There is a lot of misinformation out there about what a trading system really is. The fact is the road to wealth in the stock market requires utilizing a trading system, so it’s important to understand.
A trading system is a part of your trading plan which not only determines how you find stocks to trade (or any type of assets) but also when is the optimal time to enter and exit a stock. It’s often based on statistical analysis or some other method of technical analysis which has been historically backtested and hopefully forward tested as well, in order to allow you to quantify specific historical patterns which result in expected outcomes. In the world of finance it is required by law to state past performance is not indicative of future performance but the reality is history repeats itself. Most businesses use some sort of historical forecasting to project a future outcome, so it isn’t hard to see why this is a necessity in the stock market as well.
To give you an example of what a trading system will do for you say A, B, C, D, and E occur (and these could be a number of different variables such as a technical indicator hitting a certain point, or the price of a stock reaching a certain level) your system will alert you to the fact that if you enter a stock there’s a high probability that a stock will move in a predictable way. The amount of price movement can vary and there is no way to predict with certainty how far a stock will go. This is why contrary to what most inexperienced traders think, there is NO system out there that is correct 100% of the time. The good news is that this little built in edge is what gives you a leg up on your competition and once you have this you’ll understand how traders make significant amounts of money with imperfect information…
If you take an average person who really has no idea what they are doing when it comes to the market (which is the majority of people out there) and ask them how they trade or invest, you’ll probably get a blank stare. Then they’ll say something along the lines of “I read all the financial news (Yahoo finance, Wall Street Journal, Barrons, Investor’s Business daily (William O’Neil), Klipingers, Money Magazine, CNBC, Bloomerberg) and then I make buy decisions based on what people such as analysts or other financial pundits (like Jim Cramer or the Fast Money Monkey’s) are staying about a stock… Another common thing you will hear is “I search for a stock with a product or service that I think is going to revolutionize the world (most of the times which is from a speculative penny stock) and I buy it with the belief that I am going to get rich quick. Yet another are the people that say they follow people on Twitter, Stock Twits, message boards, online chat rooms or pay for some guru’s stock alerts. The final group are the degenerate gamblers that throw darts and just buy random stocks based on hunches or stock tips that they heard about at a cocktail party.
The one thing that all these groups of people have in common is they all have infinitely small chance of ever becoming consistently profitable traders, or even making any money whatsoever. The truth is without a predetermined framework and trading plan which defined exactly what you will do under many of the various outcomes in the market, the chance of success is incredibly low. This is mostly because the stock market is designed to steal money from all of these ignorant people. I mean it! The algorithm’s seek out these unsophisticated market participants because they have been programmed to capitalize on the poor decisions of the general public.
Now in order to make money you don’t need anything magic but you do need to be looking at something which the small group of winning traders are also focusing on. This is almost always the exact opposite of what the majority of losing traders (which are often called the herd) are looking at which is why having a contrarian opinion is essential. There are many ways out there to make money in the market but the biggest challenging is identifying what works for you and learning to stick to those strategies day in and day out. Mastering your own psychology is truly the only way to succeed as a trader because even if you have that built in edge I referenced above, you won’t get far if you don’t know how to harness it’s power.
When you are able to determine these times when the risk of holding stocks (especially volatile penny stocks) is greatly reduced only then will be able to profit consistently. The average person has no idea about how the market “really works” and that is why traders who are informed, are able to take advantage of these people.
Unlike many other things in life where practice makes perfect and over time you can become success, the biggest challenge about trading is that you can literally go years and years and never get anywhere if you don’t either come up with your own trading system (which takes a serious amount of time) or adopt somebody else’s which fits well with your personality, and make it your own.
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