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When Not to Trade is Just as Important as When to Trade


An element of randomness in the market allows for uneducated traders to make money. Based on pure luck alone someone could win three, four, five or more trades in a row, with absolutely no idea what they are doing. An experienced trader could also experience such a run, or a string of losses. 

If we can make money based on randomness, and also lose it based on randomness, what separates the consistently profitable trader from the consistently unprofitable one? Successful traders have an "edge;" they trade with strategies that have been tested to win a bit more often they lose--like the casino (the house though, not the player). This is how they make money, but even more important is how they keep it. As discussed, randomness can produce wins, but it can't prevent you from losing. Therefore, randomness won't make you consistently profitable.

A strategy provides an edge, but it also defines when trades are taken. When conditions aren't favorable the successful trader doesn't trade. The "random trader" can't distinguish between favorable and unfavorable times to trade, because their trades aren't based on rules/guidelines. Under the randomness model trading becomes "easy come, easy go." The successful trader is more readily able to hang on to what they win, because they only trade when their edge is present.

Using the casino analogy, the successful trader is like the house. The house only plays cards on its' own terms, because over many hands, based on those terms, the house knows it will win more than it loses. It is tested and proven. While any single hand could lose or win, over many hands the casino has an edge based on the rules it plays the game by. Successful traders do the same thing. They only trade on their own terms--when the market provides an opportunity with an edge. On any single trade the successful trader could win or lose, but by only taking trades that have a tested and verified edge, over many trades the trader is likely to be profitable.

When uncertain, sit on your hands. This preserves capital for when the good opportunities come along. As Warren Buffett said "You don’t have to swing at everything—you can wait for your pitch." And the wisdom of Jesse Livermore: "It never was my thinking that made big money for me. It was always my sitting. Got that? My sitting tight!" Words to live by if you're a trader and want to grow your capital, instead of just gyrating it up and down.

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