Trade Your Way to Financial Freedom

1. Develop a trading system that fits your personality and beliefs

You cannot trade the market. Instead, you can only trade your beliefs about the market.

Know thyself. Successful trading begins with self-awareness. Assess your skills, temperament, time availability, and resources. Identify your strengths and weaknesses, and develop a trading system that aligns with your personality and beliefs about the market. This personalized approach increases the likelihood of consistent execution and long-term success.

Understand your concept. Choose a trading concept that resonates with you, such as trend following, value investing, or arbitrage. Thoroughly research and understand the concept, as it will form the foundation of your trading system. Your chosen concept should reflect your market beliefs and provide a framework for identifying low-risk trading opportunities.

2. Focus on expectancy and position sizing, not just entry signals

Expectancy is the mean R multiple of your trading system.

Expectancy is key. Shift your focus from entry signals to the overall expectancy of your trading system. Expectancy represents the average amount of money you can expect to make per trade, expressed as a multiple of your initial risk (R). A positive expectancy system is crucial for long-term profitability.

Position sizing matters. Implement effective position sizing strategies to optimize your returns and manage risk. Position sizing determines how much capital to allocate to each trade, based on factors such as account size, risk tolerance, and trade expectancy. Proper position sizing is often more important than entry signals in achieving trading success.

3. Use setups to identify potential trading opportunities

A setup is about 10 percent (or less) of your trading system.

Setups as filters. Use setups to identify potential trading opportunities and filter out low-probability trades. Setups can be based on various factors, such as chart patterns, fundamental data, or market conditions. While important, remember that setups are only a small part of your overall trading system.

Diverse setup types. Consider different types of setups:

• Time-based setups (e.g., seasonal patterns)
• Price-action setups (e.g., support/resistance levels)
• Fundamental setups (e.g., earnings reports)
• Volatility-based setups (e.g., breakouts)
• Sentiment-based setups (e.g., contrarian indicators)

4. Implement effective entry techniques for timing your trades

Your primary job as a trader should be to devise a plan that will earn profits that are large multiples of R.

Entry signals. Develop entry techniques that align with your trading concept and setups. Common entry methods include:

• Breakouts
• Moving average crossovers
• Pullbacks to support/resistance levels
• Volatility expansions
• Pattern completions

Focus on R-multiples. When designing entry techniques, prioritize those that offer the potential for large R-multiple profits. This approach allows for a lower win rate while still maintaining overall profitability.

5. Protect your capital with well-designed stop-loss strategies

Your protective stop is like a red light. You can go through it, but doing so is not very wise!

Capital preservation. Implement effective stop-loss strategies to protect your capital and limit losses. A well-designed stop-loss strategy helps maintain discipline and prevents emotional decision-making during drawdowns.

Types of stops:

• Initial stops: Set at the time of entry to define maximum risk
• Trailing stops: Adjust as the trade moves in your favor
• Time-based stops: Exit after a predetermined period
• Volatility-based stops: Adjust based on market volatility
• Chart-based stops: Use support/resistance levels or trend lines

6. Maximize profits through strategic exit techniques

Cut your losses short and let your profits run.

Multiple exit strategies. Develop a comprehensive exit strategy that includes both profit-taking and loss-limiting techniques. Implement multiple exit strategies to adapt to different market conditions and maximize overall profitability.

Exit techniques:

• Trailing stops
• Profit targets
• Scaling out of positions
• Time-based exits
• Indicator-based exits (e.g., overbought/oversold levels)
• Chart pattern completions

7. Evaluate and improve your trading system continuously

Market research is an ongoing process.

Continuous improvement. Regularly evaluate your trading system's performance and make necessary adjustments. Track key metrics such as win rate, average R-multiple, and overall expectancy. Identify areas for improvement and test new ideas to enhance your system's effectiveness.

Performance analysis:

• Review trade logs and journal entries
• Calculate key performance metrics
• Analyze drawdowns and losing streaks
• Identify patterns in winning and losing trades
• Backtest and forward-test system modifications

8. Understand the big picture and adapt to changing market conditions

I believe that this step is critical, so I've devoted a new chapter in this book to helping you assess the big picture.

Market awareness. Develop a comprehensive understanding of the broader market environment and economic factors that influence your trading. Stay informed about macroeconomic trends, sector rotations, and geopolitical events that may impact your trading decisions.

Adaptability. Be prepared to adapt your trading system to changing market conditions. Recognize when your current approach may be less effective and be willing to adjust your strategies or temporarily reduce trading activity. Maintain multiple systems or strategies to capitalize on different market environments.

9. Master your psychology and maintain discipline in trading

If you learn one critical thing from this book, it should be that a setup is about 10 percent (or less) of your trading system.

Psychological edge. Recognize that your personal psychology plays a crucial role in trading success. Develop mental discipline, emotional control, and a positive mindset to execute your trading plan consistently.

Key psychological factors:

• Managing fear and greed
• Maintaining patience and discipline
• Accepting and learning from losses
• Avoiding overconfidence and complacency
• Developing a growth mindset and continuous learning attitude

10. Learn from successful traders with diverse approaches

Five different people can each approach the same scenario differently and still have success.

Diverse perspectives. Study successful traders with different approaches to gain insights and broaden your understanding of the markets. Recognize that there are multiple paths to success in trading, and learn to adapt successful strategies to fit your own style and beliefs.

Common traits of successful traders:

• Well-researched, positive expectancy systems
• Strong understanding of their trading concepts
• Effective risk management and position sizing
• Continuous self-improvement and market study
• Disciplined execution of their trading plan
• Adaptability to changing market conditions

Last updated: August 20, 2024