New trader’s guide to a profitable trading system

Lakhs of demat accounts are opened every month in India which clearly shows that there are many new people entering into the Stock Market. Majority of the new retail traders entering the stock market love stock trading over investments. Stock trading is looked upon as a get rich quick scheme by many beginners who think that it is easier to make money doing trading rather than investing. However, nothing can be further from the truth. Stock trading is one of the most difficult jobs on the planet and that’s why only a few percentage of the traders consistently make money in the stock market. If you want to join the elite league of profitable trader then this is a step by step guide for you!

Trading actually looks very simple. You buy low and sell high to make money in a long position. And you sell high and buy low to make money in a short position. This is not the complicated part – everyone knows how buying and selling works. What differentiates an amateur trader from a professional trader is a trading system. Think of a trading system like a rulebook which is based on mathematics and is designed to ensure consistent profitability. If this sound a little confusing, here is a breakdown of the rulebook –

  • Decide stop-loss and target before entering a trade

This is crucial for any aspiring trader. You do not define a stop-loss and target after entering a trade. You need to know exactly where to get out whether in profit or loss even before you have taken a long/short position in the stock. Suppose you want to buy a stock at Rs. 100, then your target of say Rs. 120 and stop-loss of say Rs. 95 should be pre-decided. A good strategy is to keep a note of the stop-loss and the target to make sure that you stick to it! Another way is to place the sell order (with target and stop-loss) as soon as you enter the trade.


  • Winning trades should make more than twice the amount of money which you lose in a losing trade

Now that we are clear on the fact that stop-loss and target are decided before hand, this is the next step. Only enter a trade when winning gives you more than twice as compared to losing. E.g. if there is stock which is trading currently at Rs. 100. Your target and stop-loss are say Rs. 120 and Rs. 90 respectively. Then it is a good trade because if your trade is successful you make Rs. 20 and if your trade is unsuccessful you only lose Rs. 10. You should not buy a stock for Rs. 100 for a target of Rs. 140 when your stop-loss is Rs. 60. Risking your capital for a 1:1 win-lose ratio is not a favourable trade. Always ensure that you make at least twice as much money in winning trades than you lose in a losing trade.


  • Always respect stop-loss

The entire system is based on having a favourable trade as explained in the previous step. Make sure that you are following stop-loss rigorously. Most traders get cold feet when their stock price approaches stop-loss and they try to change their stop-loss because they are scared of losing money. This is a crime in the world of trading. It is okay to take a loss in stock trading but it is an offence to lose more money than your stop-loss. Most traders think of stop-loss as their enemy however it is one of their best friends. Please make sure that you get out of the trade at stop-loss and limit your loss.


  • Stop-loss and targets will be decided based on Stock chart

Professional traders trade only by analyzing stock charts. Many new traders buy stocks just because they feel like it or they heard a good news about the company. Trading based on news is one of the easiest way to lose your capital in the stock market. To learn more, read Should you trade based on news or chart? Stop-loss and target are to be decided ONLY based on stock charts. Make it a habit to only follow stock charts to avoid any impulse buying. This will require a lot of practice and a good control over your emotions.


  • Use similar capital for every trade

Suppose you have a total of Rs. 5 Lakhs to trade. Divide your total capital into 25 equal portions when trading. This means that you should not risk more than Rs. 20,000 for any single trade. Always use multiple trades at a time. Do NOT put all your money in a single trade. This is very important for the system to work. It doesn’t matter if you follow every other rule. If you take a very big trading position in market, you will sooner or later lose all your capital! Never use more than 1/25th of your capital on a single trade.


Now that we have our system ready let’s check out how the system actually works. Suppose you took 7 trades following exactly the above mentioned rule book. Here is an example outcome –

If you notice the final outcome of the 7 trades, you ended up making Rs. 1500 (Rs. 1,41,500 – Rs. 1,40,000) even though you had more losing trades than winning trades! The reason is simply because every trade you take should have 2:1 or higher reward : risk ratio (as mentioned in the rulebook). This means that every trade risks less amount of money in order to make more amount of money.

This is only one of the outcome which can occur after 7 trades. But what if all my trades become losing trades due to bad luck. There is still no need to worry. In such a case, you are still protected because you followed the last rule. Never risk more than 1/25th of your capital in any trade, no matter how confident you are on that trade.

This is exactly why all the rules need to be strictly followed. Trading is not about making money in every trade. Instead it is about losing less money in a bad trade and making more money in a winning trade so that you are making a consistent profit when you add things up.

This one quote summarizes all we’ve learnt about trading perfectly –

It is okay to lose some battles to win the war!


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DISCLAIMER : I am not a financial advisor. I am not for or against any stocks mentioned in this post. Please consult your financial advisor before investing.

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Namit Pandey

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