The Importance of a Solid Trading Strategy
The Importance of a Solid Trading Strategy
Written by Katie Gomez
Without a solid strategy to fall back on when things get erratic and emotional, trades begin to fail, accounts begin to dwindle, and everything starts to spiral. A solid trading strategy helps mold a successful trader by encouraging consistent trades, inviting lessons from past mistakes, and identifying specific strengths and weaknesses. Many interested in entering the world of trading ask, “what is the secret to successful trading?” Like anything in life, you must have a plan in place before you can start expecting results.
Many traders don’t find success until they are late in their careers because they have let their past mistakes dictate their future trades. Albert Einstein said it best, “The definition of insanity is doing the same thing repeatedly, expecting a different outcome.” Although traders pride themselves on their failures, as they are just as important as their successes, if ego and stubbornness keep them from learning from them, these failures become futile. Emotional decisions cause most losses in trading, such as fear-induced buying (FOMO) or hoarding shares out of greed. (hyperlinks to latest blogs)
Why is a trading strategy important?
New traders often skip this step and head straight to the market with no plan, essentially the equivalent of jumping out of an airplane without a parachute. Part-time or full-time, stock trading has never been more straightforward, but that does not make it easy. The internet and social media evolution in the last 20 years has brought traders together via blog posts, forum threads, memes, youtube tutorials, etc. The Internet is now a haven of resources and information for traders, yet it takes time and effort to sift through.
The younger the trader, the shorter the attention span; Millennials and GenZ need the excitement and immediate gratification of trading to spark and keep their interest. Therefore, most fall into the trap of following that momentum and diving in head first, treating trading like a game instead of a business. While treating the market as a playground sounds more enjoyable than an office, this mindset causes traders to solidify bad habits and decision-making early on. Although crafting a solid trading plan would take the fun, excitement, and adrenaline rush out of trading, it actually does the opposite. The more we learn and understand about the market, the more progress we make, the more profits we yield, and thus the more enjoyable the process becomes.
What makes a good trading strategy?
The foundation for a solid trading strategy is a fixed plan to buy and sell securities based on fundamental or technical analysis so the imminent risks will not lead to a catastrophe. From this foundation, traders can formulate a more specific plan based on their clear and tailored goals. Although this strategy is adapted to change and fluctuates over time with the market changes, it should remain relatively consistent to provide objective, quantifiable, and verifiable results.
Some critical components of a solid trading plan include:
- Risk tolerance and management: Testing the waters in creating a risk/reward ratio to keep you from trading emotionally or impulsively.
- Trading products: Researching and utilizing various financial instruments helps to optimize your portfolio. Given the complex nature of market changes, learn which products add value and determine which are dispensable.
- Leverage technical analysis: Helps identify opportunities and potential risks before entering a trade. Technical indicators (i.e., the relative strength index) can help gauge market movement as well as generate buying & selling signals for the right strike price.
- Timeframe: Financial needs/Expectations: Outline a timeline for your short-term vs. long-term goals and adjust/review expectations to stay accountable for your progress. Additionally, keeping track of trades along the way to reflect and edit, if necessary, via doc, spreadsheet, or journal. (CFI Team, 2022)
These are just a few basic examples of components that can create a solid trading plan; the real test is learning how to piece them together to craft your own. Without a strategy to hold onto to stay afloat, you will continue to get swallowed up in the chaos of the market, returning with less and less confidence (and money) each time.
The stock market is ever-changing and unpredictable, but traders are not required to keep changing along with it. Adaptability is an important trait for a trader to survive, while consistency is essential for a trader to thrive. Traders that continuously deviate from their plans and make sporadic decisions based on outside changes will never see stability in their success.
Consistency is all about finding the right balance; a solid plan is easy to stick to and allows you to edit and improve upon it down the road. Trading remains a lonely endeavor, despite the many avenues we can now connect. Therefore, when the market invariably goes awry, leaving you vulnerable, a solid trading strategy can offer the support and safety you crave in uncertain times.
CFI Team. (2022, October 26). Trading strategy. Corporate Finance Institute. Retrieved December 20, 2022, from https://corporatefinanceinstitute.com/resources/wealth-management/trading-strategy/