How To Be A Trader - Part 2

In the first article of the series "How To Be A Trader" we talked about the mindset of a trader and the importance of having realistic goals. You have learned that consistency is more important than windfall profits every now and then, and that a weekly target of only $100 - $200 can compound to very nice yearly returns. If you haven't had a chance to read the first article of this series, click here to read "How To Be A Trader - Part 1"

Today we will talk about the most important skill of a trader. And it doesn't matter whether you are day trading or swing trading. It doesn't matter whether you are trading stocks, forex, options or futures. It doesn't matter whether you are new to trading or have been trading for a while. The skill I am going to talk about in this article is the foundation that EVERY TRADER needs. If you cannot master THIS, your chances of making money with trading are slim to none.

So here is the most important skill of a trader:

Step 2: How To Determine The Direction Of The Market

You MUST be able to read a chart and determine whether the market is going up, down or sideways.

Trading is not that complicated: If the market is going up, you BUY. And if the market is going down, you SELL. If the market is going sideways, you either stay out of the market and wait until it is trending again, or you apply a more advanced trend-fading strategy.

Let me explain:

In the previous article we talked about a trading strategy with a positive reward/risk ratio. We used the example of a reward/risk ratio of 1.5 to 1, i.e. you risk $100 to make $150.

Understanding Reward/Risk Ratio And Winning Percentage

You need to understand that there's a strong correlation between the winning percentage and the reward/risk ratio. The higher the reward/risk ratio, the lower the winning percentage.

Here's an example:

You might have heard about so-called "Home Run Strategies". When using a "Home Run Strategy" you use a small stop loss and a quite large profit target. Often these strategies have a reward/risk ratio of 5 to 1, i.e. you risk $100 to make $500.

If you choose to trade such a strategy, it is not unusual to have a winning percentage of only 25% - 35%. But you would still be profitable, since you will make MUCH more money on your winning trades than you lose on your losing trade. In fact, only ONE winning trade would make back all the money you lost on FIVE losing trades. So as long as you winning percentage stays above 20%, you're good.

When trading such a strategy, you obviously need a trending market. You want to make sure that prices are moving in your favor for a long time. That's why these kind of trading strategies are called trend-following strategies.

Trend-following strategies typically have a reward/risk ratio above 1.

In contrast, there are trend-fading strategies. These kind of strategies work best in sideways markets. The idea is to SELL at resistance, hoping that prices will retrace and you can BUY back lower. As an example, in sideways markets many traders like to SELL at the Upper Bollinger Band and BUY at the Lower Bollinger Band.

When using these kind of strategies, you typically have a reward/risk ratio of 1 to 1, i.e. you are risking $100 trying to make $100. Therefore you need a winning percentage greater than 50%, otherwise you won't be profitable. Often trend-fading strategies have a winning percentage between 55% and 75%.

And then there are scalping strategies. When using a scalping strategy, you apply a rather large stop loss and use a small profit target. It is not unusual for a scalping strategy to have a reward/risk ratio of only 0.5 to 1 or even less, i.e. you are risking $100 to make $50. Obviously you need a high winning percentage for this strategy to work. That's why often scalping strategies have a winning percentage of 80% and more.

Here's an extreme example of a scalping strategy:

Just BUY the e-mini Dow tomorrow morning at the open. Do NOT set a stop loss. Use a profit target of 10 points.

This trading strategy has a winning percentage of 99.9%, because how likely is it that the Dow Jones moves to ZERO? - Next to nothing, right?

So often you will hit your profit target. The problem is TIME. It might take you days, weeks, months and maybe even years before your profit target is hit. But if you could sustain the drawdown while being in the trade, you would have an extremely high winning percentage.

Obviously this is just an example. Don't even THINK about doing it! But I'm sure you understand what I'm trying to explain here.

Why You MUST Be Able To Determine The Direction Of The Market

So why is it so important to learn to identify the direction of the market?

Because the direction of the market determines what kind of strategy you need to use!

  • In a trending market, you use a trend-following strategy.
  • And in a sideways market, you use a trend-fading strategy.

If you use a trend-following strategy in a sideways market, you will get whipsawed.

And if you use a trend-fading strategy is a trending market, you will get stopped out frequently.

Have you every experienced the following: You trade a strategy, and sometimes the strategy works great, but then there are other times when the strategy under-performs. If this ever happened to you, then you probably traded the wrong strategy for the current market conditions.

And that's why I like to use multiple trading strategies. I use trend-following strategies in a trending market, and trend-fading strategies in a sideways market. I explained what strategies I use in a previous article. Click here to read the article about "The Best Trading Strategy"

Summary of "How To Be A Trader - Part 2"

The most important skill of a trader is to determine the direction of the market, since the market condition determines what trading strategy you should use.

