10 Topics to Master To Become a Profitable Trader

10 Key Trading Skills To Become A Successful Trader

Technical Analysis
Trade Management
Risk/Reward Ratio
Risk Management
Trading Psychology
Backtesting
Historical Chart Studies
Sentiment Analysis
Trend Analysis
Trading System Development

1. Technical Analysis

Technical analysis is the art and science of reading charts to quantify the trend or trading range the price action is in, the path of least resistance for the next directional move, and the area of value on the chart, and creating good risk/reward ratios by defining key technical levels.

There are two major schools of thought within technical analysis: predictive technical analysis and reactive technical analysis.

Predictive technical analysis is practiced when traders project what will happen next in price movement based on a current chart pattern. They look for clues of volume, trendlines, and the levels of support and resistance to project the probabilities of future price movement. It attempts to predict future price action based on current and past price action.

Reactive technical analysis is practiced when a trader’s entries and exits are based on current price signals that backtest as profitable by creating good risk/reward ratios. Their quantified price signals tell them when to get in for a good probability of success and where to get out with a small loss or to lock in a profit. Reactive traders rely on trade management as the price action plays out to minimize losses and maximize gains for profitability. They rely on quantified systems to make money in the markets, not knowing the future.

Four primary trading tools are used in technical analysis to identify entry and exit signals:

A trader must understand each tool’s purpose, so they are implemented correctly.

2. Trade Management

For each trade, you have to manage five things:

Entry: Your trade entry has to be based on a quantified signal that will put the odds in your favor of the price moving in the direction to make you profitable.
Stop loss: You have to decide on the price level that the price should not go if the trade is going to work out in your favor. Your stop loss is that price level. Will you accept that your trade will probably not work out, and you will exit with a loss?
Position size: Based on the volatility of what you are trading and the placement of your stop loss, you have to decide how much capital you will put into your trade. You must consider the total percentage of your trading capital you will put into your trade and how much you will lose if your stop loss is triggered.
Trailing stop: In winning trades, you must choose a trailing stop with a price level or a moving average that will lock in profits if your winning trade reverses to that level. This is how to maximize a winning trade by not exiting until you have a reason to.
Profit target: This is a predetermined level where you will lock in profits if your trade reaches a specific price or technical level. This a way to minimize giving back paper profits when you are satisfied with a large enough profit.

Our success is based on how we manage our trades. How we control our emotions, maximize wins, and admit quickly when we are proven wrong about a trade.

3. Risk/Reward Ratio

On trade entry, the risk/reward ratio measures a trade’s potential for loss versus the magnitude of possible profits. In backtesting, the average of all the losses in a system compared to all the average gains gives you the system’s risk/reward ratio based on historical price action.

Looking at your stop loss versus your profit target for any trade can tell you whether the risk is worth taking. Most trades are only worth taking if you have a 1:2 or 1:3 risk-to-reward ratio based on your plans to manage the trade after entry.

The higher your reward versus risk, the less your winning percentage has to be to make money with your strategy.

Your risk is established by the location of your stop loss, which will show you that your trade will not work out and it’s time to exit while a loss is still slight.

Your profit target on entry for where you think that price could go if the trade is a winner is where your maximum potential profit is located and can be used to establish the reward in your ratio. You can maximize the potential for capturing a big trend by being flexible and leaving your upside uncapped by using a trailing stop loss to take you out of a winning trade. You can create bigger winning trades and maximum rewards by only exiting when the price reverses.

To psychologically create a significant risk-to-reward ratio, you need to be very patient with winning trades and give them enough room and opportunity to play out for the most benefit but, at the same time, have no patience for losing trades and exit the moment you are proven wrong based on price action going where it shouldn’t go if the trade is going to work out in your favor.

Creating good risk/reward ratios with high probability entries through stop losses & letting winners run is the core of all profitable trading.

