The Golden Rules of Trading III – Trading like a Business
The majority of new participants approach Forex trading with no idea in mind but to trade and win. They did not make a plan, and their objectives aren’t clear as well. They enter the market with one dream: getting rich, starting with a $1,000 or less trading account. Usually, they did not make a plan, don’t know the needed skills, their strengths, and weaknesses, and think that trading is just predicting the market. The outcome of this mindset is failure and frustration. To succeed, trading must be considered as a business.
In this video, we are going to talk about the importance of treating trading like a business.
1.- Initial Assessment
You need to create an initial assessment document. On it, you’ll need to define the following:
Your current beliefs about yourself and the market. Your vision about you, your life, and your goals.
List your strengths ( what are you good at- programming, recognizing patterns, math skills…)
List the resources you will need
Determine your weaknesses and how to overcome them.
2.- Establish your objectives
Set your monthly profits goal, then divide it by 20 to determine your daily profits goal. Finally, establish how many market signals you take on average using your trading plan and decide on your average profit per trade.
Define your tolerance for drawdowns. Will you allow 10%, 26%, 40%, or higher max drawdown? Max drawdown is a critical value you should know for you to set your dollar risk per trade. That was dealt with already, but let’s remember the key fact: Max drawdown, together with the percent losers of your system will help you set a likely max losing streak. For example, a well known trend-following system with only 35% winners will sometimes show up to 20 losers in a row. If a trader using this system establishes its max drawdown to 30%, the dollar risk per trade must be set to 30%/20, which is 1.5% risk. Determine how much you will pay yourself and what percentage of your profits will be reinvested to grow your trading account.
3.- Operating rules and contingency plans:
Establish the maximum number of consecutive trades you’re going to take
Set the maximum daily dollar losses you will accept before stopping to trade for the day
Set the maximum dollar gains you are going to take before halting your day-to-day operations. That way, you keep your trading rational, avoiding losses due to your child’s side take control.
Define also your weekly and monthly loss sizes. In the case these amounts are reached, you should switch to paper trades until the next week or month.
Establish a trading record with the relevant information needed to measure and analyze your performance and the system’s improvement/adaptation to the current market conditions.
Define the reviewing period for the performance analysis of your systems. Use statistical methods to analyze them.
4.- Markets, Timeframes, diversification
Define the best timeframe for your needs and time availability. Please beware that shorter timeframes are more costly because the costs of trading (commissions, spreads, and slippage) do not change, but the trading ranges shrink, and so do your profits.
Define your basket of pairs to trade. Criteria for the list should include liquidity, volatility, and trendiness. Avoid illiquid markets or excessive volatility.
Ensure diversification to lower your overall risk. For instance, trading only major pairs will be sensitive to the dollar movements; thus, a sharp dollar move against you will affect all your trades at the same time. In this case, make sure you have 50% of your positions long the dollar and 50% short the dollar.
Know the big picture of all the pairs on your basket. We should remember that Fundamental Analysis is the driver of the underlying trend, and that surprising figures will trigger price shocks.
5.- A basket of Systems
Make sure your systems have an edge and that the average Reward/risk ratio is greater than one.
System diversification: Use at least two different and facing systems. One of them might be a trend-following system, while the second system fades the trend. That will help when there are no trends, and the pair is ranging. Sometimes one will lose, and the other one will win. If both systems are profitable, the long-term result will be the sum of their performance, but the downside is limited, as one of them will tame the other system’s losses.
Use the position sizing as explained above, ensuring that your maximum risk per trade is limited to fit your preferences for drawdown.
Continue developing new ideas and strategies, doing paper trading on them if the backtests are worthwhile.