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The Long and Short of It


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Deciding to invest in the share market can be a scary proposition. When real money is on the line and there is the possibility of losing your life savings, it is understandable that many feel that the risk is too much to bear.

It doesnít have to be that way. Trading can be a very rewarding endeavor which has the ability to increase your wealth significantly and improve your quality of life.

Below are 13 tips to make your transition from a beginner to an experienced trader a lot less painful.

1. Start small or begin with paper trading
The last thing you want to do when you start trading is put yourself in a position where your risk of ruin is too large. A good idea is to begin with paper trading. Many brokers offer this service and it allows you to enter real trades using fake money. This will not only give you loads of experience but also allows you to learn the trading platform you will be using when you take the plunge and use real money.

Some believe that paper trading offers no real benefits but I tend to disagree because it allows you to become familiar with the process of placing trades in a live environment. Although your emotions may be quite different when you enter real trades, I believe this practice will only help you in the long term.

When you do begin trading real money I suggest trading small positions until your confidence builds. Once your confidence builds and you are able to place trades without a large number of errors you can increase the size of your positions gradually. Yes brokerage will have a bigger affect on your profits of a small account (you may not make any at all) but its far better losing $15 on brokerage than $1000 from a large trade that has turned into a loser.

2. Always have a stop loss
One of the most important steps to take before entering a trade is to determine a point where the reasons you entered the trade are no longer valid. This point triggers an exit from your position and is known as a stop loss. A stop loss not only protects your capital but can also be used to determine your position size. Serious traders and investors always set exit criteria when entering a trade. Failing to do so is would be to follow a gamblers mindset and one that is setup for failure.

3. Learn about risk to reward
Statistics have a lot to do with trading and some professional traders use advanced levels of statistics to give them an edge in the market. Having a basic understanding of probabilities and your risk to reward ratio can help to improve your profitability. Another reason the above point regarding having a stop loss is important is that without it you cannot determine your risk and without that you cannot determine your reward to risk ratio making this exercise pointless. As you may have already figured out you are also going to need your reward. Often this is hard to quantify so in many cases this is an estimate.

Generally speaking it is wise to enter trades that have a reward to risk ratio above 2:1. This means that your potential reward is 2 times greater than the risk you are taking. What this also means is that you only have to successful hit your profit target 33% of the time to breakeven. Of course you still need a solid strategy and enter trades that have a high probability of success but your ability to identify those opportunities will develop as your experience grows.

4. Determine your maximum risk per trade
This is something that you will need to work out yourself as it has a lot to do with your risk tolerance. One of the most common methods used is the 2% of capital method. This method involves taking the total amount of money you have to trade and taking 2% of that amount. This then becomes the maximum amount that you will risk on any 1 trade. To give you an example, if you had $250,000 to trade with your risk per trade would be $5,000 (being 2% of $250,000).

What you decide to use is completely up to you. You may think that 2% is too high and would prefer to use a lower percentage like 1% or even a completely different method to calculate this figure. The choice is up to you but it is one of the most important choices you will make and one that could be the difference between making money and losing the lot.

5. Prepare to lose money
Making money all the time is generally reserved for the large banks and market makers who spend tens of millions of dollars refining their trading methods. For the retail investor itís pretty much a certainty that you will lose money at some point so you should prepare for that now.

For those that are starting out, the probability of you losing money is high. This is another reason why starting small is important to your longevity of your trading life. You donít want to start off with a loss that wipes out half of your account. Doing so will cripple your confidence and also significantly dampen your ability to remain profitable.

6. Be aware of the effect brokerage has on your account.
The commission charged by your broker is something most new trader fail to take into account when working out their potential return on a trade. This can be particularly destructive to smaller trades. Those trading small positions looking for a potential return of $100 should consider that at $15 per trade, the total charges of a trade (being the buy and sell) will reduce your potential profit by 30% and increase your risk by 60%.

In simple terms this means that instead of your reward to risk being 2:1 ($100 reward to $50 risk) your now risking more than you stand to gain (being a reward of $70 and a risk of $80). Using what you learned above, you will now know that instead of you having to successfully hit your profit target in 33% of your trades to breakeven, you now need to hit your profit target in 53% of your trades when commissions are taken into account. Factoring in the cost of commissions into your profit and loss calculations is therefore a must.

7. Determine your risk tolerance
Everybodyís tolerance to risk and how they cope with a loss is different. Some people like to take big risks in life while others prefer the safer option. Your financial situation and job security play a big part in determining how much you willing to risk in life. If you have ever been to a casino you can see examples of people at either end of the spectrum.Some play the $5 tables and some are in the high roller suite betting thousands of dollars per hand.

Trading has its differences to gambling but the same concept applies. You need to determine how much you are comfortable losing if the worst happens so that when it does your confidence isnít destroyed along with your trading capital.

8. Find a strategy that fits with the above
Once you determine how tolerant you are to risk the next step is to find a strategy that works for you. There is no point in trading a strategy that is prone to large drawdowns if itís going to affect your emotions in a negative way. You may need to try a few different styles of trading until you find something that you are comfortable with but when you find the sweet spot, stick with it.

9. Remain calm and donít let emotions affect your trading
Investing in the share market can be a very emotional game. Being unable to control your emotional state can affect your decisions in every aspect of a trade from getting into a position to getting out. Having your risk tolerance defined can limit the fear of losing too much. It is very important to remain in a calm centred state when you are investing in the market. Failure to do this can cause you to act from an emotional perspective and not by the facts in front of you. This is a dangerous path and one that can quickly lead to you self-destructing in the market.

10. Patience is the key
Itís very easy to become frustrated with the market, bored with the lack of opportunities or overexcited when youíre on a hot streak. Patience is an important quality to have and the market can teach it to even the most impatient.

Donít be disappointed when you miss a great opportunity, another one may be just around the corner and you need to be in the right mind frame to trade it.

11. Know your product
Just like you wouldnít buy a house without first inspecting the property or take out a loan without first reading the terms and conditions. By the same logic you shouldnít invest in the share market without knowing the ins and outs of it. Despite this being pretty self explanatory itís a common trap by most beginners.

It doesnít matter what product you're trading. You need to know everything about that product including how it trades, its volatility, the liquidity and also its costs. The more you know about the product the less likely it will be that something will come out and surprise you in a bad way.

12. Know about market depth and how to use it
Market depth lists the total amount of buyers and sellers in a specific security. It shows the liquidity (or the ease of entry and exit) of a specific security. Traders and investors can use this information to gain better entry and exit prices depending on your skill level. It also allows for smart traders to take advantage of market inefficiencies.

13. Leverage of the professionals resources
If you donít have the time or the resources to gain access to the information you need you can utilise the help of a professional who has access to the information you need. Finding the right professional for your needs however is the hard part but when you find the right one it can substantially increase your success in the market. This will often increase your cost slightly but can save you time and capital outlay.

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