There is no question trading successfully in a consistent manner will take years to master, but here are some key concepts to lay a solid foundation of knowledge and discipline.
Whether you are just starting out or have been trading in financial markets for years, these should prove useful exploring or revisiting.
Here are the 5 trading concepts that every trader should know and master.
- Risk Management
To maximise gains, traders should first ensure being able to limit their losses so that when setbacks occur, they do not penalize the overall portfolio too much.
The most important for risk management is understanding the potential losses that may result from trading activities and putting strategies in place to mitigate those losses.
These include setting stop-loss order limits or ‘mental’ stop losses, diversifying to spread risk, and only going after trades with high risk-to-reward ratio.
Taking shortcuts to good risk management may result in taking too much risk, which can lead to unexpected losses.
- Technical Analysis
Price history is not necessarily indicative of the future, but it offers perspective. Technical analysis involves using past price and volume data to make an educated guess about future market movements. Technical analysis can be done using various technical indicators such as relative strength indicator (RSI) and Bollinger bands.
Drawing trendlines or the basic support and resistance levels can prove very useful to predict floor or tops in the given time frame.
Traders are also able to put stop-loss orders around those resistance or support levels to limit their losses, an efficient tool for risk management.
- Fundamental Analysis
Looking at the strength of investment rationale is called fundamental analysis. It focuses on the present and future. It’s an important concept that aims to remove momentum and emotions from markets. However, traders must understand that markets can remain irrational for long periods of time.
By developing an acute understanding of how fundamentals of the markets work, traders can make correct judgement calls. For instance, to know to buy dips, if we have established that we are in a bull market. Bull markets could be in some stock indices, currencies pairs, or even some commodities. What is important is to use fundamental analysis to establish the probabilities of the investment going in a certain direction up or down.
- Trading Psychology
Emotions play an important part in driving short-term movements in financial markets. For that reason, it is important to develop a disciplined approach for trading. This includes setting clear objectives, establishing the strategy, and staying focused.
- Position Sizing
The concept of position sizing is key to manage risk, that is to define the potential loss should the trade go in the wrong direction. In the long run, carefully managing position sizes, for instance limiting one’s portfolio to 1-2% position size per trade, can help traders to have more control over the return probabilities. Particularly at the beginning, trading with smaller position size could help traders to understand and gain experience in the markets.
In conclusion, these trading concepts should help traders to develop the right approach to trading financial markets. It should brighten the trading experience and improve the chances of success. Now each trader may have their own strategy. For instance, one may focus on short-term moves with a focus on support and resistance levels, using position sizing and stop-losses to manage risk.