5 Key Ingredients to a Profitable Trading Methodology
As people get into this great business of trading, many are exposed to a heck of a lot misinformation. So, that being said, let me lay out what I truly believe are the 5 keys to a profitable trading methodology:
- Reliability. This basically means at what percentage of the time do you actually make money? A lot of people (most in fact) emphasize this. Many traders want to be right on every trade because they were taught that 70% or less is failing. NOT in trading though, you can be right only 50% of the time and still make a lot of money…as long as you have the other four keys in place (below).
- Risk to Reward Ratio…in other words, this is the relative size of your profits compared with you losses. Ultimately you want to have a 2:1 (or better) risk to reward relationship when first putting on a trade. However, this may be pretty difficult to find. It would be more realistic to find (or create) a trading methodology that has a 1:1 risk to reward relationship; then once you factor in your ‘trade management’ to the trades it comes out to a 2:1+ risk to reward type of trade. You’ve heard this many times before I’m sure, and it applies here too: cut your losses short, and let you profits run. It’s obviously one of the keys to successful trading, but is very hard for many traders to do.
- The number of your trading opportunities. This means how many trades does your trading methodology actually generate? If your system only generates, let’s say only 25 trades a year (for swing or position trading), that’s fine, but you’re limited to how much you can make due to the low amount of trade set ups. However, if you have a system (trading methodology) that trades five or ten times that amount (25)…you will make a lot more money, assuming that the other 4 keys are in place that are outlined here.
- The size of your trading capital. Let’s face it, if your trading account is real small (i.e. $1,500 to $2,500) it’s harder to make really good returns. But, when your account is larger (i.e. $10,000+) it becomes easier to make good returns.
- Position sizing strategies. Position sizing strategies tell you how much to risk throughout the course of a trade. It’s an essential ingredient to the whole money management philosophy. In fact it’s so very important that without implementing a position sizing strategy the chances of you succeeding are doubtful. Position sizing is responsible for about 90% of your overall performance variability; that’s how important it is.
So, there you have it, the five keys to a profitable trading methodology once again are:
2. Risk to Reward Ratio,
3. Number of Trading Opportunities,
4. Size of Trading Capital, and
5. Position Sizing Strategies
And regardless of the market or time frame you decide to trade, all five of these keys are important to a highly profitable trading methodology. At the minimum, you need number one (Reliability), two (Risk to Reward Ratio) and number five (Position Sizing Strategies) to make a lot of money in the markets. So, I urge you to honestly evaluate your current trading system/methodology to see how it stacks up against these five keys in a successful trading approach.