What is the most important skill in successful trading?

No question about it – good money management. Show me one trader with money management skills but no gift for market analysis – and another trader who is a brilliant market analyst but has no money management skills – and I will risk my money with the first trader every time.

Maybe you don’t want to hear that. Maybe you want to envision yourself as someone with extraordinary market analysis skills – able to correctly predict market movements when no one else can. Well, that’s a great talent to have, and I certainly recommend that you work at developing it. But the cold, hard truth is that that’s not the talent that will make you big money in the long run. That honor belongs to the skill of excellent money management.

Here’s the simple strategy for becoming a super-successful, winning trader: Manage your money in such a way that you conserve your trading capital until you stumble upon a “home run” trade that makes you a fortune.

Winning traders keep their risks minimal, and thereby keep their losses small. They simply refuse to enter trades where they have to risk a large amount of their trading capital, no matter how tempting a trade may be. They cut their losses short. (Losing traders, on the other hand, lose their trading capital by taking losses that are much too large – they cancel stop-loss orders, and stay in bad trades, and end up losing $3,000 on a trade they could have – and should have – gotten out of with just a $300 loss.) The trading history of a winning trader looks like this:

• A lot of small, manageable losses
• A fair number of winning trades, that aren’t really huge winners, but that all together add up to a modest profit when all the small losses are subtracted out
• One or two “home run” trades per year, that provide the bulk of the trader’s income

If you can just manage your trading capital sufficiently to do a little better than break-even on a week in, week out basis, eventually, if through nothing more than sheer, blind luck, you will run across a trade that will move rapidly and massively in your favor, making you at least a small fortune. The “trick” is merely staying alive until you get to that trade.

Losing traders don’t have the patience to wait for that trade, and so they overtrade and over-risk, churn and burn up all their capital in markets that are stuck in a trading range, going nowhere at all - trying to force the markets to give them money when the markets simply aren’t ready to do that.

Winning traders carefully conserve their trading capital while patiently waiting for the next “easy money” trade to arrive. When it does, they take full advantage of the opportunity and realize maximum profits…while the traders who failed to practice good money management are long gone, sitting at home, looking at a missed opportunity, and thinking to themselves, “Boy, I wish I still had enough trading capital left to get into that market.”

You can’t control what the market does. You can, however, completely control what you do in the market. Take care of your money, and the trades will take care of themselves.

Halston Adams
www.futures-trading-strategy.com

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People who put money into a bank savings account expect their investment capital to continually increase and never suffer even a temporary loss. (Of course, they fail to consider that between inflation and taxes on interest earned, they aren’t making any money, and that the real value of their “investment” is, in fact, continually deteriorating.) If that is the mindset that you have – that you simply cannot bear the thought of the amount of your investment capital ever dipping down, as opposed to continually going up – then you don’t have the mindset necessary to be a successful trader.

For a trader, losing trades are part of the game, every bit as much as strikeouts are part of the game for baseball players, or incomplete passes are part of the game for a football quarterback, or bogies are part of the game for a golfer (even Tiger Woods). In fact, the analogy of quarterback in football is a fairly well-chosen one. A quarterback is considered “successful”, and actually very good, if, on average, he completes about 50% of the passes he throws.

Likewise for a successful trader. In my own case, I have earned a very good living from trading with a winning trade average of just around 40%. Yes, you read that right – I am what some might call a “master trader”, and yet my total trading history shows more losing trades than winning trades. Some people (who don’t know much about trading), when they hear me say that, wonder how it can be possible. It’s possible – it’s eve n easy to do – because my average winning trades are so much bigger than my average losing trades, about 3-4 times bigger, to be exact. When I take a loss, it’s a small one. In over a quarter century of trading, I can practically count on one hand the number of times that I’ve risked more than $1,000 per contract on a single trade. My actual realized losses tend to fall in the $300-$500 range. In contrast, my winning trades average $1200-$1500, that is, about four to five times larger than my average losing trades. Therefore, I can lose up to 4 out of 5 trades and still be an overall profitable trader.

Losing trades are part of the process. Losing trades provide you with feedback on your trading decisions, every bit as much (sometimes more!) as winning trades do. Losing trades allow you to take the pulse of a market, to get a feel for current market action. Losing trades help you hone your trading skills. I wish that every trade I put on was a winner – just like quarterbacks wish they completed every pass they throw, and baseball players wish they got a hit every time at bat. But that simply isn’t the way it works. The way it works – reality – is that even the very best trader is not a perfect trader; even the very best trader has losing trades. I remember a super-successful bond trader who, when interviewed, claimed that he never had a single losing day in the markets. The interviewer was, naturally, skeptical of such a claim – but when she checked it out, found it to be true. In ten years of trading, this trader had never had a losing day. However, the untold part of the story was the fact that this trader still had numerous losses within the course of any given day – but still came out ahead due to the fact that, at the end of the day, his winning trades always added up to a higher total dollar amount than his losing trades.

