GETTING A BETTER POSITION – tips and tricks for traders

Inspired by CMC Markets’ renewed partnership with NSW Waratahs, the below piece provides traders with tips and tricks on getting a better position. By Ric Spooner, Chief Market Analyst, CMC Markets Australia.

Taking a new trading position is usually a pretty positive experience. We traders tend to get into the market with a degree of conviction about our insights and with a nice profit firmly in mind. Getting out of trades can be more fraught, especially if we are operating without a plan. When it comes to quitting positions, traders often find themselves exposed to the two most harrowing aspects of the pursuit – dealing with loss or facing the fear of missing out and leaving large profits on the table.

ENTRY AND EXIT STRATEGIES THE KEY

Logically, where you get out of a trading position is just as important as where you get in. After all, the outcome of a trade is determined by the difference between where you buy and where you sell. I know this seems a trite point but the reality is that a lot of people struggle with trading because they go about things in a way that doesn’t recognise this simple reality. They don’t plan exits. Instead, they approach each trade with a conviction that something is a “buy” and a loose idea that they will sell for a profit at some stage. This might work for the Sydney property market but it’s unlikely to achieve the consistent results needed to succeed as a short-term trader.

Trading is about developing a set of repeatable strategies for position entry and exit. So, tip number one for getting a better position is that it must make sense based on where you plan to get out (either for a profit or a loss). Let me explain.

THE ELEMENTS OF TRADING SUCCESS

Trading is not about capital gain, rental income or dividends. It’s about relatively high turnover and frequent short term profits and losses. There will be plenty of losses but successful traders finish most years with a lot more profit than loss.

At a basic level, achieving profits over time is about two key ratios. Your percentage of winning to losing trades (success ratio) AND the average value of profits compared to losses (pay off ratio)

The key to success is how these ratios combine. For example, for every 100 trades:

  • A 60% success ratio with an average profit of $1000 and an average loss of $1000 will net an overall $20,000 profit
  • A 40% success ratio with an average profit of $2500 and an average loss of $1000 will net an overall $40,000 profit
  • A 60% success ratio with an average profit of $1000 but an average loss of $2000 will net an overall loss or $20,000

You won’t necessarily succeed as a trader by simply having a lot of winning positions. It’s also going to depend on how big your losses are. The opposite also applies. Simply “letting your profits run”, as the trading texts often advise, isn’t necessarily enough. If you hit the ball out of the park every now and then but have too many losses in between, you’ll finish in the red.

THE PROBLEM

One very useful observation about market reality is that over the long run, there’s usually a trade off between the success and pay off ratios. You can usually get your success ratio up over time by taking small profits quickly but hanging onto losing trades, waiting for them to come good eventually. Taking small profits and not letting positions run, cuts down the number of positions that start off well but eventually turn into losses. Riding out losing trades will also reduce the number of losses. There will be plenty of times that positions will eventually come good.

The problem can be that while these techniques can give you more winning trades, they might also result in a very poor payoff ratio. You might end up with a lot of small wins but have some very large losses on the occasions when bad positions don’t come good but the loss just keeps getting bigger and bigger. The payoff ratio can be so bad that it becomes virtually impossible to make money even with a very good success ratio.

In fact, this kind of approach describes a common problem for traders. When it comes down to  it, once they are in a position their primary motivator is the fear of losing. They try to make every trade a winner, and in the process, wind up losing overall because the average size of their losses will be too large compared to their wins.

THE SOLUTION

By now you may be thoroughly depressed. However, recognising that this is how trading works is the key to success.

The real trick to taking a better positions is to put together plan for when to buy and when to sell that will deliver profit over every 30; 50 or 100 trades. Each separate trade, whether it wins or loses, is part of a consistent strategy. You can fit a set of trading rules with a winning combination of success and pay off ratios to a lot of trading ideas. It’s a matter of experimenting a bit until you find something that works.

A good way to begin is by looking at entry and exit rules that might give you a lot of profits and not too many losers. Take profits quickly and allow a bit of width on your stop loss to reduce the number of “whipsaw” losses. Then do the opposite, apply a set of rules to your trading idea that might give you a good payoff ratio.

Aim for large profits and place your stop loss close to the first point of failure. If one of these approaches works; great. If not, look at strategies that fit somewhere in between to find a winning combination of success and payoff ratios.

Good traders tend to be process driven. Their aim is to make money at the end of the period and they are relaxed about the fact that this inevitably involves taking losses along the way. It doesn’t really matter if the route to success is a lot of small profits or a few large ones with a lot of small losses. It’s the money in the bank at the end of the year that counts.



Ric Spooner is Chief Market Analyst for CMC Markets in Australia, and is the most experienced global analyst in the CMC Markets team with over 30 years working in financial markets.