Achieving a successful trading mindset is paramount for any sophisticated financial trader. To navigate the complexities of trading, one must set clear expectations, practice patience, define performance targets realistically, and emphasize risk management. Watch our video below for a discussion of how these elements come together to form a resilient trading psychology:
The Cornerstone: Setting Expectations
Setting realistic expectations is crucial. When starting with pair trading, we suggest you aim to break even after the first three months. Even if there’s no immediate profit, the experience gained is invaluable. Expect losses—they are part of the learning curve and should not come as a surprise. By reducing the pressure to perform, having a break-even initial period means new traders can focus on honing their skills rather than chasing unrealistic gains.
A Successful Trading Mindset is Like Being a Good Fisherman
Patience is the most important trait for any trader. Avoid the temptation to rush trades or chase after them impulsively. Let the trades come to you. After a loss, resist the urge to engage in revenge trading, which is often fueled by the need to be right rather than to trade well. Remember, successful trading is about capitalizing on market mispricings, not predicting them perfectly.
Should I Set Weekly or Monthly Profit Targets?
We tend to believe that setting weekly or monthly profit goals can be counterproductive because the market operates on its own terms. Instead, focus on ensuring your pair portfolio is expertly selected at all times, that your execution record is as clean as possible, and then target long-term performance. Track your trading statistics diligently but aim to outperform the market on a yearly basis. Given the market’s unpredictability, a 20% annual return is an excellent target, as even top hedge fund managers struggle to achieve this consistently.
Realistic Yearly Performance Expectations
For traders managing smaller accounts, achieving significant percentage returns is more feasible compared to large hedge funds. Striving for a 20% annual return is a realistic goal that places you among the top performers in the industry. However, maintaining such returns requires a disciplined approach and acceptance of the inherent volatility in trading. Because a small retail trader (say under $1 million account size) can easily enter and exit positions in companies without heavily daily trading volume, the opportunity set is greater but volatility can be higher. Your annual return expectations need to be balanced with your risk undertaken. What position-size will I use? How will I adjust to high-volatility pairs? Based on these factors, how large is my likely maximum drawdown over the year? My Risk of Ruin?
Importance of Risk Management
A well-defined risk management plan is essential to limit future maximum drawdown. Aim to keep drawdowns below 20% to preserve your capital and maintain trading confidence. Drawdowns exceeding 30% can significantly impact your ability to stick to a trading plan, underscoring the importance of stringent risk controls. Can you achieve a greater than 20% annual return with less than a 20% Max DD? We think so, and much better too. If you want to focus on our risk management techniques, watch our video here.
Crucial Importance: The Nature of a Stock Pair Trade
Pair trading involves buying oversold stocks and shorting overbought ones. Most pair trades initially move against you, providing an opportunity to scale into positions strategically. Expect to carry open losses, but stay alert for quick reversions to the mean, which can offer favorable exit points. This approach allows for breaking up trades into smaller chunks, mitigating the impact on the market.
Conclusions
Cultivating a successful trading mindset involves:
1. Setting realistic expectations
2. Practicing patience
3. Focusing on expert pair selection and high-quality trade execution
4. Targeting long-term performance
5. Emphasizing risk management
By embracing these principles, traders can navigate the challenges of the market with confidence and resilience. Why not join our free webinar PairTrading 101 today? Learn how this hedge fund strategy, our system, and our acclaimed pair trading software can give you the successful trading mindset you need.
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