What is Good Stock Trading and What is Bad Stock Trading?
For most traders in the market, a losing trade is simply categorized as a “bad” stock trade and a profitable trade is simply categorized as a “good” stock trade. But this isn’t always the case. Losing trades can actually be good trades and profitable trades can be bad trades.
This fundamental misunderstanding of what constitutes good and bad trading is difficult for new traders to accept. I mean, how could the end result of an individual trade not matter? But the truth is that having rules, plans, systems, and a strong decision-making process over the course of hundreds of trades is far more important than trying to only hit winners and completely avoid losses.
The reason why so many traders are obsessed with the result of every individual trade is because they want instant gratification. But opting for short-term emotional gratification typically comes at the expense of long-term success. The market won’t just conform to your personal urges and desires on a trade-by-trade basis. So you have to be fully prepared to deal with the inherent uncertainty.
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With that said, good trading is simply having a statistical edge and capitalizing on it with consistency and discipline. It’s about following your rules and sticking to your plans. Bad trading, on the other hand, consists of making impulsive decisions, strategy-hopping, and chasing hot stock alerts. It involves a lot of hoping and wishing, and closely resembles gambling rather than legitimate trading.
The result (profit or loss) on any individual trade doesn’t determine whether it’s good or bad. Your execution of your rules does.
What is a Statistical Edge in Trading and Why is it Important?
One of the main components of durable market success is having a statistical edge (or multiple statistical edges). This means that you have to develop or find at least one particular setup (based on technical and/or fundamental criteria) that works out in your favor over a large number of trades. Long-term trading success is not about being right or generating a profit on every single trade – which is impossible to achieve – it’s about having a mathematical edge that generates consistent profits over the course of many trades.
This is known as positive expectancy, and if you track your trades properly, you can actually calculate it for yourself. All you need are four variables – win rate, average dollar win, loss rate, and average dollar loss. Many traders concentrate solely on win rate in their search for a strong trading system, but win rate alone doesn’t tell the whole story. A system can have a 99% success rate and still have a negative expectancy. For example, if the average dollar loss is $100 and the average dollar win is $1, the expectancy is -$.01 per trade.
Expectancy or Expected Return = (Win Rate x Average Win) – (Loss Rate x Average Loss)
Expectancy or Expected Return = (.99 x $1) – (.01 x $100) = ($.99) – ($1) = -$.01
What this means is that win rate alone doesn’t matter. Just because you have an extremely high win rate doesn’t necessarily mean you have a winning strategy or system over the long run. It might feel good to win 99 out of 100 trades, but if you give it all back and more on 1 out of 100 trades, then what good is it? In the example above, you can expect to lose a penny on every single trade. Since the expectancy is negative, this system either needs to be adjusted until it produces a positive expectancy or completely scrapped.
To really hammer this point home, your goal as a trader should be to find a system with a positive expected return. For a simple example of how this concept can be viewed, let’s take a basic coin flip – a 50/50 event. But let’s say that when it lands on heads you make $3 and when it lands on tails you lose $1. In this scenario, anything can happen on just one or several flips. You could potentially flip tails five to ten times in a row. But over the course of a large number of flips, the probabilities will work themselves out.
This is the law of large numbers. And this is a bet you should want to take every single time because it has a positive expectancy of $1 per flip. There will certainly be streaks of losses along the way, but this is a winning system over the course of time.
Good Stock Trading = Having a Statistical Edge and Executing on It
Now that we’ve discussed what a statistical edge is, it’s time to talk about properly executing on that edge. In theory, profitable stock trading is really simple – just execute on your statistical edge with consistency and discipline. When you boil it down, that’s all it comes down to. But most market participants frankly don’t have the proper trader mindset required for success.
When I mention mindset in relation to trading, most people get the wrong idea. They have this notion that I’m referring to hustling, grinding, and working hard to force a result – things that business and life coaches repeat all the time. But when I mention trading mindset or psychology, that’s not what I mean. What I’m referring to is the ability to deal with risk, loss, and uncertainty in a constructive way. It’s about increasing focus, clarity, patience, and objectivity. You want to flow with the market instead of fight it.
The problem is that no one naturally has an effective trader mindset. We all have urges, cognitive biases, and defense mechanisms that lead us into irrational, impulsive, and destructive trading decisions. With money on the line, most traders don’t have the mental fortitude to follow their rules, plans, and systems. When a trade starts going against them, they freak out and bail, or remove their stop loss, or carelessly add to their losing position in hopes of a recovery – instead of just following the rules that constitute their edge.
This is why I think one of the best first steps for a new trader is to go through a top rated mindset course like the one offered at 2ndSkies Trading – Advanced Traders Mindset. I’m of the belief that there are plenty of edges to be found in the market – even ones that can be capitalized on with fairly rudimentary systems. Regardless of how often traders try to blame strategies and systems for their trading woes, the bulk of their problems usually occur in the execution of those strategies and systems.
Conclusion – What is a Successful Day Trader or Swing Trader?
To wrap things up, a successful day trader, swing trader, or any other type of trader is one who focuses much more on the process than the profits. The process includes developing and refining your statistical edge (system), as well as developing and refining your mental edge (mindset). And when the process is right, the results (profits) take care of themselves.
I think Rich Friesen at Mind Muscles For Traders explains the concept of good trading vs. bad trading beautifully with his model of Lousy vs. Lucrative trading. And as I similarly stated above, the “lousy” and “lucrative” labels have nothing to do with the profit or loss on the trade. They’re determined by your own behaviors – your ability to follow your own rules, plans, and systems. A trade is lousy if you go against your rules and a trade is lucrative if you stick to your rules. Simple as that.
Unfortunately, most traders get easily distracted by short-term noise and consistently fail to follow their rules. This lack of behavioral consistency leads to frustration, anger, and losses. Which then turns into claims that “trading is gambling” or “the market is a scam”. But trading is only gambling if you treat it that way. By acting randomly and impulsively, it can be your own personal gambling arena. Conversely, you can put the odds in your favor with a strong statistical and mental edge. The choice is entirely yours.
New traders tend to be shortsighted. They want to get rich on just one or two trades. They crave short-term emotional gratification even if it correlates with poor long-term results. But remember that long-lasting success is a marathon, not a sprint.
Written by Matt Thomas (@MattThomasTP)