The first step to becoming a profitable trader is developing loss and risk management rules and habits. This may seem strange, but at the foundation of any probabilistic endeavor, of which trading is one, is managing risk.
Either you manage risk and loss like a professional or you are a degenerate gambler, no different than the guy at the riverboat casino flushing away his family’s rent money on penny slots. Your only saving grace being the fact that your embarrassment happens in the privacy of your own home and you get to call your folly, “trading” instead of what it really is, gambling.
You start with rules. Write them down and commit to them. Practice and ingrain them into your trading routine until they become automatic and unconscious habits.
I want to stress the importance of risk and loss management rules and habits, because they are the only things that will allow you to survive the business of trading.
There will be many losing days and even losing periods in your trading career, whether you are trading a single micro contract or hundreds of full-sized contracts.
Properly managed through robust risk and loss management rules, losses, losing days and extended losing periods are simply business expenses, no different than inventory loss for a retail store or alcohol spillage for a bar.
Unmanaged Risk Ends Trading Careers
Without properly developed risk and loss rules and habits, every losing trade can potentially be the trade that empties your trading account and ends your trading career forever.
Any losing day potentially can be the day that empties your trading account and ends your trading career forever.
Any period of losing days can potentially be the period that empties your trading account and ends your trading career forever.
Think about that and let that sink in for a minute. You don’t have to be in the trading business long to either personally experience a devastating loss or know someone who experiences one because of poor risk and loss management rules and habits.
Understand the truth of this statement and the fact that it looms not only as a real possibility, but as a high probability if you trade without strong risk and loss management rules and habits.
Develop Proper Risk Habits Early
Ironically, if you are new to trading developing the right risk and loss rules and habits is much easier than the correction of ingrained wrong risk management rules and habits that experienced traders have to undergo to get to consistent profitability.
If you are new to trading do not squander this opportunity to establish right loss and risk management rules and habits. It will save you countless hours of frustration and large amounts of money.
You Will Develop Habits, the Only Choice is What These Habits Will Be
Just be aware that the choice is not whether to develop right risk and loss management rules and habit or not to develop these rules and habits. You will develop some risk and loss management rules and habits.
The only choice is whether you intentionally and mindfully develop right rules and habits that will help you as a trader or whether you unconsciously and without awareness repeat the same behaviors until they become automatic habits that will undermine and sabotage your trading no matter how much time energy and money you pour into your trading.
This seems like an extreme example, who would trade live without some sort of risk and loss management rules? You would be surprised. It happens a lot more than you think.
These traders are around only for the briefest of periods, because they invariably suffer a devastating loss and decide trading is not the easy money they were told.
But the risk runs deeper than just the crazy newbie trading live with no risk and loss management rules. Many of us who consider ourselves serious and prudent traders do it all the time.
You Play Like You Practice
Many traders develop poor trading habits while practicing in SIM. SIM trading or paper trading is an invaluable tool to the developing trader. Unfortunately, many of us use it in such a way that bad habits are developed that bleed into and affect our live trading in a very real and negative way.
Often while paper trading risk and loss management rules are ignored or stretched, because there is no monetary consequence, we think this is harmless. However, we are that which we consistently do. You play as you practice.
You can no more expect to practice trading in an undisciplined way and then trade live with discipline then a professional athlete can expect to practice lazily and without disciple and then to execute plays with precision and disciple under the stress of a real game.
It doesn’t happen and it won’t happen for you.
Trading Rules and Trading Habits are Not the Same Thing
I keep mentioning rules and habits together, but what you need to take away from this is that rules are necessary but not sufficient. You start with solid rules, but they must become instinctive and automatic habits.
There is a real difference between having trading rules and having trading habits. If you have been trading for a while and been struggling with discipline you know intuitively, if not consciously what the difference is.
All traders have trading rules and trading habits, whether productive or destructive. Often a trader will have great rules but terrible habits. Unfortunately, habits ALWAYS trump rules.
Trading rules are the careful well thought out plans you make every night and in the early morning, before the trading session begins. Trading habits are what you actually do in the live market with real money at stake.
Trading Habits ALWAYS Trump Trading Rules
Let’s look at an example. Billy is a conscientious learner, studies hard and has a genuine commitment to making himself a successful trader, but unfortunately, he is a struggling trader.
