Management, psychology and success in trading

Based on our team's extensive trading experience and the knowledge we have gathered from numerous professional traders we engage with, we have reached the following conclusions.

The key to success in trading lies in the following combination of elements:

• theoretical framework;
• extensive practical experience;
• effective trading system;
• proficient risk management;
• skill in calmly adhering to your trading strategy;
• analysis of trading performance

Theoretical framework

Trading history dates back over 100 years ago. During all these years, outstanding professionals in this field have devoted themselves to in-depth research, seeking patterns and tools to optimize the effectiveness of their trading actions. The topic of trading has been extensively covered in a multitude of books, encapsulating an immense wealth of knowledge on the pages. Numerous foundational works remain relevant in the present era and are likely to remain so for a long time to come. The phrase "Veni, vidi, vici" famously spoken by Julius Caesar, is entirely irrelevant to the world of trading. Adhering to those words would almost certainly result in losing one's deposit, and it would happen much more quickly than it may appear at first glance.

The systematic accumulation of theoretical knowledge serves as the cornerstone of a trader's endeavors. For a long time, we believed that there couldn't be an abundance of theory. We thought that reading one more specialized book would undoubtedly be an asset to us and bring us closer to desired results. There has always been a desire to know more because our intellect suggests that the more we know, the more effectively we can trade. In this relentless pursuit of knowledge, we devoted years to chasing after one more book, one more article, one more theory, one more educational course, one more educational stream or video.

Is it important to have a wealth of theoretical knowledge? Undoubtedly, it is crucial! Is it absolutely necessary to possess an extensive body of knowledge for successful and consistent trading? Undoubtedly, no. Of course, it is necessary to absorb and assimilate a certain volume of information. However, knowledge that is not regularly tested through practical application is merely a "partially filled memory cell" and holds no practical value.

Practice has shown that an "overdose" of theory not only fails to improve results but, in fact, has an extremely counterproductive influence on them.

Extensive practical experience

A considerable amount of practical experience holds greater value than a substantial amount of theoretical knowledge. It is precisely this experience that distinguishes useful theories and tools from those that are ineffective. It is this practical experience that aids in correctly interpreting the current market dynamics, which can have diverse effects on the efficacy of the same market prediction tools. Systematically accumulated practical experience often evolves into productivity.

Fortunately or unfortunately, the painful loss of personal funds resulting from one's mistakes is the fastest way to reduce cognitive biases in perceiving the true market conditions. The mindset of an inexperienced trader is often structured in such a way that, in the majority of cases, they are more prone to perceiving their desires as reality rather than critically assessing the current state of affairs. In other words, with a high probability, the inexperienced trader will seek confirmation for their decisions, disregarding significant facts that contradict them.

For example, many bullish patterns can easily be reinterpreted into bearish patterns. It is very easy to make mistakes when identifying wave counts according to Elliott Wave Theory and so on. With the passage of time and a quantitative approach, practical experience helps to assess the current market situation more accurately, thereby improving the quality of actions taken.

Through hundreds of hours of trading, the vast array of decisions based on the accumulated theoretical foundation narrows down significantly to a specific set of rules that constitute the primary trading system.

Effective trading system

A trading system is a comprehensive tool for decision-making, comprising a specific set of rules designed to enable traders to generate profits. Utilizing a multifactor trading system, a trader avoids making decisions based on intuition or subjective notions like "I feel that..." He has a set of rules, and when these rules are simultaneously met, he opens a trade in the desired direction and closes it upon reaching certain values. In any other case, if even one rule of the system is not met, he disregards the market and everything happening in it.

To determine the effectiveness of a developed trading system, it is crucial to perform a backtest. In other words, the trader "rewinds" the chart back and conducts testing of their system on a historical period.

