First, it must be said that there are many factors which contribute to becoming a profitable trader; there is no lightbulb moment in which someone realizes the secret formula to trading success and begins generating massive returns from that point onward.
This is just like most other professions in that proficiency is derived from many sources including time. Having said that, the first step to becoming a profitable trader is arguably the simple act of defining expectations. Those who wish to succeed must be prepared for a long-term endeavor which requires consistent effort and attention.
Once expectations are defined, the tools for becoming a profitable trader can be broken down into four general buckets: habituation, discipline, technical skill, and practice.
What are the Habits of Good Traders?
Habituation is unbelievably important in trading; without habits you are simply gambling. That is, habituation provides the consistency required to be rewarded for your skill and to identify what works and what doesn’t. Furthermore, habituation develops the psychological state necessary for trading, including discipline (the second bucket listed later in this post).
The role of habituation can be illustrated in a simple example: imagine Trader A wakes up at a different time every day, trades different securities/markets every day, follows a different trading process every day, and so forth. How will that person ever develop a strategy that works? Moreover, how will they know what works and what doesn’t? After all, without making anything into a habit, determining which winning trades were due to skill and which were due to luck would be virtually impossible.
Now imagine Trader B wakes up at the same time every day, looks at a predefined set of markets/instruments, and follows a well-defined set of trading processes. By virtue of habituation alone Trader B will be infinitely more successful over the long run due to his/her ability to analyze and refine those discrete processes.
Developing good habits must extend beyond trading itself; it must be a constant effort to optimize your mind and body. This includes practicing good mental health, maintaining a healthy diet and exercise regimen, and regulating your sleep schedule. The simple fact is that although trading doesn’t necessarily require 80 hour work weeks like investment banking, it does require the ability to think clearly and remain rational through very stressful situations.
An alternative way to express the value of “general” life habits is that if you don’t take the time to organize these aspects of your life and form strong foundational habits around them, you’re just giving up one more edge you could’ve had.
There is one habit that is so important it must be addressed individually: journaling. Recording everything you do will help you learn what you did right, what you did wrong, and will provide a custom database which enables you to find trends in your own trading patterns. In addition to recording the results of every trade, be sure to record your plan and reasoning for a trade before entering the position. Upon doing this, you can analyze your follow-through success (did you stick to what you said you would do?), your profitability across different markets/sectors/instruments, and your rate of improvement.
Discipline: The Great Equalizer
It is truly impossible to understate the role of discipline in successful trading. Not only do you need the discipline to maintain the habits mentioned in the previous section, but you also need it for technical practices. When analyzing a trend or chart pattern, you must define some criteria by which you will enter a trade and some criteria by which you will exit a trade.
As simple as that sounds, even industry professionals still fail to follow this one simple practice, all because they lack the discipline to follow through with what they promised. Your mind is a powerful tool when it is working for you but it is equally powerful when working against you. The pressure of fear and greed weighs on every trader while they hold a position; good traders simply possess the discipline necessary to manage that pressure without caving in.
Discipline plays an equally important role leading up to a trade as it does while holding the position. It takes great discipline to apply the same rigorous standard over and over again, especially when that standard tells you that none of the trades you’re analyzing are worth pursuing. In this case, temptation will come in the form of trades which are sub-par or which you don’t fully understand.
An undisciplined trader will feel the pressure to act and the commonly referenced “fear of missing out”-he/she will be uncomfortable holding cash and will enter trades that are inherently unfavorable. The reality is, going an entire minute/hour/day without trading is perfectly fine. If great opportunities hit you over the head every second then everyone would get rich trading. The fact that they don’t means that the disciplined and patient traders get rewarded while the undisciplined and impulsive traders get punished.
How Important is Technical Skill for Profitable Traders?
Discipline and habituation serve as the key foundation for profitable trading, however, technical skill must be built upon that foundation. To become a profitable trader you must become adept at tuning out market noise and identifying risk/reward asymmetries. In order to do this, you must understand the markets/securities you are trading and be able to use technology to effectively monetize that understanding.
Depending on trade duration, understanding a security/market may mean understanding its historical technical patterns, understanding the fundamental drivers of its intrinsic value, or a combination of both. That is, trading over a 1-minute timeframe will rely almost exclusively on technicals, while trading over a 3-day timeframe will rely on a combination of technical and fundamental factors. Whatever your timeframe preference, you will need to develop the technical proficiency which corresponds to that timeframe. Regardless of what some advertisers would have you believe, technical proficiency does not mean taking one course or reading one book. It takes grueling dedication to master a single aspect of trading and the learning never stops.
Profitable traders develop their technical proficiency by absorbing information from a variety of sources and constantly questioning their assumptions. They pay attention to what’s happening inside of markets and within the industry. This sort of obsessive desire to improve is vital to retaining profitability as a trader. Indeed, financial markets are full of individuals and institutions which outperform temporarily only to become complacent and lose their edge.
For example, after the dotcom bubble of the 1990’s, many long/short hedge funds substantially outperformed the broader market. These funds took short positions in overvalued securities and long positions in undervalued securities. They looked like true Wall Street geniuses until the 2008 crisis when many long/short funds suffered enormous losses due to their exposure to a variety of complex derivatives. The reason they failed was not a lack of intelligence; they simply neglected to refine their analysis and technical processes in response to a new market. Accordingly, the model which worked so well for them in the dotcom bubble fell apart in the housing bubble. If you want to be a consistently profitable trader, learn from their mistake and never stop refining your technical skills.
Practice Makes Better
Although demo account trading can be useful as an initial gateway into how trading software works, the reality is that becoming a profitable trader requires practice trading real money. Developing all the prerequisites outlined above is much different when you have to reconcile the fact that being wrong will have a material financial cost. Of course, you can mitigate this cost by ensuring that the capital you allocate to trading is part of your disposable income. Doing this will ensure that you have sufficient capital remaining once you develop the skills necessary to trade profitably.
The Long and Short of Being a Profitable Trader
Becoming a profitable trader is the result of a confluence of habituation, discipline, technical skill, and practice. There is no way to circumvent any of these factors and a great trader will enthusiastically pursue all of them. More broadly, the common thread between all of these factors is time. The vast majority of traders fail because they do not recognize the level of commitment involved in developing these traits. Instead, they might think that waking up when the markets open, reading news for an hour, learning a bit of trading jargon, and practicing on a demo account for two weeks is enough to give them an edge.
The absurdity of this mindset can be demonstrated in the context of other highly competitive activities. Let’s take football as an example; would two weeks of practicing one hour a day be sufficient to produce an excellent football player? Of course not. In the case of trading, those who expect too much too fast and quit early take punishment in their bank account instead of their joints.
To avoid becoming one of the many who fall into this pointless paradigm, brace yourself for the challenge of trading and be ready to give your full effort over a long period of time. You’ll end up with some scars, but if you can make it to the other side the rewards are incredible.