A be­gin­ner’s guide to trad­ing

Si­mon Brown pro­vides some help­ful tips on how to start trad­ing, dis­cussing the most com­mon mis­takes new traders make.

Finweek English Edition - - MARKET PLACE - Edi­to­rial@fin­week.co.za

ti­his n week’s col­umn I want to talk about how to start trad­ing. But first, let’s de­fine trad­ing: it is any trans­ac­tion the du­ra­tion of which is ex­pected to be shorter than three years. This is the def­i­ni­tion the South African Rev­enue Ser­vice uses, and I con­cur.

It does not need to in­clude geared prod­ucts such as for­eign ex­change (FX), con­tracts for dif­fer­ence (CFDs) or fu­tures (see side­bar). It is about how long one holds a po­si­tion and the three-year rule means a lot of peo­ple who con­sider them­selves in­vestors are per­haps traders as they hold for less than three years.

The first thing a new­bie to trad­ing must truly un­der­stand is that you are not go­ing to make money quickly. There is a lot to learn and, like with any other skill, it will take time to mas­ter. Gen­er­ally, my ad­vice to you as a new trader would be to for­get about mak­ing money for the first year or two, and rather set a goal to break even over this pe­riod. Pro­tect­ing your cap­i­tal is crit­i­cal be­cause when it’s gone, well, you’ll have to start from scratch again.

How to use a stop-loss

You pro­tect cap­i­tal by us­ing one very sim­ple tool: a rigid sto­ploss. This is a pre­de­ter­mined level at which you will ac­cept that the trade is not work­ing. Once the stock reaches this level, you will exit the po­si­tion without hes­i­ta­tion. The prob­lem with a stop-loss is that, far too of­ten, traders ig­nore it be­cause they either don’t want to take the loss or be­cause of the pain of be­ing mis­taken. But that’s go­ing about it all wrong. Any trade you en­ter is merely about prob­a­bil­ity and even suc­cess­ful traders will be wrong about half the time. But if your prof­itable trades make more money than those that lose money, you’re win­ning.

Tak­ing it a step fur­ther, you can’t use profit or loss in any in­di­vid­ual trade as your met­ric for suc­cess. Even if you do ev­ery­thing right, this trade may just be one of the 50% that re­sult in a loss. In other words, you could do ev­ery­thing right yet get stopped out at a loss. How can you de­cide if a trade is bad when you obeyed the rules?

So, a much bet­ter way of mea­sur­ing our suc­cess as a trader is to de­cide what a per­fect trade looks like and try to ex­e­cute one per­fect trade af­ter an­other. This list of what makes a per­fect trade would not in­clude profit or loss, but would in­clude ques­tions such as: Did I wait for con­fir­ma­tion? Was the po­si­tion size cor­rect? Did I have an exit strat­egy in place be­fore I en­tered the trade? Did I ad­here to that exit strat­egy? I use a list of seven points and my aim is sim­ple: to get a per­fect 7/ 7 in every trade.

An­other im­por­tant as­pect of a stop-loss is, ob­vi­ously, where you place it. Typ­i­cally, traders place it far too close to the en­try. For ex­am­ple, 3% away from en­try on a stock that has an av­er­age daily move of al­most 2% and an av­er­age true range of al­most 5%. These two val­ues tell you that your 3% stop-loss will al­most hit even as the share is mov­ing in your di­rec­tion over the du­ra­tion of the trade. You need to re­duce the size of the trade and move a stock stop-loss to around 8% from the en­try, giv­ing you more wig­gle room.

Trad­ing smaller is also a very im­por­tant start­ing point for new­bies. You might be tempted to put all your cap­i­tal into a trade be­cause you’re con­fi­dent about it, but as I men­tioned above, trad­ing is about prob­a­bil­ity and any trade could be prof­itable or los­ing. You need to make sure that you’ll sur­vive those los­ing trades.

You can’t use profit or loss in any in­di­vid­ual trade as your met­ric for suc­cess. Even if you do ev­ery­thing right, this trade may just be one of the 50% that re­sult in a loss.

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