To date I haven't seen a strategy that performs equally well in trending and in sideways markets. Your strategy is either a trend-following strategy that performs well in trending markets. Or it is a trend-fading strategy that performs well in sideways markets.

If you apply the wrong strategy, you will be swimming against the stream. Or, as Hubert Senters likes to say "It's like hitting yourself with a hammer on the head. It feels good when you stop doing it."

In the next article I will show you some simple tricks how you can easily identify the direction of the market.

Does this help? - Leave a comment below

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Leave A Reply (35 comments so far)


  1. Mori
    3 years ago

    Great Info.. to me it all depends on trader's own psychology and patience.. that's what determines what kind of trading you will feel more comfortable with: swing or scalping, straddle, etc.
    And above all: DISCIPLINE!!

    Markus.. by the way.. I have demo traded for 3 months your system based on bollingers, rsi and macd with range bars and account equity has doubled.. setups form almost twice a day on EUR/USD 30 min. Thanks a lot!!!

    [Reply]

    Markus Heitkoetter Reply:

    Good for you! Congratulations!!! Stay in touch and keep me posted on your trading success.

    [Reply]


  2. nisar
    3 years ago

    Hi markus ,
    Its a nice article. very common talks but a new way of explaining. however can you explain how you determine the trend?

    [Reply]

    Markus Heitkoetter Reply:

    Yes. I'm writing the next article as we speak. In this article I will show you the tools and techniques that I use to determine the trend. I'm planning to publish it in the next 48 hours ;-)

    [Reply]


  3. Frank
    3 years ago

    Sometimes the obvious, stated simply, is what the doctor ordered. Thanks for using plain english in your examples. I can honestly say that I have been losing money because I have been using the wrong strategies for market conditions at the time of those trades.

    [Reply]


  4. Jose Herrera
    3 years ago

    Hi Markus very powerful information, thank you for your time and for share this knowledge with
    us; once you are in the markets for while its easy to understand the importance of all these
    qualities in order to be a successful trader. Thank you! Its really appreciated.

    [Reply]


  5. Jeff
    3 years ago

    Thanks Markus.....refresher courses are always valuable. Thanks for these articles.

    [Reply]


  6. Raj
    3 years ago

    Hi Markus

    I must say that both Part 1 & Part 2 have made for excellent reading, especially if one is starting out or has just started out on the day trading journey. Your articles capture almost everything that a new trader experiences. Great work and I look forward to sequels

    [Reply]


  7. Roy
    3 years ago

    Thank you for the easy expalnation of a difficult subject. I am having a problem finding a online brokerage system that uses "range bars" I have Think or Swim and trade monster neither support these

    [Reply]

    Markus Heitkoetter Reply:

    Roy, you can apply the trading principles I use to TIME-BASED CHARTS. I just prefer using range bars because I think they are giving me an unfair advantage. ;-) And then there's always the possibility of using a different charting software. You can still EXECUTE your trades through Think Or Swim or TradeMonster, but you would get the signals from a charting software that supports range bars. Just an idea... - Markus

    [Reply]


  8. K.L.Bhatia
    3 years ago

    Hi Markus,
    It is a beautiful article. People read and forget and again use the same old strategy. I wish every trader should follow your advice and refrain from using the old strategies.

    [Reply]


  9. Tom
    3 years ago

    Hi Marcus,great info but on the most important aspect of trading determineing trend is key,but without emotional control and discipline you are finished.Success in trading depends on this more than anything because you can have all the knowledge you could ever need,take your account to the moon and still end up blowing yourself up.I've done it and seen it done.

    [Reply]

    Markus Heitkoetter Reply:

    AMEN! In one of my previous blog posts I talked about the THREE ELEMENTS OF TRADING: MIND, METHOD AND MANAGEMENT. Emotional control and discipline plays a huge role in trading. I will write more about that in another blog post. Thanks for the great comment!

    [Reply]


  10. Erika1
    3 years ago

    Thank you Markus, this helps Yes! Will look forward to your next article.
    Love and Light be with you, Erika

    [Reply]


  11. MANOJ
    3 years ago

    nice info,,,,keep up d good work

    [Reply]


  12. Gordy
    3 years ago

    Hi Markus,

    You give clear advice and I'm happy to have found this site.

    [Reply]


  13. john martin
    3 years ago

    I understand the theory of scalping; reward/risk ratio of 0.5:1 or even less with a winning % of 80% or more. However the example you give is I believe, on stocks which has send me swimming. Can you please craft an example for me in Forex terms?

