Close to ninety percent of all traders lose money. The remaining ten
percent somehow manage to either break even or even turn a profit - and
more importantly, do it consistently. How do they do that?
That's an age-old question. While there is no magic formula, one of
Elliott Wave International's senior instructors Jeffrey Kennedy has
identified five fundamental flaws that, in his opinion, stop most
traders from being consistently successful. We don't claim to have
found The Holy Grail of trading here, but sometimes a single idea can
change a person's life. Maybe you'll find one in Jeffrey's take on
trading? We sincerely hope so.
The following is an excerpt from Jeffrey Kennedy's Trader's
Classroom Collection. For a limited time, Elliott Wave International is
offering Jeffrey Kennedy's report, How to Use Bar Patterns to Spot Trade Setups, free.
Why Do Traders Lose?
If you've been trading for a long time, you no doubt have felt that
a monstrous, invisible hand sometimes reaches into your trading account
and takes out money. It doesn't seem to matter how many books you buy,
how many seminars you attend or how many hours you spend analyzing
price charts, you just can't seem to prevent that invisible hand from
depleting your trading account funds.
Which brings us to the question: Why do traders lose? Or maybe we
should ask, 'How do you stop the Hand?' Whether you are a seasoned
professional or just thinking about opening your first trading account,
the ability to stop the Hand is proportional to how well you understand
and overcome the Five Fatal Flaws of trading. For each fatal flaw
represents a finger on the invisible hand that wreaks havoc with your
trading account.
Fatal Flaw No. 1 - Lack of Methodology
If you aim to be a consistently successful trader, then you must
have a defined trading methodology, which is simply a clear and concise
way of looking at markets. Guessing or going by gut instinct won't work
over the long run. If you don't have a defined trading methodology,
then you don't have a way to know what constitutes a buy or sell
signal. Moreover, you can't even consistently correctly identify the
trend.
How to overcome this fatal flaw? Answer: Write down your
methodology. Define in writing what your analytical tools are and, more
importantly, how you use them. It doesn't matter whether you use the
Wave Principle, Point and Figure charts, Stochastics, RSI or a
combination of all of the above. What does matter is that you actually
take the effort to define it (i.e., what constitutes a buy, a sell,
your trailing stop and instructions on exiting a position). And the
best hint I can give you regarding developing a defined trading
methodology is this: If you can't fit it on the back of a business
card, it's probably too complicated.
Fatal Flaw No. 2 - Lack of Discipline
When you have clearly outlined and identified your trading
methodology, then you must have the discipline to follow your system. A
Lack of Discipline in this regard is the second fatal flaw. If the way
you view a price chart or evaluate a potential trade setup is different
from how you did it a month ago, then you have either not identified
your methodology or you lack the discipline to follow the methodology
you have identified. The formula for success is to consistently apply a
proven methodology. So the best advice I can give you to overcome a
lack of discipline is to define a trading methodology that works best
for you and follow it religiously.
Fatal Flaw No. 3 - Unrealistic Expectations
Between you and me, nothing makes me angrier than those commercials
that say something like, "...$5,000 properly positioned in Natural Gas
can give you returns of over $40,000..." Advertisements like this are a
disservice to the financial industry as a whole and end up costing
uneducated investors a lot more than $5,000. In addition, they help to
create the third fatal flaw: Unrealistic Expectations.
Yes, it is possible to experience above-average returns trading your
own account. However, it's difficult to do it without taking on
above-average risk. So what is a realistic return to shoot for in your
first year as a trader - 50%, 100%, 200%? Whoa, let's rein in those
unrealistic expectations. In my opinion, the goal for every trader
their first year out should be not to lose money. In other words, shoot
for a 0% return your first year. If you can manage that, then in year
two, try to beat the Dow or the S&P. These goals may not be flashy
but they are realistic, and if you can learn to live with them - and
achieve them - you will fend off the Hand.
For a limited time, Elliott Wave International is offering Jeffrey Kennedy's report, How to Use Bar Patterns to Spot Trade Setups, free.
Fatal Flaw No. 4 - Lack of Patience
The fourth finger of the invisible hand that robs your trading
account is Lack of Patience. I forget where, but I once read that
markets trend only 20% of the time, and, from my experience, I would
say that this is an accurate statement. So think about it, the other
80% of the time the markets are not trending in one clear direction.
That may explain why I believe that for any given time frame, there
are only two or three really good trading opportunities. For example,
if you're a long-term trader, there are typically only two or three
compelling tradable moves in a market during any given year. Similarly,
if you are a short-term trader, there are only two or three
high-quality trade setups in a given week.
All too often, because trading is inherently exciting (and anything
involving money usually is exciting), it's easy to feel like you're
missing the party if you don't trade a lot. As a result, you start
taking trade setups of lesser and lesser quality and begin to
over-trade.
How do you overcome this lack of patience? The advice I have found
to be most valuable is to remind yourself that every week, there is
another trade-of-the-year. In other words, don't worry about missing an
opportunity today, because there will be another one tomorrow, next
week and next month ... I promise.
I remember a line from a movie (either Sergeant York with Gary
Cooper or The Patriot with Mel Gibson) in which one character gives
advice to another on how to shoot a rifle: 'Aim small, miss small.' I
offer the same advice in this new context. To aim small requires
patience. So be patient, and you'll miss small."
Fatal Flaw No. 5 - Lack of Money Management
The final fatal flaw to overcome as a trader is a Lack of Money
Management, and this topic deserves more than just a few paragraphs,
because money management encompasses risk/reward analysis, probability
of success and failure, protective stops and so much more. Even so, I
would like to address the subject of money management with a focus on
risk as a function of portfolio size.
Now the big boys (i.e., the professional traders) tend to limit
their risk on any given position to 1% - 3% of their portfolio. If we
apply this rule to ourselves, then for every $5,000 we have in our
trading account, we can risk only $50-$150 on any given trade. Stocks
might be a little different, but a $50 stop in Corn, which is one
point, is simply too tight a stop, especially when the 10-day average
trading range in Corn recently has been more than 10 points. A more
plausible stop might be five points or 10, in which case, depending on
what percentage of your total portfolio you want to risk, you would
need an account size between $15,000 and $50,000.
Simply put, I believe that many traders begin to trade either
under-funded or without sufficient capital in their trading account to
trade the markets they choose to trade. And that doesn't even address
the size that they trade (i.e., multiple contracts).
To overcome this fatal flaw, let me expand on the logic from the
'aim small, miss small' movie line. If you have a small trading
account, then trade small. You can accomplish this by trading fewer
contracts, or trading e-mini contracts or even stocks. Bottom line, on
your way to becoming a consistently successful trader, you must realize
that one key is longevity. If your risk on any given position is
relatively small, then you can weather the rough spots. Conversely, if
you risk 25% of your portfolio on each trade, after four consecutive
losers, you're out all together.
Break the Hand's Grip
Trading successfully is not easy. It's hard work ... damn hard. And
if anyone leads you to believe otherwise, run the other way, and fast.
But this hard work can be rewarding, above-average gains are possible
and the sense of satisfaction one feels after a few nice trades is
absolutely priceless. To get to that point, though, you must first
break the fingers of the Hand that is holding you back and stealing
money from your trading account. I can guarantee that if you attend to
the five fatal flaws I've outlined, you won't be caught red-handed
stealing from your own account.
For more information on trading successfully, visit Elliott Wave International to download Jeffrey Kennedy's free report, How to Use Bar Patterns to Spot Trade
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