The testing period also holds great importance. Often, many traders consider it sufficient to test the performance of their system based on a small number of previous trades. The point is that it is necessary to consider the timeframe when conducting testing. For example, if a flat period (or an uptrend/downtrend) on an asset lasted for 10 days, then depending on the chosen timeframe, it will contain the following number of candles:

For a daily timeframe, this period will contain 10 candles, while for a 5-minute timeframe, it will contain 2880 candlesticks. Despite such a significant difference in the number of candlesticks, we are referring to the same period and, therefore, the same market conditions. An effective backtest should cover a large number of different market conditions, as it provides the trader with a clear understanding of the effectiveness of their trading system. It is quite possible that a trading system can be effective in one market situation and ineffective in others. Clearly, within the given period from the example above, the minimum number of trades generated by the tested system will vary significantly across different time frames. For example, if 30-50 tested trades are sufficient to evaluate the system's performance on higher time frames (as they cover a significant period of time), on the very lower time frames, hundreds of test trades need to be conducted. Otherwise, the test will be irrelevant since it will most likely perform differently in other market conditions. Therefore, the conclusion to be drawn from this is:

Proficient risk management

No matter how great a trading system is, it cannot guarantee 100% successful trades. Such high success rates may be achievable over a short distance, but as the distance increases, the proportion of successful trades will decrease accordingly.

In any business, the income structure comprises two components: profits and expenses. Consequently, influencing income is not only achievable by increasing profits but also by reducing losses.

Risk management is a system of managing risks that involves limiting losses in each executed trade, regardless of the time horizon of its holding. In other terms, it involves assessing the risk exposure a trader is willing to accept when initiating a trade. When initiating each new trade, the trader should already have a predetermined exit plan in case the trade if it moves against them. This is a predetermined stop point at which the trader realizes that the trade has failed to perform as expected, prompting them to close it and limit their losses.

Even the perfect trading system will be helpless without risk management and will not be able to protect the trader from wiping out his trading account. In the case of trading futures, where each percentage move in price is multiplied by the leverage, it's even "deliberately killing one's own deposit."

Risk management consists of the following key components:

1. Risk Capital: The amount of money a trader is willing to lose when entering a trade
2. Profit Target: The desired level of profit a trader aims to achieve, considering the potential risk of incurring a loss
3. Trade Quantity: The number of trades a trader is willing to engage in simultaneously

Risk Capital: The amount of money a trader is willing to lose when entering a trade

When discussing futures trading, the management of potential losses is done through three approaches: stop size, trade volume and margin leverage (for more detailed information on leverage, please read here)

Stop Loss (SL) is a risk management tool that involves automatically closing a trade to limit losses when the price moves against the trader's position. It is typically defined as a percentage of the asset's price movement from the trade entry point.

The impact on the loss amount is interchangeable across the mentioned methods. The screenshot below showcases how adjusting different parameters results in the same loss sizes.

This screenshot demonstrates that the same $5 loss size (first row) can be adjusted using the following methods:
- by opening a trade with a position size of 5% of your deposit, selecting a leverage of 10x, and setting a 1% stop loss distance;
- by opening a trade with a position size of 1% of your deposit, opting for a leverage of 10x, and setting a 5% stop loss distance;
- by opening a trade with a position size of 10% of your deposit, setting a 5% stop loss distance, and choosing a 1x leverage.

In all of the aforementioned scenarios, a loss of $5 was incurred, but it was achieved through completely different combinations of adjustable variables.

Why use so many methods to determine the size of a trade's loss if they all lead to the same results?

Firstly, the key point is that the stop loss level on the price chart of an asset is not a constant value, and it will vary for each individual case. The stop loss level always follows a logical approach (rather than being set arbitrarily as "I want to set the stop loss at 3% for this trade") and takes into account the current volatility of the asset, which can be highly variable.

In the majority of trading strategies, a loss size of 2-3% of the overall trading deposit is deemed acceptable for a single trade. This allows the trader to participate in multiple trades simultaneously, and such a loss size helps mitigate the risk of losing all of the trader's funds. Additionally, this range is mentally acceptable and allows the trader not to worry excessively about the potential losses in case of a failed trade.

Moreover, through the manipulation of leverage in trades, traders can unload their deposit and, if required, release some of their funds to engage in additional simultaneous trades. (For more information on deposit "unburdening", you can read this article)

Profit Target: The desired level of profit a trader aims to achieve, considering the potential risk of incurring a loss

A proficient risk management strategy involves not only controlling losses but also maximizing profits. It is logical that in order to generate income, profits must exceed losses. There are two important factors that influence profitability: the percentage of successful trades and the size of profits in each trade. These factors are closely interconnected. The screenshot below demonstrates how this relationship can impact results.

The Risk/Reward Ratio (RR) is a calculation method used to set the trade target based on the stop loss distance and the ratio between the take profit distance and the stop loss distance (the risk-to-reward ratio).

