The market is a wild and unforgiving beast. Over the years that I have been involved with markets, I’ve seen a rather alarming number of traders get viciously chewed up and spat out indiscriminately by it.
The market doesn’t care who you are, how smart you are, what your background is and what you believe you are entitled to.
The market only trades and it handsomely rewards those who get it right.
And it leaves those who get it wrong by the side of the road. There is no middle ground, there is no discrimination.
You are either right, or you are wrong. And price relative to your position is the only thing that determines this.
So now that the scary stuff is out of the way, there is some good news. Every single person can become a trader.
As mentioned above, the market does not care if you are smart or well educated, it treats us all the same.
This means that each one of us has an equal opportunity to become a great trader.
The stock market is probably the only great frontier left in which someone can start with almost nothing and literally make millions.
Trading is a skillset that can be learnt and practised over time. The trick to becoming a great trader is very simple: just survive the learning period.
Over the years that I have been actively involved in markets, I have been fortunate enough to learn some invaluable lessons, both firsthand and from several great mentors.
Even though there are probably enough lessons to fill an entire encyclopedia, I find the following lessons to be some of the more important ones for traders at pretty much any stage of their trading careers.
1. Becoming a great trader takes longer than you think
This is not really a lesson as much as it is a guideline. Trading is a skill that can be learnt and must be practised. It’s like becoming a Formula One driver.
It doesn’t matter how talented a driver you are, if you were put in a Formula One car tomorrow, you will likely not win the championship.
It is going to take years’ worth of practice before you become one of the greats. The lesson here is persistence.
You must persistently endeavour to keep learning and practising, possibly for many years and through times of doubt, to really become the great trader that you have the potential to be.
2. Stick to your timeframe – and the longer the better.
There are many different recipes to make a stew, but it is generally advised that when you start making a stew following a specific recipe, you should not switch to another one halfway through.
Otherwise you end up with some weird concoction that probably won’t taste great.
In other words, if you have decided to take a trade based on analysis done on a daily chart, do not switch to a 1-hour or 30-minute chart halfway through the trade in order to find reasons to stay in or exit the trade.
Yes, you should continually be evaluating and analysing market movements – however, once you have decided to place a trade in a specific timeframe, based on specific variables, you should not change those timeframes or variables during the trade.
Also, from personal experience, I have found that trading in longer timeframes is not only much easier, but very often more profitable.
Everybody wants to be a day trader, but the truth is that trading only a few times a month on a daily timeframe is really what is best for the vast majority of traders.
Patience is profitable. Just because you are not trading every second of every day does not mean that you are not a trader.
3. Keep a handle on the risk you are taking
Managing risk is just one of those absolutely vital things that you must do. It must become a habit that is so ingrained that it is a natural part of your trading process.
In general, traders manage risk by identifying where they should put their stop-loss and then calculating how many shares they must trade in order to only lose a predetermined percentage of their capital if they stop out, which is usually 2%.
Although this is generally a good rule, it is also incomplete.
In addition to this 2% rule, you should keep track of how much exposure you are taking to the market in proportion to how big your account is, especially when trading derivatives.
If you are using tight stop-losses, position sizes tend to get a little bigger. (See box.)
If you have multiple positions open at a time, this could lead to you running three or four times (or more) exposure versus your capital.
In other words if, for example, you have R100 000 in your account, you could be running exposure of R300 000 or R400 000 in the market.
This is a hidden risk that can be extremely dangerous. If something completely unforeseen happens and all your trades go horribly wrong at the same time, it could lead to unnecessarily excessive losses.
4. Don’t mess with your stop-losses
There are many different stop-loss strategies out there. The one that you choose must be the one that you believe best suits your personality or makes the most sense to you.
Whichever stop-loss strategy you use is up to you, but you absolutely must use stop-losses.
Further, once an absolute stop-loss level is set, do not change it, ever. Stops save lives. Not only does taking a stop-loss help to protect your capital, but if properly used and executed, they protect your “trading” mindset and prevent you from falling into despair.
