To Be a Successful Stock Trader, Define Your Objectives in These 8 Categories

The following is adapted form Automated Stock Trading Systems.

When I ask anyone who wants to invest what their objective is, the first answer they all give is, “I want to make as much money as possible with the lowest risk possible.”

That’s what everybody wants, and frankly, it’s a terrible answer. It’s vague and impossible to measure. Plus, everyone has a different idea of what constitutes risk.

Entering stock trading with an objective like that is like taking a road trip without a map. Your objectives are a GPS that will guide your strategy and decisions as a trader. The more specific and clear you are, the better.

In order to attain your personal vision of success as a trader, define your objectives in the following eight categories.

#1: Personal Objectives

Defining your personal objectives as a trader means answering questions around how you would define your perfect life as a trader, looking at your personal situation and asking what you really want.

What is your reason for trading? Is it for wealth accumulation? Monthly cash flow? Or do you have some other objective?

Many people have less obvious objectives that can actually be bad for their trading success. For example, they may want to be in a high-paced environment. They may live a boring life and want some excitement. They may crave the high of winning at a game.

These approaches can be very dangerous. Such traders will take position sizes that are too large, and if the market turns against them, it can wipe out their trading account. This is not a game: these are your finances, and your motivations for how you handle them need to be well understood and managed.

#2: Psychological Objectives

How do you want to feel during trading? The answer will be different for everybody, but it should be defined because you need to determine the mental state that guarantees you do not override your systems.

There can be no second-guessing, no hesitation or doubt about your positions, no fear, no insecurity—nor too much excitement, either. If you’re too excited, that means you’re making too much profit, which means you’re taking too much risk. When you’re risking too much, when the market turns down, that excitement turns into fear, which will cause you to make emotional decisions.

One of the beliefs of top traders is that trading should be kind of boring. If you approach it as boring, then you can execute your trading systems flawlessly because you are not emotionally attached to any trade.

#3: Risk Tolerance Objectives

What is the average drawdown you can handle easily in live trading? Without exception, every single trader I know overestimates this number. Experience has taught me that 99 percent of all traders should cut their acceptable drawdown estimate in half because otherwise, they’ll chicken out when they get close to those numbers.

Also think about the maximum drawdown you can handle in live trading without suspending the system. At times your system will be hit harder than normal, and that’s when you may be due for an upward move. But if the maximum drawdown is larger than expected, that’s also when most people suspend and throw in the towel. You need to be able to trade within these drawdowns without any second thoughts that could lead you to suspend trading the system.

Then there is the question of the duration of the drawdown. How long can you tolerate being underwater and not making money? After the 2000–2003 bear market it was seven years before the S&P 500 got back to where it had been and began making money. If you can’t handle a long drawdown duration, you need a system with a high trade frequency.

#4: Return and Profit Objectives

This is where everybody wants to start! They want to make 100 percent return per year, but they don’t understand that they are going to have to risk the bank to do so. Return and risk are always in line. If you want a high return, you must be able to handle a high risk.

I have people who say, “Okay, I get that. I want at least 30 or 40 percent return, but I can’t handle more than a 4 percent drop in my accounts.” I tell them they simply can’t achieve that in the long term. They might achieve it in an over-optimized backtest, but they’re going to exceed that drawdown in live trading and then chicken out.

The more you are willing and psychologically able to risk, the higher your returns can be if your system has a significant edge. But the risk has to be in line with what you are comfortable with. You have to understand that you need those drawdowns because you are risking money. If you’re not able to risk money, just go to cash and get zero percent.

#5: Style Objectives

There are basically two styles: trend following, and mean reversion or counter-trend. In the trend-following style, we follow trends, preferably of a long duration, sticking with it until the trend bends. The longer the trend duration, the better the profits.

The issue with trend following is you have to withstand some pretty large drawdowns, and it only makes money 30 or 40 percent of the time, when the markets are actually trending. Otherwise the markets are sideways. Most of the time the trend following systems don’t do that well until there is a trend, and then they make big money.

The mean reversion style is generally a short-duration trading style. You buy a stock that has been overbought or oversold with the expectation that it will revert to its statistical mean. You hold positions only for a few days, and the expected profit on each trade is quite small. That means you must have a high trade frequency to make big returns.

Someone who is impatient probably will prefer mean reversion, because there’s a higher win rate and more action. Other people prefer the quiet approach of trend following.

The best of both worlds is when you combine both styles, exponentially increasing your compound annual growth rate while reducing your drawdowns.

#6: Directional Objectives

We can trade both long and short. Long trading is speculating on an upward moving market, short trading on a down market. Based on backtest data samples, the market clearly has a long bias; that is, it has risen 8 percent per year, on average, over the last twenty-four years.

If you are trading inside an IRA account, your directional objectives are limited by regulations that don’t allow short-selling of stocks in those accounts. I also know traders who don’t like to short because they feel it is unpatriotic to bet on a company’s stock moving down. That doesn’t bother me, but if that’s a value you have, that’s fine.

More broadly, some people are uncomfortable with shorting because the risk of loss is theoretically unlimited. Here’s what I mean:

Let’s say you enter a long trade of 1,000 shares in a stock at $10, and the next day the stock opens at zero. You have lost your entire investment of $10,000.

Now let’s say that instead of buying long, you shorted 1,000 shares of that stock at $10. You are betting the stock will drop from $10 to $8, and you’ll make the difference—$2,000. Instead, it opens tomorrow at $30. You have to cover your position. You’re not out $2,000; you’re out $20,000. This level of risk is unacceptable to many people.

#7: Timeframe Objectives

How do you feel about overnight market exposure? If you are worried about your positions after the close of the market or during the weekend, then overnight trading might not be for you. You may prefer day trading, where you close out all your positions at the end of every day to avoid overnight risk.

Do you want to grab fast profits? Or do you say, “I like long-term positions because I think there’s too much noise in the markets—I think I need to give the market room to move and be more patient”?

As with the style and directional objectives, if you are comfortable combining short and long time frames, you will improve your results.

#8: Operational Objectives
How do you want to trade? Specifically, when do you want to enter your trades?

Do you only enter them once, before the market opens, and then don’t look at them after that? Do you want to watch them carefully and be glued to the screen the whole day?

Do you want to enter them manually or use an automated platform?

There are many options that will influence your day-to-day operations and thus the trading systems you design.

Build Your Ideal Trading System

Everyone has a different picture of what “success” looks like in trading. By defining your objectives, you can understand what your personal picture of success looks like and build the trading system that will get you there.

You won’t “make as much money as possible with the lowest risk possible,” but you’ll get something better: your ideal life as a trader.

For more advice on creating a trading strategy that works for you, you can find Automated Stock Trading Systems on Amazon.

Laurens Bensdorp is an expert at combining multiple non-correlating trading strategies to achieve a high risk-adjusted return regardless of what the market does. He shares that knowledge with a group of brilliant and dedicated students in the exclusive Elite Mentoring Program that’s part of his Trading Mastery School, of which he is the founder and CEO. What Laurens has found is that teaching has helped him exponentially grow his skills as a trader. Author of the bestselling book The 30-Minute Stock Trader, Laurens has lived in eleven different countries and travels the world as he pleases. He currently resides in Spain with his beloved wife and children.