The New Trading for a Living

Trading successfully isn't about blind risk-taking—it's about knowledge, discipline, and learning how to make informed decisions while managing your emotions.

1. Beware of Hidden Costs in Trading

The excitement of trading can quickly dim when hidden costs like commissions and slippage deplete your funds. Beginners often overlook these expenses, but understanding them can save you thousands. For instance, commissions come out of your budget every time you trade. If you trade frequently, such fees pile up quickly, potentially eating away a significant chunk of your capital.

One strategy to reduce commission costs is choosing a broker or platform with reasonable fees. Researching different options will help you find the one that offers value without draining your account. Moreover, it’s essential to understand the type of orders you place. Market orders—where you purchase a stock at the current price—increase your risk of paying more than you'd prefer if the price spikes unexpectedly.

Limit orders are a better alternative for beginners. With a limit order, you specify the price you’re willing to pay or accept, ensuring you don’t overspend or sell too cheaply. This tactic helps prevent slippage, which occurs when a trade gets executed at a less favorable price than anticipated.

Examples

• A trader who pays $10 per trade and makes eight trades weekly will lose $4,000 annually with frequent commissions.
• Using limit orders, a trader can avoid paying unexpected higher prices, such as buying stocks for $53 when intending to pay $50.
• Opting for a broker with lower fees can reduce the expenses associated with frequent trading.

2. Trading is Not Gambling

Good trading strategies separate professional traders from gamblers. Gambling relies on chance and often leads to emotional decision-making, which is detrimental in the market. A gambler may impulsively buy and sell without assessing risks or having a clear plan, while professional traders approach the market with calculation and clarity.

One sign of gambling behavior is feeling an uncontrollable urge to trade, driven by emotion rather than logic. For example, traders who feel euphoria when succeeding or despair after a loss are relying on emotions rather than strategy. Good traders avoid placing personal feelings onto their trades; instead, they focus on process and outcomes.

Another key behavior to avoid is overleveraging without safeguards, such as stop-loss orders, which can limit losses. Self-sabotaging decisions often lead to catastrophic results, like losing your entire portfolio due to a single reckless trade. Trading is a discipline where risk should be balanced against reward through thoughtful decisions.

Examples

• A pharmacist-turned-trader once left an open position during a vacation, returning to find his entire capital wiped out.
• Emotional trading, where a person trades out of excitement or fear, often causes huge losses.
• Using stop-loss orders and limiting risks per trade can help control losses and avoid financial ruin.

3. Avoid Herd Mentality

The market reflects a crowd's behavior, often dictated by trends rather than logic. Following the masses can lead to disastrous outcomes, like buying overvalued stocks because 'everyone else is doing it.' Historical events, such as Tulip Mania in the 1600s, show how market bubbles form and burst due to crowd psychology.

Human instincts naturally drive us to follow others for a sense of safety, but in trading, this can backfire. Successful traders recognize the patterns that bulls (optimistic buyers) and bears (pessimistic sellers) create in the market and use tools to assess these behaviors rationally.

For instance, chart analysis can help identify trends and potential turning points. By understanding whether a market is in a bullish or bearish phase, independent traders can make better decisions instead of blindly trusting the crowd.

Examples

• Tulip Mania led ordinary people to abandon jobs for the tulip trade, only to find themselves broke when the bubble burst.
• A bullish market may tempt people to buy overpriced stocks, while a bearish one might incite panic selling.
• Chart analysis tools help traders identify whether bulls or bears dominate, guiding better decisions.

4. Mastering Bar Chart Basics

Successful trading starts with understanding one of the simplest but most important tools: the bar chart. Bar charts depict all the vital price movements within a given timeframe, offering insights into market trends and the battle between bullish and bearish forces.

Each bar in the chart represents an essential data point: opening price, closing price, high, low, and price range. Professionals often base their trading decisions on the closing price, as it represents the market's final judgment during that period. Meanwhile, the difference between the high and low reflects the day’s activity and intensity of the bulls-versus-bears conflict.