4. Risk Management

In trading and investing, risk management is defined as the process of understanding, identifying, adjusting, and managing all of the potential risks that an account is exposed to so the size of losses and drawdowns are minimized for the magnitude of the negative impact they will have on a systems risk of ruin and long term profitability.

Some examples of possible risks to investment portfolios and trading accounts include strong reversals during trends, correlation of positions, gap downs in price, political events, market crashes, company or country bankruptcies, currency risks, earnings reports, government reports, inflation, lack of liquidity, and monetary policy.

Any event that causes prices to move against your position is a type of risk and must be managed, so worst-case scenarios are limited in size and scope on your account.

The first step in risk management is to identify possible risks. Once you accept the potential risks involved in the markets, you can plan for what could go wrong. Too many see the potential rewards only and don’t consider the risks involved in the markets.
The next step is understanding the frequency and magnitude of possible risks. Companies report earnings every quarter, the government issues economic reports regularly, Central Banks make interest rate decisions, and there’s a bear market about once every decade. These risk events should be expected and planned for.
Before you enter any position, you should know where you will get out if it doesn’t work out. Traders should have a stop loss level based on price action moving against them. Investors should have a plan to exit an investment if the fundamentals decline and the trend for a company’s sales and earnings changes.
Position size your trade or investment so being wrong will not ruin you. How much of something you buy is just as important as what you buy. You should never risk your whole account in one position. If you have several highly correlated positions in one sector or that move together, then all the smaller positions are like having one big position.
An exit strategy for locking profits is just as important as an entry strategy. Profits are made at the exit, not the entry, and profits are just on paper until you sell your position and lock them in. A trailing stop loss based on price action can tell you to lock in profits as a trend starts to bend. Open profits also carry the risk of loss. However, open profits must be risked to capture a bigger trend.

Risk management is playing defense in the game of trading or investing.

5. Trading Psychology

The hardest thing about trading is not the math, the method, or the stock picking. It’s dealing with the emotions that arise with trading real money and the ego’s need to be correct. From the stress of entering a trade to the fear of losing the open paper profits that you’re holding in a winning trade, how you deal with those emotions will determine your success more than anything else after you have a quantified trading system with an edge.

To manage your emotions, first, you must trade a system and method you truly believe will be a winner in the long term. This confidence arises from back-testing, historical chart studies, and faith in yourself to execute it with discipline.

You must understand that every trade will not be a winner and not blame yourself for equity drawdowns if you are trading your system with discipline.

Do not bet your entire account on any one trade; in fact, position sizing correctly and risking only 1% of your total capital to a loss on any one trade if your stop is triggered is the best thing you can do for your stress levels and risk of ruin odds. I am referring to the maximum loss here, not position sizing.

With that explained, here are some examples of emotional equations to better understand why you feel certain emotions strongly in your trading:

Despair is caused when you’re losing money and your trading is not improving

Don’t despair; look at your losses as part of doing business and paying tuition fees to the markets. Focus on executing your system with discipline, not the results. Hope will arise as faith in yourself grows as a disciplined trader.

Disappointment happens when expectations were far greater than the current reality

Enter trading with realistic expectations. What do you expect your annual returns on capital to be based on similar traders that use your methodology? How can you estimate your drawdown based on your win rate and risk/reward ratio? Trading a robust system over the long term with discipline will lead to profitability, but your path can involve peaks and valleys. Understanding the math of what to expect will help curve disappointment.

The disappointment causes regret in a loss caused by a lack of discipline

If you followed your trading plan and lost money because the market did not move in your direction, that is just part of the process, but if you went off your plan and traded based on your feelings and ego, you should feel regret and stop being undisciplined. You should ensure on every entry, and with every position size, that you have no regrets regardless of the trades outcome; your job is to execute your trading system with consistency and discipline.

You will enjoy your trading when you have winning trades and no fear of ruin because you’re trading with the right position size

Trading is much more enjoyable when you risk 1% of your capital to make 3% of your capital with a zero chance of ruin. It’s not enjoyable when you put a huge percentage of your capital on the line in each trade and are only a few bad trades away from your account going to zero.

