Why do professional traders succeed in beating the market permanently, whereas private market participants lose the battle on the stock exchange?

What distinguishes these two groups? Are they secret indicators, proximity to the market, complex algorithms or super-computers with fast and direct high-speed Internet connections to the world's stock exchanges? Or are they in the end completely different factors that are ultimately responsible for lasting success? This article provides a glimpse behind the scenes of a professional trader who is active on the financial markets day after day and has been trading successfully for years and shows what really counts on the stock exchange.

So in order to get to the bottom of the question which elements are essential for success on the stock exchange for a technically oriented professional trader, it is necessary to take a closer look at the strategy of a trader, since a holistic trading strategy is divided into several individual components.

Before we do so, however, let us take a look at Carl von Clausewitz, a Prussian general and military theorist who wrote in his treatise On War that "tactics is the study of the use of armed forces in battle. Strategy, on the other hand, is the doctrine of the use of individual battles for the purpose of war".

Although this quotation may seem martial, a certain analogy between the military and the struggle in the financial markets cannot be dismissed.

Similarly, as in historical battles described by Clausewitz, different market players try to defeat each other day in, day out and gain a financial advantage in the form of a trading profit.

It makes sense to subdivide a trading style into an overarching strategy, namely maximizing the return on the capital invested, and tactics, namely the concrete ways and means of how this higher goal of "portfolio growth" can be achieved through planning, preparation, implementation, setups and follow-up.

In concrete terms, this means that we first look at this strategy in its essential sub-areas in order to then clarify the interrelationships, so that finally the essential aspects come to the fore.

Basis for investment and share purchase

Before you can become active in the financial markets, it is necessary to create at least an approximate "equality of arms" between you and the other traders.
This means that you need to meet some of the institutional requirements that a trader has to meet from the outset.
These prerequisites essentially include the following points.

a) Hardware and software for stock trading

You will preferably need a redundant computer with a fail-safe Internet connection. Two independent systems, for example a desktop PC and a laptop, each with its own Internet connection and installed software is recommended at least in case one system has a defect.

In addition to the hardware, however, you need a chart software, as the chart is your main tool in technical trading and you need to be able to view the underlyings easily and quickly.

b) Chart setting for share purchase

With regard to chart settings, you should be aware that there are different forms of price display, including candlestick, bar and line charts.
Candlestick charts are useful because they offer a lot of information compared to line charts. With candlestick charts, you not only have closing prices, but also opening, high and low prices within the selected period.
The charts can be constructed with an arithmetic or a logarithmic price scale.
In principle, the arithmetic price scale can be selected for shorter-term observation periods and the logarithmic price scale for longer-term representations. It is important that you use only one or the other form of presentation within the selected period of time to avoid irritation, since with arithmetic setting the price scale shows the same price units, whereas with logarithmic scaling in a long market the percentage increases become smaller with increasing distance.

c) Course data supply

If you want to trade in the range of minutes or hours at short notice, but also if you want to optimize the timing of your entry into the daily chart, you will not be able to avoid a fee for the supply of price data.
Make sure you use an established and reliable real-time data feed provider that not only displays trading places such as Xetra, but also provides market depth (Level 2), because this gives you insight into the Times & Sales list and the order book.

d) Times & Sales List

The Times & Sales List (T&S) shows you each traded price with the corresponding number of units in real time and you can read the respective new price with the corresponding turnover. It is therefore a chronological list of the entire market activity of an underlying asset, with each buy and sell offer and each completed transaction being listed here line by line.
Viewed in isolation, the knowledge gained from this may not be overwhelming at first glance, although you can at least quickly see whether a security is currently being actively and strongly traded, i.e. whether it is rather liquid or not.
Much more important, however, is what can be created from the T&S list.

e) Tickchart

The T&S list is used to generate the "mother of all charts", the tick chart.
This tickchart is a line chart that visualizes each transaction by recording each new price or tick from the T&S list in the chart together with the corresponding time and marking a data point in the chart.
The tick chart cannot be displayed as a candlestick or bar chart, since it only visualizes the transactions that have taken place using a data point and therefore cannot form an opening, closing, high, or low point.
The tickchart thus provides a native and unbiased view of the supply and demand situation of a value.
For this reason, it is unadulterated, since it is not synthetically pressed into a period - be it 1 minute, 1 hour, 1 day, etc. - but rather shows the transactions made one-to-one.
Basically one tick chart would be enough to trade.
However, it is generally quite impractical to use a tick chart to look at a whole year in an underlying asset, for example. For this reason, period charts such as minute, hour or day charts etc. are usually used.

