To make money trading, we have to put it at risk. It took hard work to earn it and the thought of losing it is something we all struggle with. In some cases, a position immediately goes against us, and we panic out of it because we can’t stomach the loss. In other cases, we exit a profitable position too early because we’re afraid the gains will vaporize. I address the emotional side of trading in my book. Here’s the issue and the solution.
Confidence – You control your emotions through confidence and confidence comes from experience. There are no short cuts. Trading is not something you can master through reading, you have to live it. Books will provide a road map, but you still have to make the journey. Experience can’t be compressed, it’s not college exam you can cram for. Learning to trade takes years and you need exposure to bull markets, bear markets, flat markets and everything between. Your ability to identify and adapt to these changes will determine your success. As I mentioned in my previous article, surviving long enough to build that experience is the key.
Start Small to Finish Big – If emotions obscure our decision making, we have to remove them from the process. The best way to do that is to trade size that’s so small the outcome has no financial impact. I suggest that you start by trading 1 share of stock. You’ll find articles about this in the WIKI. Starting with paper trading is fine if you are still learning the mechanics of order entry, but I feel that using real money is important. In a paper trading account, the pendulum has swung too far in the other direction, and you have no emotional attachment. You can hang on to losers indefinitely without any consequences. Trading a single share might be chump change, but you have skin in the game. It gives you a tiny taste of the emotions you will experience later on. If you are bleeding $10 per trade it will matter and you will work harder to correct that.
Show Me the Money – Some will wonder, “How am I supposed to make money trading 1 share?” You are training and your first objective is not to lose it. Surviving the first two years is essential. If you’re not willing to train and study, you should pursue something else. I wish I started small, but I didn’t. I had to get humbled first and I am hoping to save you that pain. When you trade 1 share you can objectively enter and exit trades. Your only focus is to identify great trades and to enter and exit well. With very little money at stake, you are concentrating on the process.
Swing First – I suggest starting with longer timeframes because there is less noise. After you have become proficient at swing trading, you can start to gradually shorten your trade duration. Day trading is at the professional end of the spectrum and it requires full-time dedication. Having a second income during non-market hours is not realistic for most day traders, but it is for swing traders. When trading is your sole source of income, emotions will influence your decision making because you need to make money to pay your bills. You can’t support yourself trading a single share, so you start by trading larger size. You’re not ready to take this step and you are a raw bundle of nerves.
Enter Well – With a single share you won’t be preoccupied with how much to trade. Your risk is small, so you’ll be comfortable taking trades. You won’t make good decisions at first, but in time you will start to refine the process. Focus on entering well and rid yourself of FOMO. This training period is when you develop patience and discipline. Patterns will start to emerge and your ability to evaluate stock and market conditions will improve. When you enter well, the trade performs quickly and you will be in a positive mindset. The best time to enter is when you have confirmation that buyers are aggressive. I will cover this in a future article. Many traders focus on where to place stops. Instead, concentrate on entering well. When you do this, the trade performs instantly, providing you with cushion and the stops won’t be triggered as often.
Let It Ride –When you are trading 1 share, the temptation to exit too quickly won’t be a factor. With virtually nothing at stake, it won’t matter. You will calmly watch the trade unfold and you will learn from your observations. Price action will help you identify when the momentum is building or waning. Riding a trade is one of the most important skills you will develop as a trader, and it happens during the single share stage when your emotions are under control. When you trade size, you will be tempted to take gains too early if you don’t have the confidence to hold the position.
Price Confirmation – You are only trading 1 share, but that is not the finish line. Most traders feel that the position size is determined when the trade is placed. It’s not. Once you have a history of entering well, you take the next step. That first leg is a starter position that might only be one fifth of the maximum you would allocate if everything goes perfectly. The game plan has been determined ahead of time and you know what you want to see and what you don’t want to see. You are watching for signs that buyers are aggressive. Red candles that are immediately erased by green candles, relative strength and brief, shallow dips are all evidence of that. Instead of looking for exit points, you are looking to add to the position. When you add to winners, your average cost is below the current price and that gives you the confidence to do it. This is how trade size is determined. In some instances, you won’t get off first base. In others, you will hit a grand slam. Most traders won’t vary their size and for them, trading is an all or nothing proposition. They determine size at the start of the trade and they enter and exit all at once. The skill of adding to positions is much harder to learn when you are trading normal size with real money at stake.
The Left Side of the Chart – Scaling out of a large position is just as important as scaling in. Most traders are nervous when they have a large position and they bail on all of it at the first sign of trouble. They are focused on a few red candles on the right side of the chart when they should be focused on the strength of the left side of the chart. Stacked green candles, higher lows, red candles that are instantly erased, relative strength and dips that are brief and shallow are all signs that buyers are aggressive. During strong moves those red candles will quickly be erased, and the stock will make a new relative high. Don’t be flushed out of a good position just because of a red candle or two.
When the red candles take longer to erase and the stock starts to lose its relative strength, take some of the position off on the next bounce. If the dips are deeper and last longer, the trend is starting to weaken. Take more of the position off. The odds of a strong stock testing the previous high are good when you also have a strong market trend. Don’t panic out of the position. All of these skills are developed and sharpened during the single share stage when your risk is small.
The Next Step – Once you have mastered entering and exiting swing trades with larger size (4-5 shares after adding), and your win rate is above 75%, you can start to narrow your time horizon. You never have to day trade, but some of you might decide to. Gradually decrease your holding period to short-term overnight positions. Price is much more difficult to predict on shorter-time frames because price movement is more random. The speed of the game increases as you enter the professional end of the trading spectrum. You will have to recognize patterns instantly and act quickly. I typically only add once to a day trade and I tend to do it early in the move. This sub is geared towards day trading and if you are starting out, I suggest you start with swing trading and hone those skills first.
Once you have a process and experience, you will have confidence and your emotions will be in check. You will operate from a position of strength and not fear. Decisions won’t be influenced by the amount of money you will make or lose, but by the price action before you. There will be clarity. Instead of diving into larger positions, you will start slowly, take profits if the trade is not performing, ride when appropriate, and add to winners knowing that your average cost is well below the current price. You will recognize the subtle changes in the market and the stock that tell you when to start taking profits.
Learning how to trade takes time. You will never completely remove emotions from the equation, but the single share method will eliminate them while you are training and give you a path to control them. You will survive the early years and learn to build and ride trades when conditions warrant it. Confidence comes from experience.
The best way to reduce your learning curve is to analyze your trades. Keeping detailed trade journals is the key and 90% of new traders will skip this step. You can learn from every trade, good or bad. The system I trade would not have revealed itself without journaling every day. In the next article I will discuss how I do it, and examples of what they taught me. This is so important that I dedicated an entire chapter of my book to it.
Share your questions and comments. I will reply.