5. Don’t make emotional decisions
Money, by its very nature, elicits strong emotions from people. Making money feels amazing. Losing money feels terrible.
Going from a winning position to a losing position in a few minutes has a tremendously powerful impact on our emotional states.
It’s hard to explain to people who don’t trade, but you can go from feeling like nothing can stop you, to feeling crushed down to the very depths of your soul – literally in a few minutes.
People say that you should remove emotion from trading, but, we are merely human beings. Removing emotion is impossible, so we try to suppress them, which of course leads to destructive outbursts.
The solution is not to remove emotion, but to understand emotion and to understand how each emotion influences the way we make decisions, particularly when it comes to trading.
This is a huge topic and I could write about it for days. But the ultimate point here is that if you are feeling anything other than confident and clear-headed, you should not be trading.
There is no rule that says we must trade every day, nor take every potential trade that comes our way.
There is a rule though, and I am giving it to you, that says that if you are anxious, tired, upset, annoyed, stressed or experiencing any other negative emotion (as well as any overbearingly strong positive emotion), you should walk away.
Remember the story about driving the Formula One car? Well, you can’t perform at the level you need to in order to race a Formula One car if you are not absolutely in the right frame of mind and focused.
Trading is like Formula One – it can bring you glory, but it can also kill you.
You must treat it as if your life depended on each and every decision that you make.
6. Protecting your capital must always be your first goal
A trader’s capital is like their lifeline. Without capital, a trader can’t trade. Your first goal should always be to protect your capital base, because if you lose your money, you are out of the game.
Your job as a trader is not to make money, but rather to ensure that you are still around to be able to take the opportunities to make money when they present themselves.
This is why stop-losses are so important, because one big loss can set you back many months of hard work and good trading. A series of big losses can take you out of the market completely.
7. Understand the companies that you are trading
Knowledge is power, so take the time to read through at least three years’ worth of annual reports and financial statements of a company you want to take a trade in.
Even if you rely on technical analysis to identify your trades, it will benefit you greatly if you understand what is happening within the company whose stock you are trading.
8. Plan your trades
Do not simply react or trade when you “have a good feeling”. Always plan your trades in advance and account for unforeseen circumstances. It helps to think down a “if this happens, then that could be the impact on the stock” line.
We can’t predict what is going to happen, but we can plan around potential macroeconomic and fundamental risks to our trade ideas. Try thinking a few steps ahead and plotting out both favourable and unfavourable scenarios that might influence your trade.
This way, you'll have fewer nasty surprises.
9. Don’t let the opinions of others influence your own analysis
You’ve spent a lot of time researching the company whose stock you are trading in and have gone through the effort of planning out your trade and accounting for potential risks, do not let the opinions of other traders influence your positions.
They might have the opposite view to you and they may even be right, but that’s what makes a market – opposing views and people willing to act on them.
If your risk management is done correctly and your stop-losses are in place, then being wrong on a trade and losing some money should not faze you.
Being wrong is okay, but being right and getting out of a trade because someone else told you that you are wrong is not okay.
10. You are only competing against yourself
In the stock market, you are interacting with millions of people who are taking positions based on what they believe about a company’s future.
The only person who can influence your success or failure though, is you. Your own mind and your own self-control are the only stumbling blocks that can trip you up.
How you react to different situations is really only up to you. If you lose money, it is because of a decision that you made. If you make money, it is because of a decision you made. The only competition you have in the market is yourself.
For some reason people have this thing about telling everyone else about how big they trade. Do not fall into the trap of thinking that you should trade bigger because someone else is sort of trying to make fun of you around the braai.
Trading is a long-term game and over time, if you do well, your position sizes will naturally increase.
Your focus should be on staying in the game forever, not making a quick buck. Most traders lose money, so chances are that most of the “big traders” around the braai aren’t going to last. Do not compare yourself to them.
The traders who are careful, protect their capital and manage their risk are the ones who will still be around a decade from now.
