How do you know when you are right and not just luck?

This reply is relative because different investors/traders are likely to have different opinions but for me you are right when you make money, and you are wrong when you lose money… Ignore the ego and reinvest profits. Focus on the bottom line and you will do better this way. If you are rich, you are right. If you are poor, you are wrong. This is the reality of the world.

Is is Possible to time the Market?

I’m afraid it’s the wrong question. If the stock market goes down 10% and you only go down 9%, you have beaten the market but you have also lost 9%. Hopeless.

The question you should be asking is this: what do I [personally] need to make to justify taking some risk with my money? A building society typically offers about 2.5%, so what return would tempt you out of the safety of cash?

For me the answer is 3x. If I think I can make 7.5% this year then I don’t mind whether the market goes down or up 10%; it’s not a competition, I don’t set out to beat anything or anyone.

Back-Testing a Trading System

A theoretical way to know whether you are right is also in the method of “back-testing”, which will at least indicate whether the trading system that you are utilising with is actually has a positive expectancy. For instance say I have a particular trading system in mind that deals with trades that activate when a stock makes a new high and breaks through a past resistance level. Why not pick a date at random, and find all of the shares that made new 52 week highs on that date? Then track them through as though you were trading for real. If you can perform that process in an unbiased and disciplined way for 100 different trades, you’ll then get an idea as to whether that particular trading system works. Importantly, be honest and don’t cheat to make the numbers look better!!

If you’re able to achieve an overall profit (hopefully a sizable one) following on from 100 simulated trades, then is that just luck? No, chances are, you might be on to something. Have a good look at that trading system, place some hard-and-fast rules around it, and then re-test those trades. Then, take action and work with that trading system.

Also, keep in mind that when trading, you decide a market direction and take a trade based on your prediction. You simply have to follow a trading plan. Most importantly, keep your losses small – losing almost 50% of your capital straight away in a single trade is like committing suicide with your capital. You shouldn’t risk more than 1-3% of your entire capital on any one trade. That gives you a lot of “wiggle room” to breathe if a few trades go against you.