We all know that trading is largely a mental game. There is the excitement and there is the adrenaline rush, but there are also huge capital risks that you run. Hence it is very important to understand the game of trading before embarking on the same. You first need to understand how you must behave and think as traders vs. investors. Successful trader strategies are all about adopting a disciplined, methodical approach and managing your risk smartly. Here are the traits of successful traders and how they need to do things differently from investors..
10 things a trader must do differently from an investor
Focus on protecting your capital. That is the most important trait of a trader. You cannot bet your bottom dollar on a single trade. You have to first decide how much loss you are willing to risk on that trade. Your smartness in identifying good trades comes afterwards. First you must learn to survive to fight another day.
Be paranoid about transaction costs. Stop thinking like a millionaire when you are a trader. You are focusing on churning your money quick and hard. That means your transaction costs have to be low. There are enough zero-brokerage no-frills trading accounts in the market today. Pick one of them. If you are careless about your trading costs they can eat away a good chunk of your trading profits.
Be paranoid about tax impact. Not just about transaction costs but you must also be paranoid about the impact of taxes. When you trade your income is either speculative income or business income. Either ways you are going to be taxed at your peak rate. Straight away you are giving away 30% of your profits to the government. Your number of churns and return targets should be determined by that.
To be a successful trader the odds are stacked against you. That is a statistical reality. It is like gambling in a casino. The survival of the casino depends on more people losing than winning. Therefore, in trading the odds will be stacked against you. The percentage of successful traders is abysmally low and that is piece of data that will work against you.
Momentum matters more than value. Value is great for an investor with a five year investment perspective. As a trader, you do not have that luxury. You are more intent on churning your money in the short term. Your focus should be on the momentum and the direction of the momentum. As the great Jesse Livermore once put it, “In stock markets there is no bull side and bear side. There is only the right side and the wrong side”. That is what momentum is all about!
As a trader, one bad trade can spoil your show. You will be surprised how one bad trade or one bad day can make a mess of your full year of trading hard work. You will be judged by your final outcome. So focus on the outcome and manage your risks accordingly.
Focus on compounding returns but do it more often. OK it is not just investors who focus on the power of compounding but even traders focus on the power of compounding. We are not talking about earning 25% returns per annum but we are talking about earning 5-7% net returns per month. If you can churn and sustain that kind of returns then you are looking at outstanding returns at the end of 1 year. As a trader you have made a living.
Diversify and don’t take on the risk of leverage. As a trader, diversification is a lot more important than for an investor. You need to spread your trades to spread your risk. Too much concentration is not a good idea for a trader. More importantly, avoid leverage like the plague. If you think that you can borrow at 2% a month and earn 5% a month and retain a spread of 3% then you are grossly mistaken. Actual trading rarely works with such precision. Always trade with own money and avoid the risk of leverage!
You do not have the Buffettian luxury of holding forever. When you get into a trade remember that you do not have the luxury of holding on forever like Warren Buffet and Charlie Munger. You need to keep your stop losses and you need to trade with strict profit targets. So avoid averaging positions and avoid taking a second opinion on your stop losses and profit targets. Discipline is the key when it comes to trading!
Trading has a huge opportunity cost, focus on what you are missing. Learn to put trading in perspective. If the net returns you have earned in a year is around 23% after all costs and if the index fund is giving 22% returns then you have failed the perspective test as a trader. Your entire trading effort is pointless. As a trader focus more on what you are missing and that helps you evaluate your trading strategy better!