Many novice traders jump into the markets with an approach akin to gambling – with results to match. When trading is driven by indiscriminate/addictive behaviour or relegated to a form of hobby, it usually produces detrimental results.
Many traders also appear to be hard-wired to lose as their approach to the markets is influenced (or clouded) by their emotional reactions ingrained in their psyche – a consequence of inherent fear or even hearsay.
To turn trading from a hobby into an income-producing exercise requires a plan that sets objectives and employs strategies to achieve them.
Step 1: Define objectives
You need to take into account your lifestyle and investment time horizons. The amount of time you can devote to researching and trading the markets is key in defining your objective. Try to be specific and realistic. For example, if you are a fulltime worker, your objective might be to make a 20% return on your trading capital per year versus 50% for a fulltime trader. Devise a trading strategy to suit your objective. You also need to also have an idea of what proportion of your capital you could lose without qualm, without losing sleep.
Step 2: Which markets?
Depending on the objectives defined, you will need to understand the likely returns you stand to achieve from the various markets or trading products. If you are trading shares without leverage and with limited capital, it may be unrealistic for you to aim for a high return. A share CFD, which is leveraged and tradeable on margin (a small capital outlay), may be a more suitable product. If you thrive on short-term trading and have a higher risk tolerance, you need a product that is more volatile (for example, Margin FX), where fast trade entries and exits can be made. Education and knowledge is a key aspect here.
Step 3: Define entry rules
In making trading decisions, use tools of fundamental analysis and/or technical analysis. Fundamental analysis examines all relevant factors (economic data, company earnings data, etc.) affecting the price of a financial instrument or commodity and technical analysis looks at charts and identifies trading patterns/trends or even price retracement/reversal points. A good entry point is a culmination of the analysis work you do.
Step 4: The risk plan
Risk management or money management is a set of rules designed to preserve your trading capital and keep you in the market. Novice traders are usually prone to either overtrading or not reacting to negative market movements appropriately or in a timely manner, resulting in a speedy whittling away of their capital. A well worked out risk plan helps you keep your losses to a minimum and maximize profits on a winning trade. An example would be to commit no more than 20% of your capital to any particular trade and risking no more than half of that (limiting your losses) should things not go according to plan.
Step 5: Define exit rules
Where you get out of a trade is more important than where you get in as this determines your result. It is key for a trader to be disciplined enough to exit a trade when objectives are met or when a potential negative price impact is identified. You need to act on it.
One way to counter a negative impact is through the placing of a stop-loss order. A stop loss order is an order to close a position (through buying back or selling back) at a certain price. This is usually designed to limit risk (or extensive losses), but can also be used to protect profits.
Step 6: Back test, refine
After defining your strategy, you need to be able to back test it. Get access to a chart of a particular market or product. Recreate a fundamental and/or technical view at a particular point in time, and examine its past price movements. See if it reacted as you thought it ought to have.Add to the mix your capital outlay, investment time horizons and targeted returns and see if a trade would have gone according to plan. Refine what needs to be refined.
Step 7: Back to Step 1
If backtesting doesn’t give you satisfactory results (less than desired returns or higher losses), rethink your strategy or even your objectives. You will find that it is a constant learning process – a means for you to upskill yourself and realise how your emotions or rational thinking come into play.
A big part of trading is taking responsibility for the results you get – it is disempowering to think it is outside your control or someone else’s fault. Try to follow a plan to meet investment needs and objectives with steadfastness and discipline. For assistance, you can always consult an advisor.
Sunil Khemlani
StoneBridge Securities (NZ) Limited
Tel: 09 308 0787
Email: sunil.khemlani@stonebridgegroup.co.nz
StoneBridge Group is an Australian-owned trading house (accredited with the ASX and NZX exchanges) providing advisory and execution services on foreign exchange, commodities, futures and options, shares and CFDs.
This publication has been prepared on behalf of and issued by StoneBridge Securities (NZ) Limited (“StoneBridge”). This is not an offer to deal in any financial product and is not specific advice for any particular investor. StoneBridge believes that any information or advice (including any recommendation) contained in this publication is accurate when issued but does not warrant its accuracy or reliability, and is not liable for the future performance of transactions or for any loss or damage arising in connection with this publication. A full Disclosure Statement in accordance with the Securities Markets Act 1988 is available free of charge on request.