Profitable Trading: A Step-by-Step Guide

Sep 5th, 2022 • By Jad Malaeb

The Guide to Profitable Trading

Profitable trading

The road to becoming a consistently profitable trader is a bumpy one, and many fail to get to the finish line. If you’ve ever tried to trade for a living, you most likely would’ve come across the saying that “80-90% of traders fail.” What you probably didn’t know is that this claim is actually backed by studies.

But you’re a dreamer. You like that the odds are stacked against you, you’re willing to take on the challenge, and you’re hungry to prove people wrong.

As traders ourselves, this is the kind of passion that inspires us. We want you to continue to fuel this passion, but we also want to make sure you have a clear picture of the path ahead.

Here’s everything you need to know to get your trading right.

Profitable Trading: The Recipe

The recipe for a profitable trader is simple. It consists of only three ingredients.

1. An Edge

A concept crucial to profitable trading is the prevailing randomness of the market. The author of The Art and Science of Technical Analysis, Adam Grimes, talks about this immutable quality of the markets and how it affects traders in his book.

“Most of the time, prices fluctuate in a more or less random fashion,” Adam writes. “Though a trader may make some profitable trades in this type of environment purely due to random chance, it is simply not possible to profit in the long run; nothing the trader can do will have a positive effect on the bottom line as long as randomness dominates price changes.”

The cardinal sin of the aspiring trader is trying to predict what is purely random price action. You are in a hamster wheel here: you try, you push, you analyze, but it’s all worthless. Your wheel is just going to keep on spinning.

Instead, profitable traders look at small parcels of price action that have a high degree of predictability. These parcels are where a trader can develop an edge, which is a statistically non-random cash advantage over other market players. Once they find one or more of these rarities, profitable traders stick to them. This leads us to our next ingredient: discipline.

2. Discipline

Trading is a practice instigated by emotion. For most of us, the infatuation with the market begins not with the analysis of the charts but with what this analysis can bring. Financial independence, more time to ourselves and family, freedom over our work and our workplace are just some of the highlights that speak to the allure of a trading lifestyle. Traders are dreamers, and dreams attract emotions.

You are likely to have heard of the three emotional crusaders Greed, Hope, and Fear if you’ve interacted with the financial markets in any serious capacity. It’s from these that such trite statements as “there’s no room for emotion in the market” are born.

Emotions are notorious for hijacking Reason. Even after we have found our edge, and we know what path we must take to achieve profitability, our emotions constantly tug on the sleeves of Reason, forcing us to do things that simply do not make sense.

The bottom line is we are not as rational as we like to think we are, so we need a mechanism to keep us on track. This mechanism is discipline, and it’s a skill. Like any skill, it must be honed, tracked, measured, and perfected in order to efficiently serve its purpose.

This is your single most important attribute as a trader.

3. Risk Management

The last ingredient to a successful trader is proper risk management.

Profitable traders know how to identify setups that have high potential gains with low potential losses. They are experts at knowing when a setup is no longer working and managing their losses in a sustainable fashion.

These traders know that losses in this industry are inevitable and treat their trading like a business. All businesses have expenses. For corporations, these are employee wages, office rentals, office purchases, and the like. For traders, our expenses are our losses. Like any good business manager knows, losses need to be properly maintained, or the business will go under.

Good risk management protocol involves a detailed plan and some key considerations: Where do I cut my losses? How much am I willing to risk per trade? How many trades will I take per day? What’s the maximum loss I can accept on any given day?

Profitable traders have answers to each of these questions.

Becoming Profitable: How to Start Cooking

All this theoretical information is excellent if trading were a written exam, but it’s the furthest thing from that. What practical applications, then, can we glean from the Profitable Trading recipe?

1. Developing an Edge

There are two general roads a trader can take to find a trading edge. The first is through independent analysis.

Usually, the process of finding your own edge comes from additions to an already-known strategy. Suppose, for example, that you choose to trade reversals. Reversals are a well known method to trade the markets. Through some time in the simulator, you notice that when there’s multi-time-frame alignment and poor market conditions, a reversal off the highs yields promising and consistent results.

You’re not done there. Too many traders fall for the trap of thinking they’ve found an edge when they’ve not accumulated enough data. For an edge to be justified, it must stand the test of time.

You must spend significant time ensuring that the results you’re attaining are statistically unrandom. You can facilitate this process through backtesting, but there are barriers to this approach.

If you’ve the time, a great way to test for an edge is simply to practice. Make sure you’re controlling essential variables - position sizing, entry points, exit points, profit targets are all kept relatively stable - and monitor the results.

How does the supposed “edge” test after 100 trades? 150? 1,000?

The larger the data set, the more faith you can have that you’ve discovered an edge. It may be time-consuming but finding an edge can be life changing. For us traders, it is worth the wait.

Alternatively, if you don’t want to go through the (sometimes, life-draining) process of finding an edge on your own, what you can do is follow someone else’s proven plan. Amongst the wealth of trading “furus” out there, there are a few genuinely profitable traders who are willing to give back to the community by sharing their successful strategies.

