By TraderToks
The Basics Of Trading
● Know how to Identify a trend:
I know what you’re thinking, “Of course I know how to Identify a trend!”,
However you may be surprised to find out that what you have learned may be
incorrect when it comes to identifying a trend. First we must define each trend.
What is an Uptrend? By definition, an Uptrend is a chart that is making Higher
Highs (HH) and Higher Lows (HL) when compared to previous highs and lows.
This may sound confusing in text, don't worry, at the end end of this there will be
picture examples with what each trend looks like. Now what is a Downtrend? By
definition, a downtrend is a chart that is making Lower Highs (LH) and Lower
Lows (LL). This is the most effective way to identify when a market is trending, or
when a market is reversing. It is pure price action and reflects pure market
sentiment, things such as trendlines and indicators such as moving averages can
be helpful in visualizing the trend but should not be used when Identifying a
trend.
Examples of Trends
Uptrend Downtrend
As displayed in this example, we can see that the uptrend is making Higher
Highs as well as Higher Lows, thus making the trend, by definition, an Uptrend.
We also see that the downtrend is making Lower Lows as well as Lower Highs.
Now some of you who are more advanced may be asking, “What about when the
market is going neither up or down (consolidating)?”.For the purpose of the way I
trade, the market is technically never consolidating, it is always trending either up
or down. Why? Well, an uptrend is only broken when a down trend begins, and
vice versa! Therefore consolidation is nothing more than a pause within a trend
expectation.
● Know How to Read a Chart:
Understanding how to to read price is probably one of the most important skills
a trader can learn, however it is also the least understood by retail traders. I am
about to show you the single most effective and clear cut way I have found of
understand where price has been, where it currently is, and where it is expected
to go, all with no indicators and just a chart! To begin we have to first understand
what a chart is exactly. Simply put, a chart records historical transactions where
buyers and sellers agreed to one price. Using charts, we are able to gauge the
strength and weakness of buyers and sellers, since all transactions are displayed
in plain sight. If we can gauge the strength and weakness of buyers and sellers,
that means who can also gauge whether or not price is likely to move up, or
down, depending on which side has the most strength! So, how do we read a
chart? Well, there are 3 main components.
Depth: This is the amount price pulls back relative to its last swing, this can be
quantified using Fibonacci Retracements. If you are unfamiliar with fibonacci
retracements, I will not be going into depth on them here but a quick google search
should suffice. Essentially, the less price pulls back (Shallow depth), the stronger the
current trend. The more price pulls back (Large Depth), the weaker the current trend.
Here is an example
Projection: This is the amount price continues to climb/fall after breaking to a new
High or new Low. For example, If price breaks out to a new high, then quickly reverses
after a few points, this is a weak sign for the buyers as they could not push much
higher. If price breaks down to a new low, then quickly reverses after a few points, this
is a weak sign for the sellers as they could not push much lower. So, the further price
goes after breaking out/down, the stronger the current trend is.
Pitch: This is essentially the same thing as momentum. Pitch is the speed in which
price goes from point A to point B. An easy way to measure pitch is to draw a line from
the High and Low of a price leg, the steeper the angle (pitch) of the line, the more
momentum that specific move had. The less steep, the weaker the momentum in the
move. This is useful for gauging who has the current strongest momentum and allows
us to know how cautious to be when entering a position. When entering a position long
for example, it is better for the pullback you are entering on to have a shallow pitch (less
steep), as that means the sellers are weakening and buyers are fighting for control.
● Know How to Draw Support and Resistance
We have all heard of Support and Resistance, but how many know how to
properly identify these areas where the markets are likely to turn? First Let's
briefly discuss the definition of Support and Resistance. Support Is an area on
the chart where buying has occurred and is likely to occur again. Resistance Is
an area on the chart where selling has occurred and is likely to occur again. Now,
there is no easy way to describe in words how to identify support and resistance
so we will look at examples shortly. However, before that, I want you to notice
that I wrote “area” in the definition. Support and Resistance are areas, not single
price points or lines. They must be treated and drawn in as zones. Many traders
will make the mistake of marking a single price point as support and resistance,
and as soon as price passes that point they say “ugh, support and resistance
doesn't work”. I am going to show you how to not be that trader. Let's look at
these examples.
