Last Updated on 17 November, 2020 by Samuelsson
Trading seems to share a lot of terminology with gambling. Successful traders love to brag about their ‘winnings’ while those on a streak of bad trades are often saddened by their ‘losses’. When this is coupled with the fact that the layman has very little knowledge about how trading works, people start to wonder if trading is all about luck.
No, trading is not about luck. Although it is possible to ‘luck out’ on a trade, good traders find ways to eliminate luck from their trades, and use trading strategies that have the odds in their favor. In the end, the only thing trading has in common with gambling is the fact that both of them present opportunities to make and lose vast amounts of money.
So why is trading not all about luck?
Why Luck Has (Nearly) Nothing to do with Trading
Traders trade with the probabilities on their side and know that they might lose the coming trade, but that the long term probabilities are in their favor. This means that on each individual trade, there is a certain amount of luck involved.
However, once you have made a fair number of trades, the luck element starts to wither. The longer time you trade and the more diversified you are, the less an impact luck will have on you. On top of that, there are numerous ways through which you can further reduce ‘chance’ from your trades. We go through some of them later on!
The Fallacy of the Beginner’s Luck
Many people make money during their first days, weeks, or even months in trading. However, a proportional number of people also start to regularly lose money after that. This has led people to believe that there is a
‘Beginner’s Luck’ in trading. This is a term that has been imported from gambling, and it further muddies the art of trading in the eyes of the layperson.
Each and every trading market experiences certain periods of upswings (bull) and downswings (bear). What has actually happened is that the new trader entered the market during a bull run. Because of this, the vast majority of securities in that market were increasing in price and most traders would have come out ahead during that period.
Once the bull market ends, that is when a trader’s real test of skill begins. This is when it is actually difficult to make money in the market. As such, beginner traders seem to fall off at this point and feel like the forces of luck are against them. To add insult to injury, many beginner traders have gotten cocky by this point as they believe that they know how to trade and thus make risky trades. However, they usually endure heavy losses subsequently and realize that trading is not a game.
Great traders distinguish themselves from the average ones by being able to capitalize on both bull and bear markets. The bear market also presents many opportunities to make money, both by going long and short.
As such, it is advisable for beginner traders to be careful during the first year of trading, paying attention to the overall climate of the market, and not to get too confident.
How to Eliminate Luck from Your Trades
Here are some steps that you can take to make sure to minimize the role of luck in your trading.
Create Your Trading Strategy
The good thing about trading is that there is no one correct way. In fact, there are multiple correct ways to trade. If you were to ask 10 experienced traders about their winning strategy, there is a chance that every single one of them trades differently from one another.
Having a strategy means that there are certain rules that you need to follow. This automatically means that luck will not play a huge part in your trades since all of your decisions will be based on a set number of factors.
Different strategies cater to different temperaments, and it is important to note that a strategy that suits one person might not suit another. As such, it is good to test multiple strategies on a virtual portfolio before selecting one that fits you well.
Remember that in order to gauge the effectiveness of a particular strategy, you need to make sure you follow it to the letter. Straying away from the limitations that you have placed on yourself will only add more luck to your trades and will be detrimental in the long-term.
However, before going live with a strategy, you should make sure that you have tested it thoroughly and that it has passed your robustness criteria.
In this article, we show you our process of creating a trading strategy!
Backtest Your Strategies
Experienced traders employ multiple different strategies. For example, they might use one strategy for the stock market and another one for the forex exchange. They might also be using different strategies for bull and bear markets so as to capitalize on the differing nature of the two.
Everyone will eventually need to use multiple different strategies if they want to maximize their profits. A great way to test a strategy before using it is through backtesting.
Backtesting is the idea that if a strategy has worked well in the past, it will work well in the future too. In order to backtest, you need to employ a strategy on historical data and see if the results were satisfactory.
You can backtest on your own or use software to decrease the complexity of the process. Amibroker and Tradestation are some of the most widely used backtesting software with a lot of robust features. However, it is quite expensive and the cost may not be justifiable for many new traders. Such traders can make use of TradingView or backtest their strategies using Microsoft Excel.
Still, we really recommend getting a solid trading platform. It really pays off in the long run!
Diversifying across different markets is a great way to decrease the impact that luck has on your trades. For example, suppose you open a position in a US stock. Despite the fact that your trade was sound and you would have made money under normal circumstances, it is possible that the trade does not work in your favor. It could be due to any number of reasons (e.g. tensions with China flare up again, and the company you invested in has production lines in China), but you can combat this through diversification.
The best way to combat luck in the aforementioned scenario would be by also investing in stocks of other parts of the world, like the European stocks. The European Union has trade deals for the whole block and might not suffer as much from US/China-related news. You could also diversify by investing in gold or oil instead of stocks. However, it is important to remember that you should only diversify into markets that you have knowledge of. Diversification just for the sake of diversification is bound to lead to a loss of capital.
Even if there is a little bit of luck in trading, it has a way of evening itself out. Over the course of a few years, luck is bound to have a negligible impact on the value of your portfolio. Remember that even if it seems like you are having a streak of bad or good luck, it will eventually end and things will return to normal.
Detach Yourself from Your Trades
In order to be a successful trader, you need to try to remain completely emotionless. Remember that there will be both good and bad times. If you have lost money in a trading session, do not try to make it back in one last trade before the session ends.
Remember that single trades are largely irrelevant. What you need to do is to consistently turn a profit. To do that, you must make sure that your psyche does not get the better of you. Make sure you use logic over instinct every single time and never act on impulse.
It is possible to make the case that there is a little bit of luck involved in trading. However, the good news is that you can easily eliminate much of it by following the aforementioned steps.
It is understandable why a layperson may think that trading is like gambling. However, trading is an art that requires hard work, dedication, a lot of study, and a mind with ‘nerves of steel’. Trading and gambling are two different activities and they should be treated with a different mindset.