This often comes at an expense, of course, but being able to learn from a consistently profitable trader comes with a variety of benefits including a shortened learning curve, a direct source for questions, shadowing opportunities, and general guidance.

The market is a highly competitive place, and, as a beginner, it will do you well to learn from a professional before taking the world by storm on your own.

Be highly cautious of these individuals, however, and make sure that they’re the real deal before committing to anything.

2. Sticking to that Edge

We’ve already mentioned the war between Reason and Emotion and how it affects our success as traders. Thankfully, some traders and educators have written and researched a variety of methods to help us sharpen our discipline. We will briefly discuss some of these techniques.

It may seem like a no-brainer that you have to know your plan extremely well before you can work on your discipline, but it is worth repeating this because many trading plans are not specific enough and many traders have superficial knowledge of their plan.

You must have a clear-cut plan. Plan specificities usually include: what security to select, what setup to look for, what signs designate an entry, what your risk is, what your profit target is, when you’re going to cut your loss, and what market conditions are present. This page shows a simple construction of a trading plan.

Once you’re sure you have your plan nailed down, create a journal. A journal can be customized in many ways, but it typically includes the security you traded, the result of the trade, notes on what you did, whether you stuck to your plan or not, and any other important considerations. This is vital to improving your discipline as it physically shows you where you’re going wrong (and right) and allows you to aggregate metrics that quantify your psychological progress.

The more you practice your plan, the more you will experience the tug of war between Reason and Emotion. Learning to identify when your Reason is losing the battle is a key component of risk management as a trader. Professional traders and seasoned meditators will call this ability mindfulness, and it’s an excellent tool to have in your arsenal as a trader.

Meditation is a great way to start building this mindfulness. Author of Trade Mindfully, Gary Dayton, heavily advocates meditation to improve trading performance and his book outlines several techniques to identify and respond to emotions as they come up in your trading.

This leads us to the final component: reading. You want tools on how to stick to your edge, read about the professional traders and psychological trainers who have spent years helping others hone this very skill. The already-mentioned Trade Mindfully and Mark Douglas’s Trading in the Zone are excellent contenders in this space.

3. Practicing Risk Management

You may have heard Warren Buffet’s famous quote: “Rule number one: never lose money. Rule number two: never forget rule number one.”

This perfectly describes the importance of a fundamental concept of trading and investing: protect your capital. Before anything, to survive in the markets you must learn to protect your assets.

While the Buffet quote is a favorite, it’s a little misleading. Losses in trading are inevitable. It’s not a question of “if” you lose money but “when” you lose money.

The relationship between your average profit, average loss, and your accuracy are the only metrics that will matter in your trading, and they’re expressed together in a single formula called the Average Profitability per Trade.

APPT = (Probability of Win x Average Gain) - (Probability of Loss x Average Loss)

For example, a trader with the following metrics:

  • Win probability: 0.5
  • Average winner: $100
  • Loss probability: 0.5
  • Average loser: $50

Has an APPT of $35, meaning on average, they make $35 per trade. Notice that the trader’s accuracy is only 50%, and they’re profitable.

While in reality profitable traders tend to have 60%+ accuracy, this shows you that theoretically, you can only be right half of the time and still make it as a trader.

This should not be your focus, however. The key takeaway here is that professional traders set consistent profit targets and losses on their edge to ensure that the edge produces a sustainable stream of positive results.

In other words, pro traders do the same thing every day. They set their profit targets, their position sizes, their stop losses before they enter trades, and they execute on them with iron discipline.

Practicing proper risk management has strong ties to the psychological component of trading. Sometimes, traders know what their profits and stops are, but they let their emotions take a hold of them, and they fail to execute on them.

This is why we define discipline as the single most important factor in trading.

What to Expect on Your Journey

It does not take an astronomical IQ or a rare talent to become a trader. The blueprint to a successful trader is composed of only three things: finding an edge, sticking to that edge, and properly managing risk.

But the journey to profitability is cumbersome. Gary Dalton explains that humans are poorly manufactured for trading - we are littered with cognitive biases and emotional impulses that make it very hard to achieve success in this field.

As a rule of thumb, we highly suggest you follow a professional when starting trading. In our experience, learning from a mentor helps shorten the learning curve by a large margin.

It also helps to find a niche. Trading is an intensely personal experience, and there are countless ways to trade. You have to find what works best for you and stick to it.

Finally, it always helps to have the right tools when you’re trading. Working alongside your brokers, Stock Alarm provides you with a direct reminder of any moves that you don’t want to miss and helps you mitigate your losses.

In all circumstances, we wish you the best of luck on your journey, whether we are a part of it or not.


DO NOT BASE ANY INVESTMENT DECISION UPON ANY MATERIALS FOUND ON THIS WEBSITE. We are not registered as a securities broker-dealer or an investment adviser either with the U.S. Securities and Exchange Commission (the “SEC”) or with any state securities regulatory authority. We are neither licensed nor qualified to provide investment advice.

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