On the screenshot above, the following hypothetical situation is provided as an example:

• there are 15 trades in total, where the asset price changed according to the data in the first column (in different trades, the asset showed movements of 9%, 7%, 5%, 4%, 1%)
• the table is divided into 4 sectors, each corresponding to a specific risk-to-reward ratio (RR 1:0.5 / 1:1 / 1:1.5 / 1:3)
• "Stop Loss, %" indicates the stop loss in percentage, which was set for each trade
• "Take Profit, %" indicates the take profit size based on the RR sector assigned to each trade
• "The Trade Profit, %" shows where trader set a target in percentage per each trade
• "Profitability of the trade, %" shows the profit in percentage per each trade
• "Trade Result" indicates whether the trade was profitable or resulted in a loss

Now let's take a look at the impact of the success rate of trades and the percentage of profit in the trades on the results.

Trade Quantity: The number of trades a trader is willing to engage in simultaneously

Based on the information provided, it is important to determine for yourself the maximum portion of your account you are willing to risk if all your trades result in losses due to a combination of factors. It's crucial to carefully consider your risk management approach and ensure it supports your long-term trading goals. Since it is generally recommended to limit the loss per trade to 2-3% of the overall trading account size, we have determined for ourselves maximum losses up to 12.5% of our trading deposit. This decision aligns with our risk tolerance, trading strategy and personal comfort level.

This means that when our team opens multiple trades simultaneously, we calculate total percentage of potential losses for all trades relative to the total account size. When this percentage approaches the threshold of 12.5, we refrain from opening new trades until one of the existing trades will be closed. This approach helps us manage our risk and ensures that our trading activity remains within the acceptable risk tolerance level defined by our team.

Experiencing a -12.5% loss in the trading account can be relatively easy to handle psychologically. Moreover, it is not considered critical and it can be recovered within a short period of time. Below is a table illustrating the possible outcomes for a trader at different levels of losses and the efforts required to restore the initial deposit size:

As seen from the table, to compensate for a -20% damage to the trading account, a profit of 25% is required, which is nearly equivalent to the loss and can be relatively easily achieved in a short period of time. However, to compensate for a -50% damage, a profit of 100% would be necessary, which is much more challenging. A loss of -70% of the total trading account is practically irrecoverable.

A question arises: if it is so risky to open a large number of trades simultaneously, why not open just one trade? Could it be worthwhile to open it with a larger amount of funds?

It is inefficient because:

a) If you open a low number of trades with risk management that implies a maximum loss of 2-3% per trade, you critically limit the potential for profit.

b) With a quality trading system, the probability that, for example, 10 simultaneously opened trades will all result in a loss (and let's say generate a cumulative -30% damage to the deposit) is significantly lower than the probability that a single trade with big amount will result in such a loss.

Skill in calmly adhering to your trading strategy

No matter how comprehensive the theoretical foundation, how extensive the trading experience, or the effectiveness of risk management, no trading system will succeed if the trader does not follow it strictly. Deviating from it will transform systematic trading into unsystematic trading, order will turn into chaos and profits into losses.

At first glance, it may appear that there's nothing complicated about it. You create a system - just stick to it. What could be the problem?

And it is precisely at this point where the most challenging problems arise, as they no longer lie in the realm of computational processes but rather in the realm of psychology. In the early stages, a potential trader's mind becomes overwhelmed while absorbing a vast amount of trading-related information. While it may seem incredibly fascinating, absorbing and assimilating such a vast amount of specialized information is no easy task. Once the knowledge is assimilated, the journey of trial and error begins in an attempt to find effective practical applications for the accumulated knowledge. And this part of the journey is also challenging. With time, it becomes possible to develop a solid trading system and devise effective risk management strategies. This process may consume a considerable amount of time, effort and energy. And when all these stages are already completed, and it seems that you are so close to attaining your desired material possessions like a boat, car, motorcycle, house, or other valuable assets. There comes a critical period where the only task left is to push the buttons and execute trades according to your strategy. Exactly during this time that one of the greatest difficulties in trading arises: emotions.

There are two basic emotions: greed and fear.

Hyperinflated greed blunts the sense of caution, obstructs calculated and composed actions, distorts the perception of the current market situation and turns trading into a roller coaster ride with results resembling a lottery.