Being willing to risk being wrong, to take a temporary loss, is what enables you to be there and to be right when there’s big money to be made. If you can’t stand taking a loss, you will never become a superstar – at anything. And you’ll never make a million dollars through investing either. You might as well just go ahead and get yourself a savings account at a bank.

Halston Adams
http://www.futures-trading-strategy.com

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In trading, as in golf, the importance of having a good “short game” simply cannot be overstated.

It remains true that the majority of traders seem to have a built-in prejudice against selling short, and a corresponding predisposition to buying long. This has been particularly unfortunate in the recent past, as the futures market was essentially a bear market throughout the last two decades of the 20th century. (It is, I’ll note here, definitely a bull market at the moment, and the bull market in basic commodities should continue for at least another three to five years. However, even bull markets have down cycles in them, so it’s still important to be ready to go short when it’s appropriate. (Cocoa, after rocketing above 20 for the first time in decades, came almost all the way back down to its original take-off point before shooting back up – the perfect play would have been buy-sell-buy, much more profitable than a “buy and hold” strategy.)

The interesting fact is that it’s really easier to make money from the short side than from the long side, as markets always tend to fall more rapidly than they rise. Investors are much more prone to panic selling than they are to panic buying, and just as in the physical world, it’s simply easier to fall down a mountain than it is to climb up one.

Therefore, if one correctly enters a market on the short side, he/she is more likely to see a quick, significant profit than is usually the case with adopting a long/buy position. I also believe that a study of historical market statistics will reveal that a bear market tests short-term tops less frequently and intensely than a bull market tests short-term lows. What this means for a trader is that, when selling short, one generally doesn’t have to take as much heat worrying about being stopped out of a position as is true when buying long, and a trailing-stop can be more effectively used.

It may help to remember things like the fact that the two most profitable trades of the legendary trader Jesse Livermore were both short sells. What’s the absolute best trade, the most massively profitable killing that anyone could have made in the last century? – Sell the stock market short in 1929.

I have tried a number of methods over the years to help traders get over their in-born prejudice to be buyers rather than sellers. One has been to try to get them to just look at their market choices in other terms besides the traditional notions of “up” and “down”. Try thinking, instead, of choosing, say, between “right” and “left”. Or look at the two options of market prices going up or down as being like the two options of “red” and “black” in roulette (fortunately, we don’t have to worry about zeros or double-zeros in market trading). At any given moment, with every new spin of the wheel, the odds are perfectly even between the two choices. Such new perspectives have helped people more clearly see that the market itself has no built-in preference for price movement up or down. Once they can clearly realize that fact, it becomes easier for them to adopt and maintain a similarly neutral position, one that’s not overly inclined to favor long positions over short positions.

There are not too many guarantees in the world of trading, but I can guarantee you this: Your trading will be more successful when you are just as willing to sell a market as you are to buy it.

Halston Adams
www.futures-trading-strategy.com

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Winning traders are aware of the basic, fundamental differences between bull markets and bear markets. Knowing the different characteristic patterns of the two basic types of markets can make your trading significantly more profitable.

Markets “push” upward. They “fall” down. Pushing is slow and difficult; falling is fast and effortless. Something has to happen - there has to be a reason - for a market to work its way higher. Otherwise, it’s natural tendency is to fall. Bull markets are a long, protracted struggle to reach the summit; bear markets are a crash, a sudden, drastic fall, that happens (figuratively speaking anyway) in the blink of an eye. In short (no play on words intended), markets go down much more easily than they go up.

Market tops occur as sharply pointed peaks - they are quickly made and quickly abandoned by subsequent price action. In contrast, market bottoms generally occur as troughs - they take time to form, and the bottom tends to be tested several times, as if the market were double-checking the solidity of its foundation before attempting to “build” higher. A good rule of thumb for trading is, “A bear market always goes a little lower, and lasts a little longer, than you think it will.” Traders trying to “buy the bottom” often make the mistake of entering a market too early, and therefore getting flushed out for a loss in the final push downward before the market does indeed turn back to the upside.

Market tops invariably take most traders by surprise. As rare as buying the bottom is, it is infinitely more rare for a trader to manage to sell the top. Tops come quickly, because once they arrive, “panic selling” slams the market to the downside. Panic selling is always a stronger phenomenon than panic buying. I guess one way to phrase that would be, “Bulls scare more easily than bears.” It’s just generally true that bull markets are more skittish, more fragile, than bear markets.