f) Order book

In the order book, you can then see how the orders are being processed or gain insight into the order situation, i.e. you can see all buy and sell orders that have been placed and can use this information to position your own trading orders. This gives you a decisive advantage, especially with regard to short-term trades, as you can place your own orders in the current environment and compare them with the orders of other market participants and thus identify clever price levels for placing your orders.
Finally, the insight into the order book helps you to see - on a very short term basis - whether a value is more likely to rise or fall, as you can see if the demand or the supply is higher and thus you can get a timing advantage and a slightly better price or execution of your order.

g) Newsfeed for the stock exchange

In addition to the prices, you also need a news feed so that you have an overview of the general situation in the market and in particular to be able to react to special extraordinary events - at least in very short-term trading.
But also in longer-term trading, it is necessary to be able to take into account planned news such as US labor market data, central bank meetings, announcement of interest rate decisions by central banks, but also corporate news such as quarterly reports, balance sheet press conferences and annual general meetings, etc.
Even in the case of long-term investments in a share, it is not advisable to place an order immediately before the publication of important figures, as a buy order that is in the market overnight, for example, and a company news item is published after the close of trading may occasionally result in a significant market-moving gap, which then significantly changes the intended order price.

h) What do I have to look out for in a broker?

Now that the preconditions have been examined, you need a reliable and reputable broker for trading and for the purpose of placing orders, who will forward your trades to the stock exchange quickly and conscientiously.
In principle, a broker with whom you trade the real underlying asset is preferable.
In the case of derivative financial instruments and brokers who offer such instruments as CFDs, at least a heightened sensitivity on your part is required.

Fortunately, there are CFD brokers who guarantee in writing that their prices correspond to those of Xetra one to one!
So please pay attention to this seal of approval when choosing brokers.
Basically, every trading instrument has its right to exist, as long as it is used sensibly and you are aware of the risks such as leverage, spread increase, unclear execution and the like.
However, you should be aware that a CFD price, for example, is an artificial price created by the broker and does not have to be identical with the price on the respective stock exchange and that there can be considerable deviations in the price setting.
The following, real example should clarify this.

Figure B1 shows an hourly chart of the MDAX share Salzgitter with the period from January 13 to February 26, 2015. This chart was created with the help of TaiPan EoD and the price data supply of vwd and depicts the price development of the trading system of the cash market of the German Stock Exchange of Xetra.

The concrete entry logic on which this value is based is explained below. At this point we will concentrate exclusively on the problem of price fixing and the broker.
In this trade, the stop was shifted four times in total (in addition to the first initial stop), as you can see from the red lines. Since 05.02. the stop was just below the third red line at 23.95.
In the course of the 12.02. a relative low point at 24.30 was reached.

In the second picture B2 you can also see an hourly chart of Salzgitter with the period from January 28th to February 16th and a price data supply of a CFD broker.

Salzgitter - Hourly Chart - Chi-X QuotesSource: MetaTrader4, quote data supply Chi-X. Here you can also see an hourly chart of Salzgitter with the period from 28.01. to 16.02. and a price data supply of a CFD broker with prices from Chi-X.
In the chart the 12.02. and the opening hour candle is highlighted with a grey rectangle.

In the chart the 12.02. and the opening hour candle is highlighted with a grey rectangle.
You can see that for a short time, the value dropped to 23.689 (see red horizontal line).

This example illustrates that a good supply of price data or trading the real stock on the German stock exchange can decide whether you end a trade in profit or loss.
This is because the trader who traded the trade in Figure B1 made a tidy profit by buying the share, as his stop at 23.95 was never fetched.
Whereas the trader who bought the stock via CFD from a CFD broker made a loss, because his analytically correct stop at 23.95 was made because of the low that only existed at the CFD broker.

This illustrates the importance of laying the groundwork for you to be on a par with the other financial market players in order to be able to participate in the financial markets at all - even before any entry logic.

Technical analysis toolbox

Now that the preconditions and the basics have been explained, it is time to take a closer look at the tools used by professional traders who work in a technically oriented way.
The main work of this group of traders is technical analysis, which in turn is based on the Dow Theory.

a) Dow Theory

As early as the 1880s to 1890s, Charles Dow had created a trend definition which, in its most basic statement, can be summarised by saying that "a trend is intact until it is broken".
An uptrend is characterized by rising highs and rising lows and a downtrend by falling highs and falling lows
To illustrate this, Figure B3 shows an ideal-typical course of a trend. The relative lows of points RT1 to RT3 are the rising lows and the two points of relative highs RH1 to RH2 are the rising highs.

