This often leads to a phenomenon known as “System hopping,” where traders experiment with various strategies across different asset classes, unaware of the finite nature of their funds. As a result, they often deplete their trading capital, become demotivated, and exit the market.
To avoid this pitfall, new traders should keep in mind the following key points on their path to becoming successful traders:
Importance of Backtesting and Paper Trading
As a starting point, it is crucial to backtest your trading strategy using historical data before implementing it in the live market. Backtesting will help you understand the profitability of the strategy as well as its volatility. This allows you to fine-tune the strategy to align with your risk profile.
Additionally, it is important to paper trade the strategy to see if it actually works in real-time. While paper trading may not be as exciting as live trading, which gives you the rush of mark-to-market profits, it helps build discipline and confidence in your strategy.
Start Trading with Small Capital
It’s important to remember that backtesting is not a guarantee of success in the live market. Backtest do not account for trading expenses such as brokerage, taxes, and slippage that may occur during live executions.
Therefore, it’s crucial to implement your strategy in live trading with small capital. In my first live trade, I couldn’t square off my position at the defined stop-loss because I wasn’t emotionally prepared to accept a loss. Trading with small capital in the live market can help you understand your emotions and identify the type of trader you are.Understanding Capital Requirements for Trading
When starting with trading for a living, the goal is to replace your monthly income with trading profits. However, traders often underestimate the capital required to achieve this goal. It’s crucial to set realistic expectations and remember that if you lose all your capital, you won’t be able to trade anymore. This is especially important for beginners, as staying in the market and preserving capital should be a top priority.
Learn to aim for a Win to Loss Ratio
When it comes to trading, many novice traders often concentrate on finding the best trading strategy with the highest Win: Loss ratio, as they want to avoid losing trades. However, it’s crucial to consider both the Win: Loss ratio as well as the Risk: Reward ratio. To understand the significance of these factors in successful trading, let’s compare two scenarios.
Scenario 1 (Beginner Trader)
With a winning trade to losing trades ratio of 60% and a risk-to-reward ratio of 0.7/1 (where you make 70 paise on every winning trade but lose Re 1 on every losing trade), some traders may feel they have a winning strategy in place. However, putting this strategy to the test may result in a net loss.
Scenario 2 (Pro Traders)
In contrast, pro traders may have a winning trade to losing trades ratio of 40% but a risk-to-reward ratio of 2:1 (where they make twice the money on a winning trade). Despite losing more trades, the overall trading strategy is successful due to the higher quantum of wins compared to losses.
So, it’s not just about finding a strategy with more wins but understanding the risk-to-reward ratio for long-term successful trading.
(Shrey Jain is Founder and CEO of SAS Online)