In trading, there is a well-known concept called the Fear of Missing Out (FOMO). Cultivated by greed, it drives traders to make impulsive and emotionally-driven decisions, deviating from their strategy what inevitably leads to significant losses (if not all at once). It cultivates insecurity in one's abilities amid losses, demotivates extensively and casts doubt on a person's capability to generate profits in this field.

Overcoming this emotion is quite challenging in trading. It frequently occurs that a trader acknowledges closing a trade "too early," capturing only a modest 2% profit, while the underlying asset makes an incredible 20% movement. He may also notice the impressive profitability of a previous potential trade he didn't enter at all.

The situations mentioned above, where missed profits occur in trading, happen at every step. And driven by greed, the trader starts:

After a losing trade or a series of failures, it is greed drives the trader to "make up for it quickly," which in turn exponentially multiplies the number of mistakes made.

We recommend a number of things that can help overcome FOMO:

Fear is the opposite emotion of greed. It is triggered by completely different factors but is equally counterproductive to achieving favorable results.

In the paradigm of fear, traders predominantly perceive the potential for losing their money and often overlook the opportunities for generating profits. However, the essence of trading lies in its ability to offer traders both possibilities simultaneously.

This emotion is especially pronounced after a series of losing trades, further undermining the trader's confidence and demotivating them in their subsequent attempts to generate profits.

As we mentioned before, trading without losses is impossible. It is a normal part of the process. Even a series of losses shouldn't undermine your self-confidence.

We recommend the following things to help overcome fear in trading:

Regardless of your primary counterproductive emotion (fear or greed), the key to addressing emotions in trading is discipline. It is a crucial factor and can be your ultimate weapon. If you have a reliable trading strategy, the key to achieving desired results lies in strict adherence to it.

Analysis of trading performance

The unwillingness and/or inability to analyze past trades will be a significant hurdle in achieving the desired results. In this case, the trader remains unaware of the reasons behind their losses, which are often apparent, easily identifiable and can be rectified through adjustments to their trading strategy.

If you systematically accumulate data in an Excel file about your executed trades, provide details about the current market situation that you assessed at the time of decision-making, record key moments of trades and their outcomes, note your emotional state and document the mistakes you made in your trades, over time you will gather a vast and comprehensive dataset that will be easy to analyze.

You may be surprised when analyzing your trades and realizing that the major losses, for example, were generated by certain specific assets or timeframes, deviations from your trading strategy's setups, the direction of trades in relation to a particular asset, or even your own emotional state. By simply eliminating these sources of loss generation, you will immediately reduce your losses and significantly improve your trading results.

It is indeed possible that based on the accumulated data, you may need to significantly revise the logic of your trading system, which can have a positive impact on your results. If your trading system has obvious flaws, the sooner you identify and correct them, the smaller your losses will be. However, even glaring issues in your trading algorithm will remain unnoticed if you don't thoroughly analyze your trades.

In general, there are no specific "standard" templates for trade journal formatting. Each trader constructs the structure of their journal according to their own preferences and selects the necessary pool of data they will collect and analyze.

We recommend including at least the essential data in the structure of your trade journal:

After accumulating a substantial amount of data for analysis in various perspectives, you can organize a pivot table in a separate Excel sheet of your trade journal. This will enable you to analyze your results from various angles and in different ways.

The Conclusion

Trading is an incredibly challenging way to earn a living, especially when you're trading independently. There is no other path to consistent income in this field but through a journey of trial and failure, stress and financial loss. On the journey towards desired results, every person will encounter numerous challenges that need to be overcome. It is advisable to abandon any illusions at the beginning of your journey that with $1,000 you will earn $1,000,000, multiplying your trading account two or three times every month. This will not happen, no matter how much you desire it.

Trading is not a magical solution that turns the poor into the rich; it is a tool for multiplying existing capital. Trading does not exist for the purpose of making everyone profitable. Primarily, it is designed for the majority of people to lose their money. It is not a story of creativity, intuition, improvisation, or flights of fancy; it is a story of discipline and composure. Trading has the ability to disappoint, bankrupt and nurture complexes within person.

Despite everything, trading is an industry that is unlikely to ever lose its relevance. It is a craft that has always provided, continues to provide, and will always provide abundant opportunities to earn substantial money. It offers the opportunity to be independent and to forget about working as an employee. It is the ability to work from any corner of the world, sitting in a restaurant by a scenic bay. It is a completely realistic way of earning money that can easily become your main source of income.