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Looking from the outside in, many observers of the markets assume that successful traders have uncanny insight that is essentially like having a crystal ball.

No one can predict the market, but successful traders often do have an advantage, and it comes from focusing on three major things: identifying advantageous reward to risk outcomes, managing risk and most importantly, preparation. Let's look at all three factors:

Identifying Reward to Risk Outcomes

There are thousands of methodologies traders (successful and otherwise) employ to identify opportunities. There are fundamental rationales for initiating bullish or bearish momentum. There are also many technical approaches.

Whatever a trader's approach is, they must ask themselves, "are you being rewarded enough for the risk you take?" There is no hard and fast rule to what the proper reward to risk should be. That changes from trader to trader given his/her risk tolerances.

I am an options trader. Here, as an example, are a couple of my risk parameters. When entering a debit spread, I look for a minimum reward to risk of 2.33:1 and a maximum reward to risk of 3.25:1. If the reward to risk ratio is less than 2.33:1, I believe that I am not being compensated enough for the risk I am taking. If it is over 3.25:1, I believe that I can roll my strikes closer to at-the-money and become profitable sooner.

Risk Management

One of the most vital skills a successful trader uses from day to day is effective risk management. You must have price controls in place regardless if the trade works out for you or not. At what level do you stop yourself out? When do you take profits? Much like identifying your proper reward to risk, risk management levels will change from trader to trader.

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For example, in the case of an options debit spread, my rule of thumb to set a stop level when my invested premium decreases by 50 percent and I look to start taking profits when I achieve a positive return of 70 percent. There are always technical and/or fundamental factors that can make me become more aggressive in any given situation.

Before the Market Opens

Overnight/early morning analysis and preparation is important. This is especially true on Sunday evenings. Sunday evening gives you the opportunity to digest and analyze anything that comes out of the news cycle. More and more information is made public on a late Friday afternoon or in a Sunday morning tweet. The markets do not simply shut down on Friday afternoon and open Monday morning. It may mean missing part of the Super Bowl or some other leisure activity, but this is what traders do for a living and there are no shortcuts. I have a premarket checklist that I use every evening/morning and I think all traders should employ some sort of protocol as well.

No, successful traders do not have a crystal ball. We don't know what is going to happen. What we do know is how to identify not what is possible, but what are probable scenarios and prepare for those.

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