Trend definition - ideal typical course
Source: Oliver Wissmann / This chart shows an ideal typical course of a trend. The relative lows of the points RT1 to RT3 are the rising lows and the two points of the relative highs RH1 to RH2 are the rising highs and thus meet the trend definition of the technical analysis.

b) Trend definition - The probability on our side

This trend definition was then constantly refined and expanded in the literature and is also used, for example, in the standard work by Edwards and Magee "Technical Analysis of Stock Trends" in the 1940s and later also by John Murphy in his main work "Technical Analysis of Financial Markets" from 1999.
Edwards and Magee already described in detail the most important aspects of technical trading in the 1940s and at the same time linked trends, market participants, volumes, tensions, formations and the like and explained how these could be used to trade in the financial markets.
This makes it clear that the trading concepts are basically nothing really up-to-date, but can be traced back to numerous authors and stock exchange traders over the last 120 years or so.
Nevertheless, these basic assumptions still work today and on the contrary, they prove that the financial markets have not changed significantly in their basic values.

The basic assumption that prices in the markets move in trends and that it is more likely that a trend will continue rather than break and that the "market price discounts everything" is the basis of a technically oriented trader and allows him to gain a statistical advantage if he only trades in the direction of the main trend.

The following figure B4 is intended to illustrate that markets move in strong trends.

Bayer daily chart - Xetra prices / Source: TaiPan EoD, Xetra price data supply / This chart shows the Bayer stock out of the DAX on a daily basis over a period of about 3.5 years. What is striking is that this stock has been rising for years and is very much part of an overall trend pattern with rising highs and rising lows.

Here we see Bayer stock out of the DAX on a daily chart over a period of about 3.5 years.
What is striking is that this stock has been rising for years and is very much part of an overall trend pattern with rising highs and rising lows.

The big picture - determining the current state of the market

So first of all it is necessary to classify the big picture to be aware of the current state of the market.
This means that you look at a value with regard to its overriding trend, for example in the daily chart, over the longer term and determine whether it is in an up or down trend or even in a sideways phase.

In the specific case of Figure B4 of the Bayer share, we see here an upward trend over many years, which is also characterized by shorter subordinate trends such as the upward trend from mid-August 2014 to March 26, 2015.

Do not interpret searches!

The determination of the big picture is the indispensable prerequisite before you even consider a concrete initial setup - in the case of a trend-following approach.
There must first be a clearly visible trend, according to the trend definition shown above. Only when a higher-level trend exists is it permissible to look for a concrete entry signal on the trading level.
So look for what you actually see in the chart and what is in fact and not what you wish for. Never try to anticipate a trend. Especially not in the big main trend. This must be clearly visible.

Looking for the small in the big!

So, after our first main condition is in a value, it is time to consider a trade entry at a subordinate level.
Again, the trend definition as shown in Figure B3 above is helpful here.
This means that you are looking for a matching, smaller trend within the primary trend that points in the same direction as the main trend.
In this way, you gain increased security, since you trade with the larger trend and thus with the large capital.
As a result, you gain another statistical advantage and thus trade a trend within the trend.
In other words, you are looking for the "small in the big" as illustrated in the following figure B5.

Trend within the trend - typical course of the region / Source: Oliver Wissmann. This graph shows the ideal typical course of a trend and its subordinate smaller trend (see zoomed rectangle).

In figure B5 you can see our ideal typical course; however, shortened a little for reasons of space so that you can see the subordinate trend.
You see a red smaller trend, which is part of the last beginning movement impulse.
Under the technical magnifying glass, you can see this red trend in detail in the right-hand chart area within a rectangle.

Setups for stock trading

Using two selected setups, I would like to illustrate how the concept of trend in trend works and how you can trade profitable entries where you have the statistical advantage on your side.
The prerequisite for both setups is that there is a superior trend that functions as a clock for you and in whose direction you trade a subordinate trend (see Figure B5).

(a) trend trading when a young trend is established

This concrete entry scenario also requires the existence of a superordinate main trend. Once this condition is met, we look for a subordinate trend that we can trade in the direction of the main trend.
In doing so, we try to get an entry at the very beginning, when the subordinate trend is establishing itself in the first place.
In other words, we try to enter the market at the breakthrough of the last relative high (RH1) with a stop below the last confirmed relative low (RT2).
The following figure B6 illustrates this entry scenario. In the red subordinate trend, which is displayed in a rectangle under the technical magnifying glass, you see the entry with the dotted line under "E" and the stop with the dotted line under "S".

b) Trend trading from the correction

Trend in trend with entry order at the breakthrough of RH1 - ideal typical course / Source: Oliver Wissmann
This picture shows an ideal-typical course and the entry orders at the breakthrough of RH1.

Trend trading from the correction also requires the above conditions (presence of a major trend, minor trend towards the major trend). However, in this setup, trading does not take place immediately upon the breakthrough through the last relative high (cf. Figure B6 Breakthrough through point RH1), but rather one allows the value to develop first and then, in the correction of the subordinate trend, one enters within the correction zone (the zone between the last confirmed relative high and relative low).