Temporary reversals, market corrections, occur more frequently and intensely in bull markets than in bear markets. Therefore, for example, it’s much easier to successfully utilize a trailing stop in a bear market than in a bull market. If you’re facing the right way in a bear market, odds are that you won’t get stopped out prematurely unless you run your stop-loss order much too tightly. But in a bull market, it’s quite probable that buyers will be stopped out more than once during reversals that take place over the entire course of the movement upward - because of this fact, it’s necessary to have a good re-entry strategy if you want to ride a bull market long term.

Finally, bull markets tend to be much more “news sensitive” than bear markets. The slightest rumor can significantly affect price action in a bull market, at least in the short term. Bear markets, on the other hand, are notorious for ignoring news, be it bullish news or bearish news. I have often seen traders confounded when an unexpected, extremely bullish crop report fails to move a market to the upside. But knowledgeable traders expect, and thus can take advantage of, such non-reactions by an overall bearish market.

Likewise, bear markets are less susceptible to seasonal tendencies than bull markets are.

In conclusion, there are distinct differences in the basic operational patterns of up markets and down markets. Being aware of these differences, and keeping them in mind when making trading decisions, will enable you to both increase your profits and minimize losses.

Halston Adams
www.futures-trading-strategy.com

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There are a number of valuable numbers notes to keep in mind when trading futures. Futures markets behave in some very reliable patterns in regard to certain general price levels, and keeping these price patterns in mind will help you obtain maximum trading profits.

Here then, are a couple of the most trustworthy “laws of numbers” for futures traders:

1 - Long-term highs – when penetrated – become long-term lows.

Price levels which have served as a sort of market “cap” for several years, if penetrated, then tend to become a base low that will likely support the market for years to come. Since gold prices finally rose above $500 an ounce in late 2005 (for the first time in well over a decade), there has been no looking back from that point forward. If you bought gold when it crossed $500, and placed a stop-loss order just a bit beneath that level – you have enjoyed a trade which has done nothing but become more and more profitable over the past two years, with never a serious threat to your being stopped out of it. The $500 level has been, and should continue to be for the next several years, the effective “floor” in the gold market.

2 – Futures markets love “even”, or “par”, price levels, and will nearly always rise above those levels if they get within striking distance of them.

Futures prices may ramble up and down within a trading range for months on end, but will virtually always clear any “significant” price points that they manage to get close to. If gold rises to $690, you can safely bet that it will go to $700; If cotton clears 59, it will go on to clear 60; Wheat at $3.90 is a virtual lock to soon become wheat at $4.00. Being aware of this tendency of markets to gravitate toward nearby “rounded-off” prices can be very useful for selecting a “take profits” point in your trading. Example: Assume that I’m long wheat futures, and the current price is $3.91, but I suspect that there may be limited remaining upside potential in the market. Therefore, I’m looking to take my profits at the best possible price, or at least to very closely protect the profitability of my position. I would expect, and thus wait for, the market to at least rise above the $4.00 level. Once that level is penetrated, I would likely run a very close stop on my position, somewhere around $3.98. If the market is going higher, it will probably maintain itself above $4.00 – but if the market can’t hold above that level, then a significant reversal to the downside is possible, and therefore I would be well out of my long position at $3.98.

3 – Some markets tend to either strongly hold – or completely fill – gaps.

While gaps in some markets are equally likely to (a) hold, (b) disappear, or (c) partially fill, there are other markets – such as cotton and cocoa – where gaps have a significantly greater tendency to be an all-or-nothing proposition – where option (c) is a very, very unlikely outcome. If, for example, a 50-point gap is established in the initial trading of the day in cotton, one can expect that gap to either hold fast, or to completely collapse and be filled in. What is not likely to happen is a mere partial narrowing of the gap. This is particularly true in a daytrading time frame. Knowing this can allow you to enter a gapping market with very limited risk, because you can safely run a very close stop-loss order. In markets that have this tendency, the odds are very high that the price gap will either remain solidly in place, with no new low established after the first few minutes of trading – OR, if a new low is established, even by just a single tick, the odds are equally high that the gap will be completely erased by the end of the trading day. There is rarely a compromise settlement in which, say, a 50-point gap narrows to a 25-point gap, but then holds that new, smaller gap. Rather, if the 50-point gap becomes a 45-point gap, the gap is virtually as good as completely erased at that point. Knowing this has saved me a small fortune over the years, by allowing me to exit losing trades with the loss of just a few dollars per contract, as opposed to suffering a loss of a few hundred dollars. I have witnessed this pattern most reliably, as noted, in the cotton and cocoa markets. It is not usually applicable to the metals markets, pork bellies, orange juice, or grain markets – the grain markets especially tend to probe gaps, often narrowing them a bit, but still leaving some gap in place.

All futures markets have certain patterns of price movement. I advise traders to carefully study both the intraday and long-term price movements of markets they trade regularly. The knowledge gained from taking the time to learn a market’s behavioral tendencies is, literally, worth millions.

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