How to trade well? Trading secrets that experts don't disclose.

In the marketplace, among the winners, technology takes a back seat. Their domination of trading primarily revolves around money management, risk control, and trading strategies. The reason they are able to make money is precisely because the losers either do not implement or do not rigorously or comprehensively carry out money management, risk control, and trading strategies.

In a standoff between two armies, if technical analysis were weapons, both sides would be evenly matched; but if one side believes in the bravery of the strong and recklessly charges into gunfire, they are bound to lose. Their loss doesn't stem from inferior weaponry but from a lack of understanding of defense and protection, ignorance of combat strategies, and misuse of troop deployment. In our trading, this translates to risk control, trading strategies, and money management.

If everyone strictly, scientifically, reasonably, and comprehensively implements and adheres to money management, risk control, and trading strategies, then technical analysis can play a decisive role in influencing wins and losses.

It is this realization that winners focus their efforts on money management, risk control, and trading strategies without fussing over technical analysis. Their demands on technical analysis are basic because this suffices for them to continue being winners for 10 years, 20 years, continuously. Their broad vision and profound insights are something that traders who focus solely on technical analysis cannot match or counter. Meanwhile, unsuccessful traders will not understand the forces influencing trading, burying themselves in technical analysis books without escape.

The reason why losers are not inferior to winners in technical analysis also lies in the inherent limitations of technical analysis itself, such as Dow Theory in trend prediction, which can only confirm a trend after roughly 30% of the movement, causing missed opportunities for bottom picking and top escaping.

Ultimately, technical analysis is a matter of probability; even with excellent skills, the probability of winning is only slightly better, around 50%-60%. If the technique is poorer, the probability of winning might be around 40%-50%, nearly the same.

For instance, after a trend peaks and goes through about 30% of its movement, it should be uncontroversial to say it's near the top. With a generally uniform view on the overall trend, disagreements are negligible and don’t significantly influence the outcome of wins and losses.

But if you go all-in or heavily invest at this point, here comes the problem: Our traders can see the big direction correctly, but heavily investing gets them shaken out by minor, not very large adjustments, leading to losses. A slight daze can result in missing the trend, which is quite regrettable. A light, single position isn't frightening because the loss is minimal; following the market trends here and there, you won't be shaken out or chased away, and by continuing with the trend in this manner, and dynamically managing your positions, increasing or decreasing them as appropriate, you end up making substantial profits.

In reality, the difference in technical proficiency between parties is at most about 10%. Those with high self-esteem and heavily investing without implementing money management; those with lower proficiency, out of a sense of inferiority, try lightly and manage their funds well.

Eventually, you see, the ones who get shaken out and lose big are always those with high proficiency but heavily investing; while those with slightly lesser skills continue to follow the trend, earning modest profits.

But they have widened the financial gap with the heavy investors. After several cycles, one or two years down the road, the difference between them is like night and day. So, how do we effectively manage funds?

The trading system is the prerequisite for money management

To understand what money management is, one viewpoint must be emphasized first: market fluctuations are unpredictable.

Here I guess some might jump up to argue with me: Without predicting rises and falls, how can we buy and sell? On this, I withhold my opinions without explanations, turning from predicting to not predicting is a hurdle that requires gradual enlightenment. Once it is understood, it becomes clear. Prior to this enlightenment, no amount of face-to-face explanation will yield results.

If you can't grasp the concept that market movements are unpredictable, but are willing to accept unpredictability, then you need to give yourself some time to think. One day, it will make sense.

Why emphasize the absence of prediction? Because only by understanding not to predict can you truly comprehend and grasp trading rules, and only after understanding trading rules can you effectively construct your own trading system.

A mature trading system should include money management, which should not exist independently of the trading system. Remember, it should not, but not that it cannot. I believe that to accurately grasp the system of trading rules, the concept of money management must first learn not to predict!

Starting with risk control to achieve money management

For ease of understanding, let me explain using the moving average trading system previously discussed. Golden cross signals buying, death cross signals selling short.

Suppose, the accuracy of the moving average trading system is 30%, with an average profit-loss ratio of 7:3. Then, disregarding transaction fees and costs, this trading system wouldn't be profitable.

To understand, let's say, over a hundred trades, 30 make money and 70 lose, with profitable trades averaging seventy thousand gains and losing trades averaging thirty thousand losses, of course, it ends up being a wash.

Realistically, a trading system based purely on indicators and trading rules, in most cases, can only break even. Assuming backtesting over a long historical period reveals the system's maximum loss reached 80%, then this system is not only unprofitable but also highly risky, with an 80% maximum drawdown being extremely terrifying.

How to understand this? If you have a million in capital and the maximum loss reduces it to only two hundred thousand, even if the final outcome is a return to a million, the risk during the process is enormous, nearly out of control. Facing a catastrophic black swan event, a blowout could occur at any moment.

For a high-risk, not very profitable system, is it completely unusable? The answer is definitely not. First, we consider the risk. If the system's maximum drawdown is 80%, can this risk be somewhat reduced? Of course, it can. If the position size is halved, the overall risk factor also halves, and the maximum drawdown becomes 40%.

Then, what if we reduce the position size to 25%? Wouldn't the maximum drawdown also drop to 20%? When we incorporate the rule "keep the maximum holding below 25%" into our trading system, we obtain a low-risk system with a 20% maximum drawdown that doesn't earn money.

Note that this "maximum holding below 25%" is a straightforward and effective rule within a money management system, mainly for controlling risk.

The control of trading system risk stems from rational money management. To digress, everyone knows not to go all-in, but most don't understand why. The answer lies here.

Money management to maximize profits

For us, a low-risk, not very profitable trading system, is essentially useless.

Reiterating the point, how can this system be made to yield a positive return? In practice, not changing the rules of opening and closing positions won't alter the 30% accuracy rate, and we can't change the 7:3 profit-loss ratio either. Despite the resignation, there's still a way. We can adjust the position size. Suppose we can make the average holding of profitable trades at 25% and control the average position size of losing trades around 10%, wouldn’t we then achieve profitability?

Here, money management almost plays the role of maximizing profits. Good money management can turn a non-profitable system into a profitable one, and a small-money-making system into a large-money-making system.

Summary at the end of the document

Simple rules for opening and closing positions, combined with sound money management, can create a profitable trading system with controllable risks.

An excellent trading system should be more complex, comprising both trading rules and money management.

Rational money management can effectively control and mitigate trading system risks while also significantly enhancing the system's profitability.

For us individual traders, money management is of utmost importance. Only by managing funds well can one maintain a long-term undefeated stance. Before talking about making money in trading, first ensure to minimize losses, cutting off losses in the market. In the market, only those who can survive are truly doing well, a lesson for us all to keep in mind.