I’ve a quick question for you: What is the difference between a good trade and a bad trade?
Seems pretty simple – a good trade is one where you win a profit, a bad trade is one where you lose.
Right? Wrong. It’s not quite that simple.
Look at it this way. You have a number of decisions to make and you can only really control a small number of the variables that will determine the outcome of any trade.
You have total control over which market to trade, in what direction, over what time period and over the amount to trade. But you have no control over what the market does once you have placed your trade.
What the market does is what then determines whether you are profitable or not. So, if the market moves in a way that you did not, and could not, foresee and leads to a loss, why might it follow that the trade was a bad trade?
If you followed your plan and did everything right then surely you placed a good trade?
Take the Credit and the Blame
It’s always tempting to take personal credit when a trade works and find something to blame when it turns into a loss.
If there is no external factor then it can be tempting to blame the system or the trading plan you are using. This can lead to problems.
The key is to see that the terms ‘good’ and ‘bad’ refer not to what the market does, but to what the trader does.
But even if you do everything right according to a plan that gives an edge over a number of trades, there is still no guarantee that any particular trade will be profitable.
No plan is 100 percent successful. Indeed, 70 percent success would be very good indeed.
A trader must accept that losses are a part of trading and that even the best plan and a trader who does everything right will experiences losses. So, we can have good, losing trades.
Bad Profitable Trades
It is also possible to have bad, profitable trades and these pose some of the greatest dangers.
It can happen that a trader is operating in a random manner but winning. In such a case, the likelihood is that the winning trades are just a lucky streak. It just so happens that the market moves in a manner that provides profits, despite how the trader is operating.
The danger is that this will almost inevitably engender a sense in the trader of having ‘cracked’ the market and greater risk taking will almost certainly follow.
The chances of failure will then be stacked against the trader as the market will not continue to reward random trading and all lucky streaks inevitably end.
The 4 Types of Trades
So, you need to understand that there are four types of trades:
• Good winning trades;
• Good losing trades;
• Bad winning trades; and
• Bad losing trades.
Furthermore, you need to keep records of your trades so that you can categorize each trade under one of these headings.
If you do this then you are already well ahead of traders who only recognise two types of trades.
You should aim to ensure that 90 percent of more of your trades are good trades.
If you are experiencing losses but the percentage of good trades is not 90 percent or above then you cannot conclude there is a problem with the plan or the system you are using.
It stands to reason then that changing the system is not going to solve the problem.
Instead, the problem is with the trader and having the discipline to follow the plan. Only a run of good, losing trades should lead to a change in the system.
Follow the Plan
A simple calculation shows the importance of this.
Let’s say you have a system with a 70 percent success rate and you trade in line with that plan 90 percent of the time.
So, you will 63 good profitable trades for every 100 trades undertaken and 5 bad profitable trades.
We’ll assume you risk $10 per trade and that there is an average payout ratio of 75 percent. So your total winnings will be $510.
You will also have 27 good losing trades and 5 bad losing trades giving total losses of $320. The winnings of $190 represent a return of 19 percent on the amount put at risk.
Now let’s say you only follow the plan 60 percent of the time.
Keeping everything else the same would mean that your net winnings are reduced to just $85 – less than 45 percent of what they previously were.
Furthermore, while a plan with a success rate of 60 per cent would be profitable in the first instance it would now result in losses.
You get the picture. You need a good trading plan but just as importantly you need to follow that plan as much and as closely as possible.
If you understand your trading plan and believe in it then the chances of you following it are much greater.
In my own case, this happened when I began using the 4x4BOSS. It’s up to you to decide if the BOSS is right for you – I’m in no doubt that it’s right for me.
If you decide it’s not then I strongly encourage you to work hard to develop your own trading plan that gives you a consistent way to analyse markets and identify trades while controlling your risk.
Then you just have to follow the plan all the time.
Download the Free Trading eBook