A trader observing these charts can assess market momentum. For example, if bars consistently show higher closing prices, it indicates a bullish trend. On the flip side, consistently lower closing prices suggest bearish strength, which might signal a time to sell or avoid trading.

Examples

• A bullish market is revealed when closing prices trend higher than opening prices.
• Wide gaps between high and low indicate increased activity in the market.
• During bear market activity, bars show declining trends in closing prices.

5. Understand Support and Resistance Levels

Support and resistance levels on a bar chart help traders decide when to buy or sell. Support occurs when buying interrupts a price's downward trend, while resistance signifies a price ceiling where selling stops further upward momentum.

Recognizing these levels can improve trading decisions. Support acts like the floor for stock prices, making it a strong buy signal as prices are unlikely to drop further. On the other hand, resistance serves as a ceiling, signaling a potential sell point before prices decline.

For instance, the Dow Jones showed resistance between 950 and 1,050 from 1966 to 1982. This zone acted as a ‘ceiling,’ and prices consistently dropped after reaching it. Identifying such patterns early allows traders to plan their strategies more effectively.

Examples

• The Dow Jones's "graveyard in the sky" resistance level between 950 and 1,050 deterred consistent upward trends.
• Traders often buy at support levels, expecting prices to rise.
• Resistance levels help prevent losses by signaling the best times to sell.

6. Focus on Liquidity and Volatility

Trading success isn't just about what you trade—it’s about the quality of those trades. Two vital metrics to keep an eye on are liquidity (the ease of trading a stock) and volatility (fluctuations in its price). High liquidity means the stock can be easily bought or sold without price disruptions, while high volatility increases both profit potential and risk.

For instance, low-liquidity stocks can trap traders. If there aren’t enough buyers, large trades become difficult, often forcing sales at unfavorable prices. Volatility, measured using beta, shows how much a stock’s price deviates from the market average. Beginners are advised to start with stocks with lower beta values to limit risk.

Examples

• A trader stuck with 6,000 shares of a low-volume stock had to sell them off in small increments, incurring high commissions.
• High-liquidity stocks simplify trading by ensuring easy transactions without price distortions.
• High-beta stocks can double profits—or losses—compared to stable benchmarks.

7. Managing Risk: The 2% and 6% Rules

Trading without proper safeguards often ends in severe losses. Two practical rules ensure traders protect their capital: the 2% rule (maximum risk per trade) and the 6% rule (maximum monthly loss). The 2% rule allows controlled exposure and prevents overcommitting to any single trade.

For example, a trader with $50,000 trading equity should limit risks to $1,000 per trade. Similarly, the 6% rule discourages any new trades for the month if cumulative losses reach 6% ($3,000, for this scenario). These safeguards not only reduce financial threats but instill responsible trading habits.

Examples

• A trader who uses the 2% rule avoids losing significant portions of capital from a single bad trade.
• The 6% rule forces a cooling-off period, limiting emotional trades during losing streaks.
• Adhering to rules transforms risky trading into a disciplined wealth-building method.

8. The Power of a Trade Journal

Recording every trade in a journal fosters decision-making discipline. Reviewing past decisions helps identify patterns or biases and avoid repeating the same errors. A detailed journal should include entry points, exit points, and the reasons behind each trade.

For example, a trader struggling with emotional decisions might spot recurring patterns of impulsive trades after reflecting on their journal. Over time, this recordkeeping highlights areas for improvement, leading to refined strategies.

Examples

• A detailed journal reveals why certain trades succeeded or failed.
• Tracking an equity curve shows whether trading strategies are working long-term.
• Reviewing past trades teaches lessons that improve future decisions.

Takeaways

1. Open a virtual trading account to practice without financial risks and learn from simulated results.
2. Create a detailed trade journal to track your decisions, identify strengths, and spot costly mistakes.
3. Always set stop-loss orders to minimize potential losses and follow the 2% and 6% risk rules for each trade.