Support
Resistance
Let's first look at the example of support. As you can see I marked the level as a
blue zone, not a line. Each green arrow marks a point at which price tested this area
and was bought back up. So, as seen, this area was tested five times and was rejected
five times, this tells us that this area is of large significance and acts as Support for
price. Now let's look at the resistance. As seen in the example we see that price tested
the zone five times just like the last time (just a coincidence). Clearly, this zone is of
significance and acts as Resistance for price.
● Understand Risk Management
isk management is, dare I say, the most important factor when it comes to
R
trading. You can have a system that works for one person, and loses tons of
money for another person. Often the case comes down to one person having
better risk management than the other! Many may believe they need to make
20-50% of their account per month in order to succeed in trading. This is
ridiculous and outright impossible, at least when trading.These returns are
possible, when gambling! We are not gamblers, we are traders. Gamblers lose,
traders win. To begin learning about risk management, we must first set the basic
rules all traders should understand about risking money in the markets. The first
one: never risk more than 1-2% of your account on any single trade. This rule is
mathematically proven to allow for a smooth equity curve and low drawdowns
(losses). So for example, if you are trading a $100,000 account, you should not
lose more than $1,000-$2,000 on any given trade. Why is this? Well, to answer
that we have to understand compounding gains and losses. If we lose 10 trades
in a row, which is bound to happen at some point in a traders career due to the
law of probabilities, as long as we risk 1-2% on each trade, we would “only” lose
about 10-20% at a maximum of our account. Now even though that is quite a
large number to lose, it is recoverable. Now let's say we were risking 5-10% of
our account per trade, a common amount many newer traders risk. Well, now
those same 10 losses have resulted in a 50-100% loss of the account. To put
that in to perspective, we would now either have to make over 100% on the
account in order to get back to break even, or have no money left at all! Below is
a chart that demonstrates the relationship between losses and recovery
● Understand Probabilities
robably one of the most overlooked aspects in trading is the fact that you
P
require a strategy that has a statistical edge, meaning the probabilities must be in
favor of your strategy. What confuses many people is the fact that you, in fact, do
not need to win a majority of your trades in order to make profit. Let me explain.
Say you risk 1 dollar to make 2 dollars on every trade you take. You have also
confirmed that the strategy you are using has a win rate of about 50%. This
means you are losing half of the time, all the time. Many people would hear this
and say “That trader sucks, he's losing money!” when in fact, that trader is
making profit. How is that possible? Well remember that we stated each time he
takes a trade he risks 1 dollar, this means every time he loses a trade, he losses
1 dollar. However, when we he wins, he makes 2 dollars. Now let's take a
theoretical random sample of 10 trades with these statistics in mind and see what
the net outcome is: -1+2-1-1+2-1+2+2-1+2 = 5 dollars net profit. Even though the
trader lost half of his trades, he ended up making a net profit! This relationship
between your risk and reward combined with your probability of winning any
given trade is the only formula required to figure out if a strategy is profitable or
not. Below is a chart showing the relationship between win rate and risk to
reward. The chart should be interpreted like this: “if my risk is 5 dollars and my
reward is 1 dollar per trade, I must win 83% of the time at a minimum in order to
not lose money”
● Understand your psychology
any people believe in order to be a successful trader all you need is a “winning
M
system”, however, you can have a winning system and still have a losing trader. Why?
One very common reason is that person has not yet studied the psychology behind
trading and thus trades with a great amount of emotion. The trader can have a winning
system yet self sabotage every single trade as human emotions take hold. Why do you
think traders who trade demo accounts always make money? It’s because when no real
money is involved, the trader trades with a lack of emotion. The trader gets confident
and decides to switch over to a live account, then BOOM, what happens? The trader
begins losing money hand over fist, as now emotions are involved due to the
attachment to money! This is only natural and is overcome mostly over time through
experience, however, there are some things you can do to prevent trading with emotion.
A very important aspect is to know that your strategy has a positive expectancy,
meaning if the rules you have learned and tested earn money over time, there is no
reason to base any trades on emotion as your rules are proven to make money, while
your emotions are not!
