Sometimes trading gets so complicated that its good to step back and get a new perspective. One useful way to do that is to look backwards at what we are trying to do. Picture yourself ten years from now. Suppose that between now and then, you made 1,000 trades. Will the results be profitable? Some simple points of math will tell the story.

In short, your results will depend on two things: the percentage of winners that you bagged and the size of the winning trades in relation to the size of the losers. Period - end of story. It won't matter what method you used, whether you were an economist or a trend-follower or a coin-flipper. It won't matter how smart you were, how much time you spent studying, how many books you read or anything else. It all comes down to those two ratios.

That may sound obvious to many, but I bring it up because when we are in the thick of trading, we tend to forget those two basic things. We get lost in the news and the latest gossip. We strain our brains trying to look ahead. We waste our time trying to out-guess the weather or the next USDA report. We spin our wheels in all sorts of unproductive ways and tend to forget that our success comes down to minimizing our losses and maximizing our profits.

Beginning traders have at least two problems. One - they may not have thought in these terms before now and, two - if they have, they expect to win 75% of the time and rack up profits that are 3 to 4 times larger than their losers. Granted, that would be paradise, but trading in the real world is not that easy. For beginning traders, I would suggest that you expect to be right 25% of the time. That means that the size of your average winning trade will have to be at least three times the size of your average losing trade just to break even in this venture! (commissions and slippage included).

Telling you to expect a winning ratio of 25% is not meant to be insulting - I hope you do better. Rather, it is meant to help you to see just how important it is to keep your losses small and allow your profitable trades to grow. Trading is not about being right or wrong - even the best investors are seldom right 50% of the time. This business is all about putting your money in situations that have potential, detaching from your opinions, and managing the risk. Ten years from now, you won't care why the market went up or down and you will be baffled by the moves that you missed. Many of you will look at your trading record and see large trading losses that should have never happened. Ten years from now, you will only want to see that you made more money than you lost. Make a firm commitment today to keep your losses small and you just might make it.

To explore this topic further, read Trade Your Way To Financial Freedom by Van K. Tharp. Especially, take note of the trader on page 200 that showed positive results using random entry trading signals.

Best wishes,

Todd Hultman,
Dailyfutures, Inc.
February 4, 2010.