Winners and Losers Differ in Many Ways - TheStreet

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There are a lot of reasons why traders trade, but the only legitimate one is to earn a profit. After all, that's why you got hooked on the markets in the first place. So let's do a reality check: Are you making money this year? If so, is it enough to pay the bills or at least earn bragging rights with your family and friends?

There are many differences between profitable and unprofitable traders. It makes sense for losers to study the habits, mindset and strategies that winners take into the market each day. This gives them a chance to mimic the winners and internalize the characteristics needed to improve performance.

Consider the three stages on the path to trading profitability. First, you need to find good setups. Second, you must know when to enter and exit positions. Finally, you need to build your equity through a maze of opportunities and errors.

Many traders can master the first two tasks, but fail miserably on the last one. Curiously, the equity maze requires little explanation, although volumes have been written about the subject. Simply stated, you need the discipline to follow your chosen methodology, plan or system.

Losing traders fall into many traps, but three common behaviors stand out:

    They execute trades they don't understand or rely on a system they haven't mastered.

    They don't correct their errors because their actions are based on someone else's knowledge rather than their own.

    They remember the trades that worked but forget all the disasters.

    Profitability is a question of nurture vs. nature to some extent. Some folks are born traders, while the rest of us can spend lifetimes compensating for our genetic shortcomings. But key trading characteristics such as risk-taking can be learned by anyone with a genuine interest in self-discipline.

    Losing traders believe that profitability is just around the corner when it's often nowhere near being reached. This is a common illusion because the market gives losers just enough positive reinforcement to keep their hopes alive. But they lack the discipline required to learn from their experiences.

    Winning traders recognize the weak points in their strategies and take action to minimize the impact of those weaknesses. They are risk-conscious at all times, exercising damage control when required. They study their trading actions constantly, looking for better ways to accomplish their long-term goals.

    Trader, Know Thyself

    How does losing money begin its vicious cycle? For starters, bad things happen when your system doesn't match your personality. Sit down and list the weaknesses of your approach. Then decide if the strategy works with your lifestyle and emotional makeup. For example, you could be a scalper with the mindset of an investor, or a daytrader who hates risk.

    Losing traders don't follow the simple rules needed to be profitable. And it's telling that the same folks who ignore the reasons they lose money spend thousands of dollars attending seminars. Guess what? Personal discipline is the one thing you can't learn sitting in an audience.

    Discipline and money management go a long way toward becoming profitable. But you must be confident that your market approach can make money. Start with an examination of the expected profit on each position, vs. the underlying risk.

    Losing traders may not understand their strategy well enough to determine whether it can make money over time. So let's consider a few aspects of this important equation:

    • System traders use backtesting to gauge the profitability of their strategies. Retail traders choose to play the markets without this rear-mirror methodology, so they need to compensate with extensive record-keeping and thorough analysis of each position.
    • The sell side of the profit equation is more important than the buy side. Research suggests a profitable trading system can be built using random entry. But it won't help if you don't act when it's time to take your money off the table.
    • Profitability requires a robust trade management approach. Focus your attention on money-management issues, such as cutting losses, riding winners and mastering the reward-to-risk equation.
    • Income strategies must focus on hundreds of trades, rather than individual winners or losers. Traders abandon wealth-building practices because they hate individual drawdowns. Or they ignore good rules because they don't feel instant gratification.

    Losing traders get stuck in a vicious cycle. They want to profit so they come up with a strategy to make money. They trade the strategy until it fails, abandon it and go looking for another strategy. In the process, they don't realize a trip to the mirror will identify the real source of their continued failure.

    Which brings us back to the importance of discipline. At its core, a disciplined approach is the only proven method to break the loser's cycle and get on the road to profitability. But losing traders ignore this truth because, at an unconscious level, they never wanted to make money in the first place.

    Alan Farley is a professional trader and author of

    The Master Swing Trader

    . Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. At the time of publication, Farley did not have any positions in any of the stocks mentioned in this article, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback and invites you to send it to

    Alan.Farley@TheStreet.com.

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