Figure B7 shows this variant of the initial screen in more detail.

Trend within trend with entry order from the correction in the small trend - ideal typical course / Source: Oliver Wissmann
In this chart, we see an ideal-typical superior trend with a subordinate smaller trend (red); i.e. a trend within a trend and the concrete entry order for trading out of the correction.

You can see that the preconditions are the same as in the example in Figure B6. However, in contrast you can see that the entry "E" takes place within the correction of the red minor trend, with the stop "S" at the same position as under the above setup. This means that this scenario gives you a more favorable risk/reward ratio.

Risk, money and position size management

However, the development of a holistic strategy is by no means completed with an entry logic.
A very important factor in a trader's overall strategy must be dedicated to money, risk and position size management.
In simple terms, this means that you only use a small part of your entire portfolio per trade.
In professional trading, a range of 0.25 % to approx. 1 % of the total portfolio is permissible as the risk amount, as this is the best way to ensure capital preservation.
In addition to considering the amount at risk, the total charge on the securities account must also be taken into account. This means that you are aware in advance how much of your assets will be invested in the individual trades at the same time.
For example, 10 trades that tie up 100% of your capital represent a greater risk than if you have invested only 30% of your capital in 10 trades.
Because you must never forget that not only because of an exogenous shock on the financial markets (Black Friday, terrorist attacks, Lehman Brother bankruptcy, tsunami, decision of the Swiss National Bank to abandon currency defense and the like) all positions or a larger number of positions can be stopped from your portfolio at the same time, but also that a stop will not be executed at the point as intended, for example, due to a larger price gap.
If, for example, a gap should occur that runs against you and virtually "overruns" your stop, your stop will only be activated at the next executable price and you will lose more than you had considered in your planning.

Diversification

Closely linked to the topic of risk, money and position size management is the broad field of diversification.
Through active diversification you not only spread the risk but also take advantage of increased opportunities.
The term diversification not only covers the topics of long and short distribution in a portfolio (should a ratio of 50/50 or rather 70/30 be targeted), but also the topics of asset class distribution, sector changes, trading style combination (trend trading at the breakthrough of the last relative high, trend trading from the correction and the like), holding periods of trades, etc.

Follow-up - The Trading Journal or the accountant in us

The overall strategy and its implementation is rounded off with the accounting treatment of the business activities.
After all, the professional approach to the financial markets is a business like any other business and therefore the business model must be constantly reviewed.
In the trading world, this means that every trade is recorded and recorded by means of a meaningful trade journal, and thus, similar to the bookkeeping in a company, every single business transaction is recorded and thus, at any time and in a timely manner, allows a control and overview of the company by means of a business management evaluation, and thus, in trading, a strategy is also checked at an early stage to see whether it actually works and brings the goal closer to achieving a maximization of returns.
In such a journal not only the entry, entry price, time and position size, fees as well as the closing and the calculation of the individual profit and loss, but also the documentation of the applied setup, the time unit, the holding period and, at best, additionally the question whether a re-entry was made or not, are included.

In addition, such a managed journal then offers objectively measurable key figures at any time to check whether the strategy makes sense. Thus, not only the mere yield can be read off, but also the amount of the draw down, the duration of a draw down, the average yield per trade, the profit factor, the Sharpe ratio and the like can be determined.
In addition, a journal kept in this way also offers valuable insights to improve one's trading.
It also offers self-confidence during longer draw down phases, because a trader does not immediately fall into blind actionism and throw his trading system overboard, because, for example, a review of the past suggests that a statistically significant number of trades can just as often lead to profit and loss phases and that these phases only have to be endured because they are part of the chosen trading strategy.

Conclusion

In summary, it has become clear that the key components for lasting success in the financial markets are not to be found in individual factors, such as setups or chart software, but rather in the interaction of all individual aspects.

Subordinate factors such as entrants, which private investors like to completely overweight, play a rather secondary role.
In professional trading, on the other hand, much more attention is paid to risk, money and position size management, the determination of the overriding trend, the search for the statistical advantage and diversification.

Taking into account and sensibly linking and correctly weighting all components to form an overall strategy is the secret that distinguishes the private market participant who "takes something with him every now and then" from a professional trader who has the permanent upper hand in the markets and wins the daily battle for returns.

About the author

Oliver Wißmann is a lawyer, entrepreneur and trader.
He looks back on many years of trading experience dating back to the turbulent times of the Neuer Markt. He has learned the tools to survive in the financial markets from the ground up and expanded them through experience in institutional trading.
He is not only deputy head of the Munich regional group of the Association of Technical Analysts in Germany. (www.vtad.de) and financial author. In addition, he manages a Trading-GmbH and works as a consultant and trainer for various institutional addresses.