. Spend as much time developing
your position sizing model as you spend on looking for good entry techniques.
Holding
The world famous speculator from the early 1900’s, Jessie Livermore, made the following comment in “The Reminiscences of a Stock Operator” written by Edwin LeFevre:
“And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight!”
Jessie Livermore commented that most money in the market is made from sitting, not thinking, referring to the fact that holding positions was a key to his success. It takes time for a trade to play out and having the patience to allow the trade to develop is critical to the success of the trade. This does not mean that a trade that does not work out should be held until it becomes profitable. A stop loss is an efficient way of dealing with these trades, but for profit to grow takes time.
Scaling Out
Scaling out of a position is the reverse of scaling in. You exit part of a position on the first signs that the market may be turning around, then exit more once the turnaround is confirmed. A common strategy employed is to exit 1/3 of a position when the trade has moved in your favour by the amount of your risk, 1/3 of the position to take a profit at twice your risk and the final 1/3 when the trend finally ends.
Scaling out aligns your trading with the trend as it unfolds and increases the probability you will have a successful trade. As a trend develops it is inevitably getting closer and closer to the end of the trend. No trend goes on forever and there comes a time when the odds favour a reversal rather than a continuation of the current trend. It is impossible to consistently pick the top and bottom of a trend and scaling out allows you to capture the most likely part of the trend, but also hold onto gains until the trend ends to maximise your winners.
Taking Profits
When a trend finally ends it is time to take profits. Unfortunately a flag does not go up to signal the trend is over, so as a trader you are looking for clues that alert you to the end of a trend. As we mentioned in the section on holding, it is important to be able to distinguish between a pull back and a change in trend. There are a number of different techniques for taking profits and completely exiting a position. Choose the exits that you find appropriate to your particular style of trading, and you can always use more than one exit, taking the exit that works best for you. More than any other part of your trading, rules are required for exits.
Any exit signal that you use should be based on set criteria. Once you are in the heat of a trade your perception of what is happening is altered. It is often linked to your profit and loss rather than to what the market is doing. You can become emotionally involved with the position and your decision-making criteria can become altered. Exit the trade when your signal occurs. If the trend continues and you are exited too soon you can always re-enter if the market conditions continue to be in your favour.
Re-entry
It can be frustrating to be exited from a trade too early, but exiting from a trade does not mean the opportunity no longer exists. If you are exited too early you can re-enter a trade provided the reasons you got into the trade remain valid.
As part of your trading plan you can determine what has to happen for you to take a re-entry. It is possible to re-enter immediately after being stopped out, but this does come with some risk that the re-entry is too soon. If you have been exited from a long trade, it may be that the market bounces higher only to fall away soon after. A less risky approach is to watch the pull back to see whether the market is going to continue to drop or bounce higher. A re-entry can be taken once you confirm the market is moving higher.
Remember your first entry may not be perfect, but if your reasons for entering the trade remain valid, then a re-entry can add to your success. If at first you do not succeed, try and try again, provided the criteria for the trade remain valid.
Re-entry can be one of the hardest things to learn, because you have exited the trade to take profits, or cut a loss. You then have to adjust your view to confirm whether the original reasons for entering the trade remain valid and decide whether it is appropriate to get back in to the position. This requires you to be flexible and to remain emotionally detached from your trade.
Conclusion
Mastering these core skills will dramatically improve your trading results regardless of the market you are trading. Identify the area where you are weak and work to improve on that area. Master one skill at a time to improve your trading overall.
By Jeff Cartridge
Education Manager