11. Fees are important, but credibility is more important
In recent years, there has been this shift in the market where everyone is trying to find the cheapest broker. Yes, fees are important and no, you shouldn’t be paying more than 0.2% per contract for difference (CFD) trade or 0.3% per equity trade.
But, seeking out the cheapest brokerage on planet earth might not always be in your best interest.
Rather pay a little more and sleep sound in the knowledge that you are trading with a registered financial services provider and not some unregistered and unregulated bucket shop in an obscure foreign location.
You must trade with a brokerage firm that is registered and regulated in the country in which you are trading in, i.e. South Africa. There are laws and regulations put in place designed to protect you and your capital, so make use of them.
Also, it helps if there is a human you can talk to if something goes wrong.
Sometimes good service and advice comes at a slight premium. Don’t accept crazy-high fees, but you really don’t have to skimp on service and advice in exchange for low fees.
Stock brokers are there to help you, guide you and advise you. Find one that you trust and use them. Cheaper is not always better.
12. Don’t trade against the trend
Stocks and markets trend for a reason. There are market forces and players out there that are far bigger than you are. When things are going in a certain direction, it is natural for us to believe that at some point they will turn around.
And sometimes they do. But most of the time, they just kind of take a breather and then keep heading in the direction they were going before.
The saying, “the trend is your friend” is really true. You can’t fight it, you can’t change it, but you can follow it.
Imagine a train is coming down the tracks straight at you. Superman isn’t real (sorry, guys), so you can’t stand on the train tracks in front of the train and think that you are going to stop it. It will flatten you.
If the stock is trending up, look for longs. If the stock is trending down, look for shorts. Don’t fight against arguably one of the strongest forces on earth – a stock market trend. Rather find a way that you can use it to your advantage.
13. There is no such thing as easy money
Despite what you see on the internet or what slick suit-wearing salespeople tell you, there is no such thing as easy money. We are sold on the idea that trading is easy and that we can make a lot of money very quickly. It’s not and we can’t.
Well, we can make money very quickly, but it usually takes a good few years of practice before we learn how to make money quickly.
Trading is hard and continuous work. People have this perception that great traders just spend a few hours trading and the rest of the time they’re sipping cocktails and buying cars.
The truth is that they really spend just a few hours trading and the rest of the time doing research, looking for ideas and working on their self-awareness to root out any emotional issues preventing them for performing at their best.
There is a lot of reading involved, and a lot of waiting for the right setup to trade. Trading is probably the most difficult profession in the world. Be prepared to work your butt off. The best traders I’ve ever met are also the hardest workers I’ve ever met.
14. Nothing is ‘supposed to happen’
Sometimes we put in hours and hours of work and research into a certain trade idea and still the market does not do what we expect. Sometimes logic has no place in the market.
All the indicators, both technical and fundamental, are telling us that the market should react in a certain way, but it just won’t do what we think it should.
There is no such thing as “supposed to happen”. The market can trade at a crazy-high price-to-earnings ratio (P/E) for years and not stop going up – no matter how illogical it may seem to us.
A company might get sold down to so far below its fair value that it looks like the bargain of the century and still it might not turn around.
No matter how much research we put in and how firmly we believe that something should happen the way that we expect it to, the market will do what the market will do. We cannot fight it; we cannot impose our will on it.
It is bigger than us; it has more money than us, and if that baby is trending there is nothing we can do to stop it.
In theory, Steinhoff should not go bust… yet the stock is trading below R2. In theory, the Shiller P/E for the S&P500 has been at historic highs for years now… yet it keeps trading higher.
Our logic and views have no place in the market. Our job is to identify in which direction the market is going, and then to identify points at which we can get on board with the trend. It is what is happening now that is important, not what we think should be happening.
Some of these lessons were painful to learn, so I hope that you don’t have to go through the process of burning your fingers a thousand times for them to sink in.
Petri Redelinghuys is a trader and the founder of Herenya Capital Advisors.
This article originally appeared in the 24 May edition of finweek. Buy and download the magazine here, or sign up for our weekly newsletter here.