Wisdom comes from the experience of years of successful trading

To get good at trading, you must trade real money. Back-testing and chart reading does not make you a trader. Only put on the risk and managing the stress of actual trades can. Wisdom comes from putting real money on the line for years and proving to yourself that you can be a winner in the long term.

Faith in your system comes from a belief in its profitability through backtesting and then the experience of winning with it for years

While you must know whether an overall trading system is a winner or loser, it’s different for an individual to trade using that system. Each trade can be random, but the principles of a profitable trading method will play out over a large enough sample size to rise above the noise and capture swings and trends. A lot of emotional trading can be overcome when you don’t doubt your system. When you hold an almost religious fervor over believing in your method, system, risk management, and discipline, you will overcome many emotional problems that arise with other traders in the heat of action.

6. Backtesting

Backtesting is applying entry and exit signals to periods of past historical price data to quantify whether the system would have led to overall profits in the past through an equity curve. A backtest is a look at how a quantified trading strategy would have performed in the past. While a profitable backtest does not guarantee that the same signals will make money in the future, if it did not work in the past, it will most likely not work in the future.

A good backtest does raise the probability that since it worked on past data, it may work on future price action because the signals did navigate volatility to create bigger total profits compared with the losses. The principles of the trading system could be valid and what allowed for profitability if that is what the backtest shows.

Trading systems that create good risk/reward ratios with bigger wins than losses or a high winning percentage of trades with no large losses will backtest as profitable. Most backtested systems attempt to capture market trends and limit losses by not being on the wrong side of a trend.

A backtest is usually done on a software platform with historical data and the ability to enter signals and then test to see how it did. Some traders do use Excel spreadsheets for backtesting their price action systems. Based on price action or technical indicators, a backtest input is given with entry and exit signals that create dynamics of where to get in and where to get out. Backtests should create the quantification of an entry signal for when to get into a trade. Also, a stop loss signal for a losing trade to keep losses small and a trailing stop signal to maximize gains for the winning trades has to be part of the input process.

Some people will also input profit targets for trades. Unlike a hypothetical profit target, a stop loss creates a quantified risk/reward ratio. A risk/reward ratio and a high enough win rate can create a profitable system if losses are kept small and position sizing is managed properly based on volatility and open risk.

A backtest of signals should be performed on a watchlist of stocks, ETFs, currencies, cryptocurrencies, or commodities you plan to trade. Markets have different levels of volatility with trends, and each should be backtested for the validity of signals on historical data.

A backtest attempts to use repeatable mechanical signals that give profitable entry and exit dynamics to create bigger wins and smaller losses over the long term. A profitable backtest’s primary driver is cutting losses short and letting winners run. A system has to have signals that filter out a lot of the price action noise that causes over-trading and instead signal the opportunities to capture trends and swings in price action.

Trading quantified mechanical backtested signals also filters out much of the emotion of deciding what to do each day from your own opinion and prediction. You change from an opinionated predictor to a follower of a systematic process. Your job is to follow signals and ignore your feelings when quantifying your process.

There is no perfect backtested system. There is just a system that you can confirm worked over multiple markets in the past and has great potential for working in the present and future. It has to be a process that makes sense and that you can follow with discipline over the long term.

7. Historical Chart Studies

Studying the historical price action of the stock market and individual stocks can help you see reoccurring trends and patterns in the past. You can also see the nature of all financial markets and commodities to create bubbles, crashes, and ranges. You can learn a lot from the past that can show you what’s possible in the future. No two markets or charts are the same, but they can be similar as human nature doesn’t change.

8. Sentiment Analysis

Market sentiment, also known as investor sentiment, refers to most investors’ general overall outlook or attitude concerning a specific stock, the stock market as a whole, a commodity, or the overall financial markets. The optimism or pessimism of the market participants is most evident in the overall behavior of price action and whether a chart is going up, down, sideways, or volatile. Markets can tend to turn and reverse from a current strong trend as sentiment peaks in one direction. Bull markets tend to be the most bullish near their peaks, and bear markets tend to be the most bearish near their bottom.

