A beginner trader is often overwhelmed by the sheer volume of information and knowledge available online. It becomes difficult to prioritise and understand what information is key.
For that reason, this article lays out the 5 key trading concepts which I think are the most important to learn and understand when starting trading.
For instance, I will explain how tackling risk management and seeing trading as a probability are critical steps for becoming a better trader.
1. The Concept of Trend, Correction and Reversal
The very first step beginner traders should take is learning how to recognise the mode of the chart. Is the chart trending, correcting or perhaps reversing?
The ability to read the chart is a key and critical concept, in my view. Here is an example that occurs often. A beginner trader starts out lucky as they stumble upon a trend, trade with that trend (possibly by accident), and get a few winning trades.
The problem is that, eventually, the trend will indeed end but beginner traders will fail to see the warning signs and keep trading in that same direction.
This first step allows traders to get answers for the following three questions:
- Is the chart trending or correcting?
- What is the current or previous trend direction?
- Will the trend be able to continue or will it reverse?
Traders are in a much better spot once they can analyse the charts and answer the above.
2. Trading is About Probability
Deep down in our gut, we all feel bad when losing a trade setup. Not surprisingly, most traders, therefore, want to avoid losses at all costs.
Apparently, this very normal for humans... Studies have shown that we are much more impacted by losses than by wins.1 In other words, we feel much more pain when losing than we notice joy when winning.
Our natural instinct, therefore, is to avoid that pain and those nasty losses. Unfortunately, in the world of trading, losses are a normal feature of winning in the long run… Why?
Because traders can never achieve a 100% win record. All traders will bump into losses sooner or later, even the most experienced ones. Why? Because market conditions change, and traders can't predict the future.
Trading is all about taking a calculated risk when the odds are in your favour. Traders never know whether any particular setup will work out or not.
In the long run, of course, the performance should be positive, otherwise the trading system itself or implementation of the system might not be good enough. Traders need about 40-50 trades to have a decent idea about the long-term viability of that specific approach.
3. Risk Management is the Foundation
From point 2 we know that losses are unavoidable. Traders will need to accept losses along the way if they want to be profitable in the long-term.
This is exactly the reason why risk management is so important and why traders must try to minimise the impact of losses on their trading capital.
Let's take an extreme example: a trader opens up a 1500 euro account and decides to risk the entire sum on a single trade. A loss would mean that the entire account is gone and the trader can no longer trade on that account.
Traders need to make sure that they can continue to trade with their capital and risk management is the perfect line of defence for that.
Imagine now that the trader would not risk 1500 euro but 30 euro, which is a 2% risk. A loss would not significantly hurt the trader's account because there would still be 1470 euro remaining, even after a 30 euro loss. Enough to keep going for the next trade setup.
Taking lower levels of risk, like 0.5%, 1%, or 2% risk per-setup, allows traders to handle a string of losses (called drawdowns) without receiving a major blow to their trading capital.
Also, using key support and resistance (S&R) levels for placing a Stop Loss is useful tip. The MetaTrader Supreme Edition offers great tools for finding such key S&R levels.
4. Take Your Time to Learn
It seems to me that many beginner traders somehow expect to master analysing and trading within a few days or weeks.
My advice is simple: focus on learning step-by-step in the first few weeks and months rather than expecting crazy levels of profits. Trading and analysing is a skill like everything else and requires attention.
Also, keep in mind that the more you enjoy analysing the charts, the faster the learning curve tends to be.
5. Focus on Exits and Improving Your Style
Most traders love to test systems and entry methods, but neglect exits and trade management. Unfortunately, trading is the art of both entering and exiting.
In fact, a bad entry can be substantially improved by a good exit, but a good entry can be wasted with a bad exit. This means that all your hard work of finding a good entry method is less valuable if you ignored how to exit a trade.
My tip is, therefore, simple: always remember to also test exits when developing new entry methods and systems.
Wishing you a happy week of trading,
- The Art of Thinking Clearly, Rolf Dobelli