Last Updated on 20 April, 2023 by Samuelsson
When new traders enter the market they often wonder if trading can be profitable. With so many rumors circulating the web it’s hard to not get confused by all the conflicting standpoints.
Trading is profitable if you have a profitable trading strategy and stick to it. However, being a profitable trader by trading discretionarily is hard, and is becoming even harder as markets become more efficient. To stand a chance you need to use a systematic approach, to find the real edge in the market.
In this article, we’ll cover the key element of profitable trading. We’ll also cover some tips on how to avoid scammers and snake oil salesmen, who might be hard to distinguish from the real deal for somebody who is just starting out.
The Most Important Ingredient for Profitable Trading
If we were to distinguish the most important aspect of profitable trading, it would, without any doubt, be the edge. Without it, making any money in the market is impossible.
An edge is a recurrent pattern in the market that tends to precede a specific market movement. For example, if the market over time has a tendency to go up if the RSI indicator crosses below 20, then that would be an edge.
If the strategy or approach you use doesn’t have an edge, then you will be destined for losses, at least in the long run.
Now, this might sound quite obvious. What we are saying is that a strategy needs to produce money to be profitable, right?
To some extent that’s right, but it’s not really that simple.
To understand what we mean, there are a couple of things that we need to cover first!
1. Markets Aren’t Rational
One of the erroneous assumptions new traders make, is that the markets are rational and logical by their nature. They assume that something works since the idea behind seems sound and logical.
Now, that’s not the case. The markets are representations of human behavior. It’s humans who make up to the market, which means that our shortcomings and irrationality are carried over into the markets. In short, most market action is driven by fear and greed, which also translates into a fickle market.
Knowing this, it would be foolish to assume that a market would behave in a certain way because we expect it to. Many concepts in technical analysis build on this type of reasoning, which also is one of the main reasons why most technical analysis that’s taught doesn’t work.
Another important thing to recognize is that edges are market inefficiencies, which exist because most people don’t notice them. If an edge gets public, and enough people decide to make use of it, that will results in it getting much weaker or even disappearing.
This is another reason why what you read and hear online doesn’t work. When people get to know about it, they pour in money into trading those edges, which makes them disappear. This is why we ourselves are very careful not to reveal our strategies to the public (for others than our students). It’s certainly not only a matter of wanting to keep it for ourselves!
In this article, the issue of technical analysis that doesn’t work is discussed in further detail!
2. Most Market Action Is Random
Of all the patterns you spot and observations you make in the market, most hold no value whatsoever. They are the result of randomness, and can’t be used to trade profitably. Or in other words, they hold no edge, even if that’s how it appears.
This issue, where we mistake randomness in the market for a real edge, is called curve fitting. One of the biggest obstacles traders face is to separate the real edges from the random market noise.
If you want to read more about this, here is a small selection of articles that cover this particular issue in greater detail, together with some solutions:
Our article on algorithmic trading.
Our article on building a trading strategy
Our article on backtesting.
3. You Need to have a lot of Data
Many new traders mistake the randomness of the market as a sign of their proficiency. The truth is that it’s very easy to start trading something that, out of random luck, performs well for a short period of time.
Coupled with way too aggressive risk-taking, this ensures that some people manage to perform incredibly well for short time periods.
However, when looking at long periods of time, those traders will most likely end up with losses, since they have no edge.
To make it easier to understand, trading without an edge could be said to be like playing the lottery. Most people lose money, but some very few will be lucky and make a lot.
In short, having something that’s profitable in the sense that you’ve seen it make money for a short period of time, isn’t enough for it to be profitable going forward. Assuming that a rational idea about how the market should work is enough to have a profitable trading strategy, is not correct. Believing that a short observation of profitable behavior isn’t correct either. The randomness in the market is way too strong.
Related reading: Is Trading All About Luck?
When people say that trading isn’t profitable, it’s because they haven’t figured out that this is what’s holding them back!
However, it is possible to find an edge in the market, if you use the right methods. Our article on building a profitable trading strategy and algorithmic trading cover this in more depth.
Watch Out for Trading Scams!
In your search for profitable trading strategies, you’ll stumble upon a lot of snake oil salesmen that promise they can teach you how to become profitable. Youtube is completely littered with fake trading vendors who have massive amounts of followers that fill the comment sections with their praising comments.
Often they promise that you’ll become rich quickly with the one strategy they’ve found. They’re giving you the holy grail.
And holy grails are as scarce as easy money.
In other words, they don’t exist!
You can have a very good trading strategy, but you will never know how it’s going to perform in the future. It may fail, deteriorate, or just continue on as it has historically. You can never know with 100% certainty.
If you see somebody who tells you either of these things, then shy away immediately!
- Making a lot of money trading is easy and everybody can do it with little work.
- They offer you a pattern or strategy they’ve discovered that will revolutionize your trading.
Trading isn’t easy. If it was, everybody would be doing it!
Telling people that trading is easy is how so-called “trading gurus” attract herds of people to sign up for their programs, which often sell for thousands of dollars.
The ONLY people who succeed in trading long term, are those who are ready to put in the hard work that’s needed!
The Penny Stocks Trading Scam
Many fake trading vendors turn to penny stocks, and there is one very specific reason for that.
Penny stocks are easy to manipulate.
Penny stocks often trade with very low volume, which makes them the perfect security for somebody who wants to deceive people into believing in their methods. The scams we’re going describe are often referred to as pump-and-dump scams. This is how they work:
- The “trading guru” picks a stock with low volume, and tells his or her followers which stock it is.
- A considerable amount of followers enter the stock. Due to its thin volume, it causes the stock to appreciate.
- Once the stock has gone up, the “trading guru” tells the followers that he’s out of the trade. This immediately creates heavy selling pressure, and the stock drops.
The only person who makes money from these kinds of operations, is the trading guru who entered and exited the trade before everybody else. In fact, he’s directly profiting from the losses of the followers, without most of them noticing.
This is a very clever and subtle trick that’s easy to fall for if you’re new to the financial markets!
What You Should Focus On to Become Profitable
Most traders want to learn specific trading strategies to start trading immediately. However, becoming a profitable trader isn’t about having one or two strategies and relying on them for the rest of your trading career.
Trading strategies are tools that you use to profit in the market. And just like a shovel will get teared and need a replacement, you’ll need to build new trading strategies as your old strategies tear down.
For example, in our algorithmic trading course, we give our students a bunch of strategies, so that they can start to trade immediately.
However, what the course is focused around, is learning to build strategies. That’s the only thing that counts in the long run, if you want to succeed!
Trading is profitable if it’s carried out in the right way.
However, profitable trading is much harder than most people want to realize. As such, they tend to fall for snake oil salesmen that sell a dream, rather than something that works.