9. Trend Analysis

Trend Followers make money during market trends not because they predict anything but because they buy what is going up and sell what is going down. They discover ways to measure and react to trends based on historical price patterns. Trend traders identify a trend and enter a trade with the predefined risk of a stop loss with managed position sizing. Trend traders plan how to exit based on their stop loss at a price level that will tell them they were wrong.

“The whole world is simply nothing more than a flow chart for capital.” – Paul Tudor Jones

What causes a “trend”?

Investors and traders have the capital they want to put to work; they choose to buy what they think will appreciate. As more and more capital flows into an asset, it increases in value as more outside money wants into a limited supply of an asset. Stocks with smaller market caps can go up faster than big-cap stops due to a smaller supply of shares in small-cap stocks.
Key moving averages provide lines traders can use for quantified entry and exit signals. The 50-day and 200-day moving averages are great examples of support areas where pullbacks in the best stocks reverse and uptrends resume.
Often a stock will trend straight up with sustained momentum, and a short-term moving average will support the entire uptrend with few, if any, breaks in price beneath these critical short-term moving averages—for example, the 5-day or 10-day exponential moving average can be ascending support in an uptrend for price on a chart.
Stocks go up for only one reason: The current seller is not willing to sell for the current market price, and the buyer is willing to pay more. Stock prices go up because sellers will not sell for the current price, and buyers are willing to pay more to get in. The stock market is an auction, not a retail store; supply and demand make prices. Buyers and sellers are always equal; the price changes to adjust to the supply and demand at different levels in price.
Capital flows where earnings expectations grow. Traders and investors buy stock in companies they believe will increase in value based on the underlying companies’ projected increase in earnings.
The only reason buyers buy a stock is that they believe they will be able to sell it for a higher price later. Stocks go up on the belief of higher prices in the future. Stocks can go down for many reasons; holders need to raise cash or be satisfied with their profits.
Short sellers can drive trends by selling heavily on the belief that a stock will go down and drive the price down. Then short sellers can cause a rally when all the holders no longer sell, and the price rises and cause the short sellers to panic and buy back the shares they shorted. There are always two sides to a short sale, they have first to borrow shares to sell short, and then they have to buy back to cover their shares, creating future buying pressure.
The markets go from up trends to range bound to downtrends. The big money is in the big wins you can capture in the big trends.

10. Trading System Development

While trading systems have to be built for an individual’s risk tolerance and personality type, the principles used to build trading systems are the same. Here are the 12 key universal elements to successful trading system development.

You must choose your watchlist for your trading system.
Backtesting to find valid signals is crucial to create a positive expectancy model.
You have to choose whether your system will profit from a high win rate or big and small losses.
You must eliminate the possibility of large losses in your trading system through risk management tools: stop losses, options contracts, futures contracts, and position sizing.
You have to choose if your trading system will be one that follows the trend, buys the dip, or trades price swings. You can have multiple strategies in one system.
What will be your signals for capturing trends? Breakouts, moving averages, high or low prices in a set number of days, or breakouts to new highs or lows from an established trading range.
What will be your swing trade signals? Moving average signals, resistance, support, MACD, Stochastics, or RSI?
What will be your position size per trade?
How will you manage your trade size with volatility?
Risk no more than 1% of total trading capital per trade.
How much open risk will your positions expose you to? 6% max is a suitable parameter basic guideline.
What markets will you trade, and how will you prioritize your entry signals?

Conclusion

Trading the financial markets successfully requires discipline, knowledge, and understanding. With the right skill set, becoming an unbeatable trader is possible. Fortunately, developing these skills doesn’t require years of experience or an advanced degree in finance—these ten essential skills that any aspiring trader should master will help you become unbeatable.