I’ve been training traders for a long time, so the two questions I get daily are: “Does day trading work and how do I make money trading stocks?”
Over the past several years my answer has slowly changed…
Most people want a simple yes or no answer. But unfortunately, as with most good questions, the answer isn’t simple.
How to Make Money Trading Stocks: 2 Factors That Determine Success
At first, day trading seems like a simple process…
All one has to do is enter a position and leave it alone if it goes your way. If it doesn’t go your way, all you have to do is liquidate it.
At the same time, trading can be a difficult process where people are forced to learn advanced computer algorithms to keep up with hedge funds and institutions.
Everyday traders and investors are sometimes forced to understand the inner workings of network servers, or even master them, to be able to predict the price of future contracts three seconds ahead of time.
They might also have to learn bet-sizing techniques that require a Ph.D. in statistics if the method calls for it.
Those are two extreme examples of achieving the exact same result, which is how you can make money trading stocks.
Profitability is why a lot of people are interested in trading and continue to do it.
So before you begin your journey to learn how to make money trading stocks, I want to give you the two of the most important factors that determine success or failure…
If you master these two factors alone, you could be a profitable trader without knowing anything else.
However, if you don’t learn and focus your attention on these two factors, your career as a trader will probably be short-lived.
Trading is based on simple math…
To be successful, your winners have to be either bigger than your losers, or your percentage of winners has to be much higher than your losers.
There’s no other way to be profitable if you don’t fall into one of those two categories.
The way traders express these two categories is called “positive expectancy.”
Your trading strategy must have a positive expectation of profit in order to make more money than you lose.
The formula to test your expectancy is simple and it should be the first and last thing on your mind when you pick different trading methods… and even more so when you’re actually trading them!
You also need to find out the answers to the following things:
- What percent of your total trades are winning trades?
- What percent of your total trades are losing trades?
- The average amount you make in all your winning trades.
- The average amount you lose in all your losing trades.
Once you gather all of this data, simply plug the numbers into this formula: (Average Winner x Win Rate) – (Average Loser x Loss Rate).
This tells you exactly what your average expectation of profit should be over the long term based on your trading method.
For example, let’s say your method wins 50% of the time and you make $2 every time you win. And the other 50%, you lose $1.
You’d multiply $2 by 0.50%, which would give you $1. Then, we’d multiply the losing side or $1 by 0.50%, which would give us $0.50.
You’d then want to subtract $0.50 from your $1. So your expectancy would be $0.50.
This means for every dollar you risk, you get that dollar back plus $0.50 cents.
The higher your number is, the higher your expectancy will be and the better your trading strategy is.
Calculate Your Past Trades
Take your past trades and plug them into this formula.
This way you’ll know sooner rather than later what your expectation is and how you can make adjustments so your expectancy is constantly going up.
This is exactly what professional traders do, so there’s no reason why you shouldn’t do the same.
You Are Your Own Worst Enemy
I hate to say it, but the biggest reason why traders don’t succeed aside from using strategies that don’t produce a positive expectancy is because of how they interpret and react to the broader markets.
Psychology is one of the biggest causes of traders failing.
Most people starting out have problems holding onto winners and cutting losers too quickly.
When beginners see their positions turn profitable, they fear it will go against them and the profits will disappear. And when positions go against them, they just hope the position will come back to their entry price so they can liquidate it and break even.
But professional traders do the opposite when positions go their way…
They hope it’ll continue moving further. And when positions go against them, they fear the position will continue going against them and liquidate it quickly to keep the losses small.
Notice the difference in the thought process between beginner and professional traders…
The beginner thinks completely opposite of the professional trader.
This happens because people are naturally wired to lose money. Unfortunately, it’s just how most of our minds work!
Professional traders have to reprogram that part of their mind so this naturally wired thought process doesn’t affect their trading.
This is a process and something that anyone can develop with proper training.
Things to Keep in Mind
I hope you understand that learning how to make money trading stocks is about mastering two fundamental skills that can develop and improve with time.
How much time you devote to developing positive expectancy and proper trading psychology will directly influence your bottom line.
I hope this tutorial provides you with enough guidance to take steps to improve these two areas of your trading.
The next time someone asks you “does day trading work or how do I make money trading stocks,” just point them to this page!
For more on topics like this, please go to: 2 Swing Trading Rules to Follow for Bigger Gains and The Ultimate Trader’s Guide to Technical Analysis.
All of the best,
Senior Strategist, WealthPress