    [Reply]


  14. Andre
    3 years ago

    Hi Markus, thanks for these simple reminders, sometimes one gets so bogged down in different markets and time frames that you cant see the wood for the trees. I have been trying to apply your strategy to time based charts with little success as my software does not support range bars. Any suggestions?

    [Reply]

    Markus Heitkoetter Reply:

    Andre, there's a reason why I prefer range bars over time-based charts. Now you know why ;-)
    Just out of curiosity: Why don't you switch to a charting software that supports range bars? There are very inexpensive packages available. I've seen decent software packages that support range bars for as little as $25 per month.

    [Reply]


  15. Ganiyu
    3 years ago

    I thank you for the knowledge giving to me thank you and God Bless you,I am a forex trader

    [Reply]


  16. Vijender Singh Dager
    3 years ago

    Sir;
    This lesson is even worth praising for a new beginer like me. I try almost to go thru all your write ups.Kindly keep it up, since it helps a novice trader with limited money for margin and gadgets.
    Thnkx

    [Reply]


  17. Mike Wilkinson
    3 years ago

    Your articles are much appreciated. I am looking forward to the one on spotting the direction of the market. Too often I look at a chart and think that no way will it go higher and it does, and vice versa.
    I mainly spread bet forex on an MT4 platform. I would like to set up your bollinger bands and range bars system. Do you know if one can get range bars on the MT4 or what would you recommend? I am very much a beginner, having been trading for about 2 months with a starting bank of £1K.

    [Reply]


  18. Dr. Ubeta A.
    3 years ago

    hi Markus. What timeframe should we use to draw trend line Weekly or Dayly, because if we draw it on timeframe H4 or shorter the direction will be different. Thank you.

    [Reply]

    Markus Heitkoetter Reply:

    It depends what timeframe you want to trade. If you want to trade on 4-hour bars, then you should use THESE bars as a main reference for your analysis. You could use the larger time frames to confirm your decision, but I don't do that. For me multi-timeframe analysis is confusing. Because it's exactly as you say: Some timeframes tell you to go long, others tell you to go short. So what do you do? When I tried to analyze multiple timeframes, I suffered a severe case of "analysis paralysis". That's why these days I'm only looking at ONE timeframe. And it has helped me in my trading.

    [Reply]


  19. Shawn Carruthers
    3 years ago

    Good stuff keep it coming

    [Reply]


  20. Ron
    3 years ago

    Thanks for sharing your knowledge Markus. I've been swing trading for almost 2 years now. Initially my losses were from lack of knowledge and no real strategy. Then about 8 months ago I purchased a paid subscription that tweets the buys & sells. Since then my trading account $$ have mostly recovered but I now want to learn how to make the buy/sell decisions on my own. As such I’ve enjoyed reading your trading articles and appreciate that you have taken the time to share your knowledge and experience. Please keep the articles coming.

    [Reply]


  21. Mike Kerfer
    3 years ago

    Great post Marcus. The only addition I have is to be consistent. All strategies have losses - being consistent will be profitable in the long run. Picking and choosing trades always leads to high losses.

    [Reply]


  22. Mriazkamran@gmail.com
    2 years ago

    Markus:

    Read your book Day trading strategy and also watched videos. Simple and straightforward.

    1. As you mentioned in video, you only use Volatility based charts for day trading, which is 20 tick bar chart. Searched hard trading platform has option to use Volatility based charts with ticks bars. Do you have an idea which system supports this option and approximate cost?

    2. If can not find tick bar charting software, and want to use time based bar charts then what time frame would you think close to tick based bar chart?

    3. Placing an order, one tick above high of bar (in uptrend) and one tick below low of bar (in downtrend), how many cents you consider equal to one tick? And if using time base charts then how many cents will equal to one tick bar (rouoghly).

    Thanks, Kam

    [Reply]


  23. Joe
    2 years ago

    Very good information, particularly the need to use the correct strategy for trending or sideways markets. Thanks very much!

    [Reply]


  24. EMMANUEL DIXON
    2 years ago

    Great stuff. id like to learn your strategies,do you have a course for sale?

    [Reply]


  25. Tshepo
    2 years ago

    Good information, I like it.

    [Reply]


  26. Shyam
    2 years ago

    what do you mean by trading strategy ?
    Just for your confirmation.......................
    For example = Is it going long or short as per trend like a pullback or rally strategy at support or resistance levels in up or down trending market ?
    Is it also a called one of the strategy

    [Reply]


  27. martinmeier@outlook.com
    2 years ago

    Bullshit

    [Reply]


  28. Rick Washburn
    1 year ago

    Great article!
    I'm looking for some info on timing for shorting a stock. Is it possible to short a ETF?

    [Reply]

 
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