One of the great struggles faced by all traders, regardless of experience level, is self-awareness. Many a trader has seen their portfolio blown up by an overestimate of their own abilities, their own risk tolerance, or their own understanding of the markets. In a less dramatic fashion, an overly low opinion of your own abilities can also kill performance, with traders under-committing to positions, exiting trades early, and generally making costly errors out of fear or through double-guessing themselves. The only possible cure to these problems is to develop an accurate and unbiased estimate of your own abilities – no mean feat, but possible with patience and realism.
Trading and experience
Traders tend to improve with age, although the relationship is not linear. A big part of the age effect is that people who are poorly suited to trading and the financial markets tend to lose interest, so the survivors seem better; that said, experience is also an important driver of trading performance. One of the advantages of having dealt in varied markets is an understanding of how prices can change according to news, sentiment and fundamental factors; another is knowing how you, the trader, respond.
It is easy to imagine how we respond to certain situations, for example a sudden market crash or run of failed trades, but it is quite difficult to accurately predict our real behaviour, especially when still new to the markets. It might not be immediately obvious when a trader is overexuberant, scared or responding to market pressure – one of the advantages of experience is a familiarity with these emotions that allows us to identify our own state of mind and respond accordingly.
Understanding your responses
Since we do not have perfect self-knowledge, it is easy to make mistakes without realising, especially when external conditions impact our mindset. A trader who finds himself failing to execute trades, double-guessing his ideas and ignoring when the market crosses into territory where his strategy should go long, may be concerned they are insufficiently experienced to execute their own strategy. Despite having a convincing back-tested strategy, and run a demo account for a few weeks, if you lack confidence in your own abilities you will struggle to enter trades.
In this case, the problem is that the traders level is above what he thinks it is – his doubts stem from a lack of confidence in his own abilities. Since almost all traders are aware of the risks of overconfidence, including entering positions lightly, moving stop losses and trading recklessly, some traders start to question their own abilities, over-interrogating their trade rationales and in the end not dealing sufficient volumes to turn a profit.
An opposite problem arises when traders assume they already know everything – this is quite common with traders who have passed the ‘beginner’ phase, are familiar with how platforms work and the basics of the markets, but have not yet realised how much they don’t know about FX. At this point you can sometimes see a know-all attitude, which expresses itself as excessive conviction in trades, allocating overly large positions to single deals and using poor risk management techniques. This is swiftly corrected when (inevitably) the trades start to move against you and you lose money, but carefully assessing your own level can stop this costly disaster before it happens.
If traders are all unique, with their own experiences and financial knowledge – alongside luck – contributing to performance, we can still try to categorise some different levels of trading knowledge. This is helpful to see where you fit; perhaps you have traits of more than one category, but as a general rule it is possible to see the following levels:
Absolute beginner: a total novice, with no financial knowledge or trading experience. At this level traders still do not understand basic principles like bid and ask, volume or simple charting tools. The priority to move on is to understand the basics of FX, currency types, trading strategies and how they work, and to know how to execute trades with proper risk management and an eye on costs.
Informed beginner: the informed beginner still lacks experience, but unlike the absolute beginner has a basic grounding of financial knowledge. You can move from absolute to informed beginner solely by reading – a practice that becomes more difficult as you move to more advanced levels. Informed beginners understand basic trading principles such as fundamental and technical analysis, trade styles like swing and momentum, and knows how to compare FX trading platforms. To move beyond this level, demo trading and real trading practice are key.
Trading beginner: after building up an understanding of the markets, the trading beginner has run demo accounts with success and is now opening real positions. This is a difficult phase, as the gap between theory and reality becomes apparent. Traders may spend a long time here, even years, but those who successfully navigate the transition will normally find the later stages pass with greater ease.
Intermediate: at this point traders are aware what methods work for them, have some understanding of their own trading psychology, and use proper risk management and position sizing strategies automatically. To advance beyond this level, they need to develop theories of market price action, understand their chosen currency pairs in greater detail, and build up a track record of successful trades.
Advanced or experienced trader: traders who make it this far are profitable unless they make mistakes; they have a comparable level of financial knowledge to a professional; they have a multi-year track record of positive performance. To get this far requires immense time and patience, but the further you get the more likely it is you will reach this point.
Remember that prospective traders are lost at each level, but most traders who make it to the intermediate level will continue to be involved in the markets. Features like demo accounts can help give beginners a better idea of how markets and trade execution works, but to become an experienced trader requires a track record of real positions.
How long does it take?
Considerable effort, both in time and number of trades, is a prerequisite for moving beyond the basics. Simply put, unless you have a track record of several years showing consistent profits, you cannot consider yourself an experienced trader. How long that takes varies from person to person – some people hit the ground running and become profitable in the first few years, others take many years of intermittent trading to become profitable, some never do. Because many traders who aren’t happy with their performance end up quitting, it is hard to get accurate numbers for time required. It is reasonable to expect to spend many hundreds of hours on education, demo accounts, backtesting and live trading before you reach the upper echelons.
Survivorship bias applies in any situation where people quit at each stage. Given that unprofitable traders tend to give up, looking at the careers of successful traders is often misleading, as it gives an impression of linear progression that doesn’t hold true for many accounts. A majority of day traders will quit in the first two levels, either because they decide it isn’t for them, or they realise how much work it will take to become profitable and do not want to commit. Equally, unlucky or poorly planned trades resulting in losses can put traders off – for this reason it is important to be careful with position sizes.
On the other hand, it’s also true that once you pass a certain level, you are likely to stay ‘in’. Traders shouldn’t be discouraged by poor performance or early difficulties, provided they can identify the reason and come up with a plan to improve. Instead, view these struggles and difficulties as part of the apprenticeship of a master trader, and learn from your mistakes.
How Rakuten can help
A great way to assess your own trading level with a reduced amount of risk is to use a free demo account. Why not sign up for one with Rakuten and start trading today, without risking any of your capital?