19th December 2019
Over time, several myths of trading have become commonly accepted by market participants. While these myths may have initially had some truth to them, they are often taken out of context. In this post, we debunk four commonly believed myths of trading.
It seems logical that individual traders shouldn’t be able to compete with professional traders armed with superior technology and deep pockets. To be fair, if you take them on at their own game you probably won’t be able to compete. But you don’t need to—you can develop your own niche doing things that professional traders can’t do.
First of all, it’s important to realize that there are lots of different types of professional traders. High-frequency traders operate on timeframes that can be measured in nanoseconds. Proprietary traders mostly day trade; executing lots of trades using the firm’s capital. Hedge funds typically have longer timeframes, and they hold very large positions. Each of these types of trader brings certain strengths to the market, and you really don’t want to take them on.
However, there are opportunities that just aren’t worth their while. Individual retail traders can use two factors to their advantage. The one is patience, and the other is flexibility. Pro traders need to generate very large profits to justify the capital they use. They also need to keep that money working. As a day trader, a $100 profit is meaningful, and you can be patient to achieve it when pro traders can’t. The trick is to find your own niche and focus on the opportunities that don’t interest professional traders.
This myth is actually partly true. But it’s up to you to decide which side of the equation you are on. You can either be the casino or the gambler at the casino.
Casino operators know their win rates and they know how much of their turnover they will generate as a profit. Most of their customer’s don’t know their win rate, and on balance, they lose money.
The same can be said for traders. Pro traders know their win rates and the reward to risk ratio for each trade. They are obsessed with knowing these details because that’s how they know they can win.
This allows them to treat the market as their own personal casino.
Most losing traders approach the market the way most gamblers approach a casino. They are in it for the excitement and the chance of hitting the jackpot—we all know how this turns out for gamblers.
Traders tend to gravitate toward day trading for several reasons. Day trading allows a trader to execute more trades, which logic suggests should allow profits to stack up quickly. Because most traders use quite a bit of leverage, they are reluctant to hold their positions overnight due to the increased risk of doing so. Again, day trading makes sense.
The truth is that day trading may not be right for everyone. Day trading requires a different skillset and a different personality type from swing trading, longer-term momentum trading and investing. Day traders must be able to focus for extended periods of time and make decisions on the fly. They also need to be able to sit through quiet and frustrating periods without letting emotion get the better of them.
If you are more of an analytical or strategic trader, you may be better suited to longer time frames. The fact that you can execute more trades will not help if you are not trading the strategy that is right for you.
Most traders who use technical analysis know this but many who don’t, get this wrong. Technical analysis is not about making predictions, but about identifying opportunities with positive expectancy.
The media is largely to blame for the misconception. Analysts who make bold predictions get more airtime. Very little attention is paid to the how often they get their calls right – let alone the risk or timeframe involved. If the media instead gave airtime to the analysts who were most profitable, a very different picture would emerge.
Technical analysis is very useful for identifying what may potentially happen, potential profit targets and the amount of risk associated with a trade. If you only need to risk $100 to potentially make $300, you only need to be profitable 40% of the time to make a profit. In fact, if 25% of your trades were winners you would still breakeven.
Even simple technical analysis can help you work out what the market is doing, and likely levels of support and resistance. Combining this with other forms of analysis can help you time your trades and avoid entering at the wrong level.
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