The Big Trader’s Secret for Small Traders

Let’s be honest, everyone begins trading with the hopes of making a lot of money through their trades, maybe even enough money that they can quit their jobs and trade for a living. However, when asked how they are going to make “a lot of money trading” most traders would not be able to give you an answer. Somewhere in the back of their minds they secretly hope that they will catch the one big move that will set them up with a big enough account to be able to trade like the big boys. Unfortunately the odds of catching the “big one” are probably the same as those for winning the lottery.

So what is a trader to do? Perhaps the most important trait of any successful trader is the ability to make money consistently. This should be obvious. No trader, no matter how large of an account they have, can continue for long without consistent profits. So how does a trader develop consistency?

A successful trader once told me that I should have a trading goal. The goal did not have to be a large one, but the simple fact of having a goal would help me focus better on the markets. I would come to see better opportunities (note this is not the same as “more opportunities”) as well as managing my money better. Since I did not have a very large trading account, the trader suggested I start with a goal of netting $250 per week out of the markets using only single contracts. If I could do this consistently for four weeks, I should be able to net $1000 a month from my trades.

I was quick to point out to the trader who shared this advice that I couldn’t exactly live on a $1000 a month! He said that if I could consistently net $250 a week, using single contracts, for the next 12 weeks, theoretically there would be no limit on the amount of money I could earn by trading. Still confused I asked how this was possible.

He said that no trader, who trades for a living, does so trading just one contract at a time. The power of making money in the markets comes through the use of multiple contracts. If you can net just $250 a week using single contracts out of your trades, then with four contracts you should, in theory, be able to net $1000 a week, or $4000 a month. With eight contracts that would be $8000 a month, with 10 contracts, $10,000 and so on. However, trading multiple contracts like this without first being able to trade consistently would be financial suicide.

The key to this formula is to be able to NET $250 a week from the markets using single contracts. This means that after commissions and losses you should be up $250 at the end of each week. Now here is the tricky part: while you should never enter a trade with the hopes of making up losses, the fact remains that if you are going to make consistent gains from your trading, your winning trades will need to surpass your losers (plus commissions).

The more I thought about what the trader told me, the more I came to realize that this was possibly the best advice for cutting losing positions quickly that I had ever heard! It hit home that, while each trade is its own trade, the consequences of keeping a losing position too long would either make, or break me in the long run. If my profits were not able to offset my losses and expenses, then I might as well pack up my trading account right now and take the money to Las Vegas, where at least I could have a good time spending it.

The trader went on to point out that because the focus was on a profit goal, it was important to maintain a proper risk/reward ratio. If there was too much money at risk, given the possible reward, then it would put too much pressure on the following trades to make up for losses that were incurred earlier. However, by keeping losses to a minimum, the following trades would have a better chance of adding to the weekly profit goal.

The trader told me, that by having a trading goal, especially a smaller one, I would be more inclined to bank profits when I had them; rather than hold on too long only to watch the market eventually take the profits away. Countless traders have given up thousands of dollars in profits because they thought the market would move just a little bit more.

The trader suggested setting an exit order to bank profits, rather than using a trailing stop loss to exit the market. There are times when a tailing stop loss is more appropriate, especially if a larger market move seems likely; however for most short term trades a profit exit order will serve the small trader better than will trailing a stop loss.

As your account grows and you can afford to trade with multiple contracts, you will simultaneously be able to bank some of the profits from a portion of your open contracts, while still leaving a few contracts in place, with a trailing stop loss order, to take advantage of further market moves. Yet before you can begin trading like this, you first need to build your account and develop your consistency.

The trader reminded me that this was just a goal however and that you can not make the markets give you more than they are prepared to give. This means that you must be constantly prepared to take a profit; rather than sacrifice the profit you already have, in hopes of gaining more, even if you are shy of your goal. After all, if the market continues higher after you exit, you still have the option of re-entering the market again if the trade still looks viable.

To develop your trading consistency you first need to decide on a weekly goal. If you are like most small traders, a goal of netting $250 per week using single contracts is a good place to start. While it might not seem like a very challenging goal on the surface, you might soon discover, through your paper trading, that it is not be as easy as you first believed. Remember, your goal is to gain $250 per week with single contracts, net of commissions and any losses that were incurred earlier in the week.

While you are working on improving your trading consistency, remember that this is only a practice session and should be treated as such. Make a game of it but don’t cheat. Once you have set a weekly goal for yourself, see for how many weeks you are able to attain it. If you can reach your goal for 12 to 16 consecutive weeks you will be doing very well. If you are doing any less than that, then you still need to practice.

Start each week fresh. There will be some weeks where you will not fair very well at all. You might find yourself with a string of losses and a cumulative loss for the week that seems insurmountable. If you are unable to attain your goal for that week, do your best to learn from your mistakes and make a new start the following week. Remember that you are performing the exercise to learn to trade consistently, so don’t be too hard on yourself.

If you are able to earn consistent profits on paper then, when the time comes, it will be more likely that you will be able to reproduce the results with real money as well. Start small and most importantly, don’t rush. Learn to paper trade profits with one contract before paper trading with more. While you might be comfortable trading one contract at a time, trading multiple contracts can put a lot of pressure on the psyche. If you can consistently earn profits with one contract then add another. If you continue to earn consistent profits with two contracts add two more contracts, and so on.

Do the same when you start trading with real money. Begin by trading one contract at a time until you get accustomed to the emotional side of trading. Then if you are successful, slowly add contracts as your account size allows. As a general rule of thumb, you can allow one contract per $5000 of your trading account. Therefore if you have a $10,000 account you could trade two contracts at a time, a $15,000 account would allow three contracts and so on.

One final tip: Take care choosing the markets you wish to follow. Since your goal is consistency you might be best off to avoid the more volatile markets. Due to their volatility, these markets normally have higher margin requirements as well; however it is not usually a problem as there are plenty of less volatile, lower margin markets that offer plenty of potential for the small trader.

While any market can have volatile streaks, the grain markets are usually a fairly safe bet for the small trader looking for consistency. Some of the softs like sugar, cotton and cocoa might be worth following although OJ should be avoided as it can be very unpredictable. While some of the meats have lower margins and can trend well, they can also be fast moving markets in which it can be difficult to minimize your losses. If you feel you have to include a meat market (or two), live cattle and live hogs are usually not as dangerous as feeder cattle or pork bellies. Most of the currencies and energies will be too expensive for the small trader to participate in; however including a metal like gold or silver might serve to round out the trading portfolio.

Take your time and remember that consistently earning profits is the real goal.

For more from Erich, visit the Indicator Warehouse for additional futures resources and NinjaTrader Indicators.