Every night he diligently reviews his charts. Every night he memorizes his trading rules. Every night he thoughtfully plans his trading strategy for the upcoming day. Yet, almost every trading day ends in frustration as he consistently violates his trading rules in the heat of the trading session.
Everyday Billy promises himself that he will never break this rule or that rule again. He will never over trade, or surpass his daily loss limit or over leverage, etc, etc…
Yet time and time again to his frustration and shame he breaks his carefully thought out trading rules, even though he fully realizes that his inability to stick to his trading rules are the very things that prevent his from being a consistently profitable trader.
The Right Trading Rules, But the Wrong Trading Habits
Billy’s problem is that he has the right trading rules, but the wrong trading habits.
Somewhere along the line Billy unconsciously developed bad trading habits. He probably doesn’t even know what these habits are or what cues he is unconsciously responding to or what cravings his seemly counterproductive habits are satisfying.
All he knows is that once he starts trading live all his well laid plans go out the window. It’s like someone else takes the controls and when the dust clears and the trading session is over he is incensed and astonished at his seeming inability to follow his rules.
He calls himself all types of names and thinks self-discipline is the answer. But day after day, over and over again he does the same things and gets the same results.
Rules can never defeat habits. Habits operate at an instinctive level far more primal and powerful than rules. Once developed habits cannot be erased, BUT they can be rewritten through conscious and deliberate effort.
Aligning Trading Habits with Trading Rules
The key is aligning your habits with your rules. If you are a beginner trader hopefully you have not had time to develop poor habits. Life is much easier for these lucky few.
If you can consciously plan which habits, you want and develop them into automatic subconscious actions then you are well on your way to being a successful trader.
Unfortunately, for the more experienced trader like Billy, the battle before him is to consciously, thoughtfully and purposefully reprogram old detrimental habits into new beneficial habits.
Developing the Right Trading Habits
How then does one then turn right trading rules into actual trading habits? Here, it is beneficial to compare the trader to the athlete.
How does the athlete perform optimally in the big game? By starting small.
The athlete first practices the move or technique countless times under very little pressure, until it becomes instinctive or habitual.
Next, the athlete slowly starts increasing the pressure or stress under which the move or technique is done under. Whether this is by tightening time constraints, adding distractions or heightening opposition.
As the athlete becomes, faster, more efficient and effortless in the execution the athlete is then ready to take the ingrained subconscious habits out onto the playing field.
Here, the athlete’s skills are pitted against the field in real time. After the competition the athlete’s performance will analyzed looking for areas for improvement.
When reviewing performance, the athlete does not simply say, “I need to play better.” No, the performance is broken down into its smallest pieces.
The athlete instead says, when I shoot the ball I need to make sure my elbow is aligned properly before releasing the basketball.”
The athlete then methodically and repeatedly practices this very thing until it is instinctive and unconscious.
Until it takes a conscious effort for the athlete to shoot the basketball without aligning the elbow correctly. This is how you need to ingrain your trading habits.
Break them down into small parts and practice doing the correct action repeatedly, until its unnatural for you to do otherwise.
Start Developing Correct Trading Habits Today
If you need to develop good trading habits make developing the correct habits the focus of your trading for the next thirty days.
Make a list of the top five trading habits you want to develop or correct. Remember, much like the athlete, each habit need to be described with exact specificity.
For each habit write out three things you can do to create the habit. Let’s say for example the habit you want to create is to stop taking impulsive trades.
First, you would change the negative action into a positive action. So instead of saying, “I want to stop taking impulsive trades, you would instead say, “I want to only take planned trades.”
Second, write out three things that will help you create this habit. So here they might be:
- I will only enter trades with limit orders, no market orders
- I will only enter trades if I wrote down the entry trigger X number of minutes prior to entry
- I will only take X number of trades per day
These are only examples, the three steps you choose need to be tailored to your trading issues. Work on one habit at a time until you feel like you have made the new habit unconscious and instinctive. Then move to the next habit.
Remember, you can create the habits you desire and take your trading to the next level. What is important is not to wish for change, but to take concrete incremental steps to achieve change.