The six Elements to Trading Success

Six Elements to Trading Success

When it comes to trading, other than a trader's internal makeup, there are 6 key quantitative factors you should be analyzing and closely tracking when determining the viability of a system. These metrics act as a barometer of whether you are succeeding or not. 

The six elements I learnt after reading the book, Trade Your Way to Financial Freedom taught by the late Dr. Van Tharp in his book Trade your way to financial freedom are outlined as follows:

1. Reliability - What percentage of time do you make money? A fact about trading is that you can have a win rate of 40% and still make money in the long run. The viability of a method is a combination of payoff and probability, of course, also considering how often you trade. A higher winning rate will sustainably boost your profits but this must be supported by a higher R per winning trade.
   
   
2. The relative size of profits compared to losses when traded at the smallest possible level. You want your losses to be 1R or less and your profits to be large multiples of R. This is essentially the key to long-term success – “cut your losses short and let your profits run.” 
   
   
3. Your cost of making an investment or trade. This will mainly be commissions and spreads charged by brokers.
   
   
4. How often do you get the opportunity to trade? If you can make an average profit of 2R per trade and 50 profitable trades per year, that's a gross return of 50R. But if you make 500 trades, you’ll be up 500R gross.
   The best way to put this is to consider two traders. One a day trader who has 200 trades in a year with an average R of 1.5 and a swing trader who has 52 trades with an average of 3R for the year. The swing trader makes 300R (200*1.5) while the swing trader has 156R (52*3). Assuming they both start with USD 10,000. If the two traders have fairly the same losing percentages, the day trader makes more money year on year. 
   
   This doesn't mean I prefer day trading to swing trading. The day trader has to be comfortable with making a lot of decisions, intraday volatility caused by news, a lot of emotions etc to come out on top. Don't just look at the numbers at the surface level, consider the wider implications of choosing either trading style and see what suits you.
   
   
5. Capital - What is the size of your trading capital? Being undercapitalized is one of the biggest hurdles you can face as a trader. When your account is too small, you can make decent returns percentage-wise terms, but they may be meaningless in dollar terms. An annual return of 20%  on a USD 1000 account translates to a USD 200 return, the same return on a USD 10,000 account is USD 2000 and on a USD 100,000 account, it is a profit of USD 20,000. 
   
   
6. Position sizing model. This should be low enough so that you can realize the long-term expectancy of your system over many trades. Position sizing is like 80% of risk and money management. It tells you how much of your capital you should risk on any trade. I personally advocate risking 1%-2% of your trading capital.

          Link to youtube video: The six elements to trading success