In trading, your ‘edge’ over the market is the margin that you’re winning by. If we were casinos, who could set the odds we win by, then we’d set our edge to somewhere like 4.5%, confident that the average person to walk through the door, will leave behind 4.5p in every pound they spend.
But as traders, we don’t have the luxury of setting the odds! Instead, maintaining our winning edge is something we have to monitor and work on.
The reality of trading, even the most profitable strategy, is that any winning edge will be tight.
You’ll win some, you’ll lose some … sometimes those losses will be greater than the winnings, but – if we’re doing it right – more often, the winnings will outstrip the losses.
It’s just not possible to have a huge edge over the market – market forces act to correct these kinds of imbalances. But there are things we can do to nudge those odds in our favour …
1 • Drawdown limit
A drawdown limit goes against the idea that we have to be consistent and keep trading, robot-like, through losing runs. However, losing trades tend to bunch up, simply because the market may not be behaving in a way that suits our methods – and that’s where drawdown limits really help. A drawdown limit is a fantastically simple way to shift the odds in your favour. Here’s how they work …
- Set a daily/weekly/monthly maximum drawdown you’ll accept.
- If this drawdown is hit, stop trading until the end of that day/week/month
That’s it! By stopping trading when losses get too big, you’re automatically limiting how much you can lose. Balance that by having no limit on the gains you can make, and you’ve limited losses, and unlimited profits!
2 • Extend your timeframe
The less we’re jumping in and out of the markets, the less money we’re paying out to our brokers on spread costs.
3 • Use the right stakes
A bug bear of mine – I speak to so many traders who don’t do this! If you’re not matching your stakes to the risk on individual trades, and the size of your fund – you’re either taking too much risk, or you’re not maximizing your profits.
Fix a percentage risk per trade of 0.5–5%, depending on your risk profile – and ensure your stake reflects that for each trade (it’ll change if your stop distance changes from trade to trade).
4 • Lower risk
It may seem counter-intuitive to lower your risk to make more money! The more we invest, the more we’ll make, right? (As long as it’s a profitable method.)
But, if you’re using a method with volatile returns (big drawdowns, in return for big returns), then a lower risk can smooth out these ups and downs.
5 • Trade less
Again, these can seem counter-intuitive. If we’ve a profitable trading method, surely we want to use it as often and across as many markets as possible?
But not all trades are equal. We enter some with a better chance of winning, and a better chance of winning big than others.
If we can filter out the weaker trades, we can invest more in the better trades – making more money overall, and cutting risk.
6 • Simplify your trading strategy, not your money management
When we start adding ‘filters’ to our trades, this often involves adding extra layers of complexity to our entries – a new indicator, more hoops to jump through. But this can miss the point.
It’s not necessary to add more complexity to our trading signals – our efforts are much better spent on managing open trades, with techniques like taking partial profits, trailing stops, intelligent exits …
7 • Keep trading
One of the biggest causes of failure in trading is not being consistent. Again and again I meet traders complaining about a system they were using which hit a losing run, so they gave up on it, believing it was flawed, and moved onto another strategy that was having a great run … you probably know how the story goes …
… traders who chase winning runs will always be a step behind, catching the losing runs, before moving onto the next system that has just hit a new high (and is due a drawdown!)
8 • Don’t think – follow rules
Twice in the past week I’ve placed trades that followed my trading rules, but that I just didn’t like the look of – they felt wrong. And, guess what – they both lost.
That feeling makes me think that I should listen to my ‘gut’ more … but I know that I’ve conveniently forgotten all the times that my ‘gut’ was wrong.
What I should do is question why I had doubts about those trades, and consider adapting my strategy accordingly … then thoroughly test that before actually applying the change. But just going with what we ‘think’ is a road to ruin!
9 • Don’t listen to opinion or news
Just as in the previous point – if I’m not going to trust what I think myself – I DEFINITELY shouldn’t listen to what ‘experts’ and ‘pundits’ think!
10 • Be patient
As we’ve seen, successful trading is about having a small edge … and then we repeat, repeat, repeat ….
The only way fortunes are built quickly through trading are with a crazy gamble – and those are the fortunes that are lost just as quickly.
The chart below shows how trades which bring in a modest average profit (of 2–4%), will build substantial profits over time through compounding …
The edge only needs to be modest for real wealth to build – but it’ll only work if you stick with it.