Many people enter the world of trading with a set of unrealistic expectations. Internet marketers sell the dream of fast, easy money by simply following some guru or joining some service that will help them unlock the secret to lifelong riches, of course, with very little effort on their part.
As I am sure most of the readers of this esteemed publication already know, those stories are mostly garbage.
The truth is that learning how to trade takes a very long time.
There is a mountain of knowledge that is needed to form a base on which skills are then developed.
Learning this information takes time. Developing the skillset takes even longer.
The key for new entrants in the market is to realise and accept that they must crawl before they can walk.
They must start with the basics and build up knowledge from there.
So where do we start?
There are four major pillars on which ‘successful trading’ is built.
These four pillars are fundamental and technical analysis, trading strategy, risk management and trading psychology.
The most important is probably risk management, but in truth they are all interdependent and a firm grasp of each of them is needed.
Each of these pillars, of course, are made up of several different building blocks.
The deeper you delve, the more there is to learn.
In this edition, we’ll start with the basics:
Fundamental and technical analysis
Fundamental analysis is the study of both the micro and macroeconomic environments in which companies operate, as well as the study of specific companies – both from a stand-alone and contextual perspective.
For example, applying a certain valuation methodology to a company to determine its intrinsic value could help you determine if a share price is overvalued or undervalued, while comparing the company’s position in the market relative to its competitors might aid in determining whether the prospects of the company are positive or negative going forward.
It may also help to understand the economic conditions in which the company operates and how an improvement or deterioration in those conditions will impact the company and its intrinsic value.
Technical analysis on the other hand, is the study of historical price fluctuations to identify trends and turning points in these price movements.
Analysis here could aid traders in identifying entry and exit points to buy and sell shares in companies, with the aim to profit from the price fluctuations.
It could also be a methodology of creating mathematical models that take in large amounts of fundamental and price data and generate probabilistic forecasts on underlying financial instruments.
It is a relatively new topic in the world of finance, but is already a vast field of study with new methods created by academics in the field each year.
Trading strategies are different ways in which various elements of both fundamental and technical analysis are combined to identify opportunities.
A strategy attempts to find opportunities traders can take in which the probability of success is in the favour of the trader.
In other words, a strategy is a combination of inputs that attempts to identify an edge.
That edge is defined as the probability of one thing happening over another being greater than 50/50.
Put in its most basic form, a strategy is a series of ‘if this happens, then do that’ rules that traders use to govern their actions.
Risk management is a key input, or building block, of any trading strategy, but because of its vital importance, it is classed as a pillar.
Risk management rules aim to protect traders from mistakes.
They are based on the premise that traders are probably wrong most of the time, but even so, can speculate in financial markets successfully.
Risk management methodologies aim to minimise losses taken and maximise rewards earned.
There are rather a lot of different ways in which traders can manage risk, and being well-versed in different methods can greatly aid in building effective strategies.
It is not what you are doing, but how you are thinking while you are doing it, that determines success.
Trading is possibly one of the most emotionally straining professions out there.
Traders need to learn how they respond to stress and pressure and learn to identify when they are acting irrationally and when they are not.
Self-awareness and self-control are really, in my opinion at least, the things that separate the successful traders from the unsuccessful traders.
Many traders lose all their money and fail, not because the markets are rigged, but because they fail to learn how their own decision-making processes sabotage their own success.
This is certainly a vast topic, but truly a very important one to study.
Delving deeper into each of these pillars and studying their individual building blocks is the starting point of a very long journey.
Petri Redelinghuys is a trader and the founder of Herenya Capital Advisors.