My 25 Trading Rules | Never Break This !
Rule 1: Trade with the Trend
Among all the guidelines I encountered, the most widely embraced and, in my opinion, the pivotal principle for profitable trading is aligning with the prevailing trend. Despite being an elementary rule, it is tempting to engage in selling during bullish markets, presuming that the market has surged excessively and swiftly. I have incurred substantial losses by succumbing to this inclination. For instance, a few years ago, I perceived crude oil as overvalued at $40 per barrel and initiated short positions, only to witness its ascent to nearly $100 per barrel. Similarly, with Google, numerous individuals believed the stock was overpriced at $400 (now $702). Being on the wrong side of these significant market movements not only results in financial losses but also foregoes potential profits that could have been realized by adhering to the fundamental rule. In a bullish market, it is prudent to either maintain long positions or adopt a sideline approach. It’s crucial to remember that abstaining from a position also constitutes a strategic stance.
Rule 2: Buy Strength and Sell Weakness
Rule 3: Have a Plan for Your Trade
I particularly endorse this approach. When initiating a trade, envision it as potentially the most significant trade of the year. Refrain from entering a trade hastily; instead, ensure thorough planning, including a well-defined strategy for both augmenting the trade and orchestrating exits. Prior to entering a trade, meticulous research is imperative. Determine your entry and exit points in advance, irrespective of whether the trade turns out to be profitable or not. It’s crucial to have a predetermined plan, avoiding the formulation of new opinions during market hours. Once you commit to a specific strategy, adhere to it. If the strategy is fundamentally sound, consistent adherence to it over time will yield positive returns.
Rule 4: Predetermine Maximum Losses in Every Potential Trade
As a crucial aspect of trade planning, it’s essential to identify the worst-case scenario for your trade. This proactive approach ensures that if the worst does occur, you won’t be caught off guard, enabling you to maintain a composed trading mindset rather than succumbing to panic. If you find yourself in a state of distress when facing the identified worst-case scenario, it indicates that your potential maximum loss is excessive and warrants adjustment for future trades. Understanding your potential maximum loss not only assists in determining the appropriate number of contracts to trade but also aids in evaluating whether the risk is justifiable for the trade.
Rule 5: Don’t Chase the Market
Exercising patience is an indispensable trait for traders. When you feel the impulse to enter a rapidly moving trade or one you’ve missed, it’s crucial to pause and reflect before hastily making a decision. Waiting for a correction or identifying a solid entry level before initiating the trade is advisable. Markets seldom surge without a pause or retest of a level. I’ve observed instances where hastily entering a trade resulted in a reversal just 15 minutes later, requiring a considerable waiting period for it to return to the entry level. Cultivating patience is vital, and there’s no need for undue concern if a trade is missed; opportunities for new trades will arise.
Rule 6: Give a Trade Time to Work
Exercising patience remains crucial once you are actively engaged in a trade. Once you’ve initiated a trade, allow it the necessary time to unfold and generate the anticipated profits as per your initial planning. Prematurely taking profits can be significantly detrimental in the long term. The substantial gains in trading often stem from capturing a few substantial market moves, rather than accumulating minor profits along the way. The well-known saying “let your profits ride” holds particular relevance in this context. If you succumb to impatience and exit prematurely, you risk forfeiting substantial potential gains.
Rule 7: Keep Losses Small
Contrary to letting your winners ride, there’s the imperative to cut your losses—a combination that encapsulates one of the oldest adages in trading. The key is to incur small losses rather than allowing them to escalate into significant ones. Opting for minor, swift losses when you recognize that you are at a disadvantage is far preferable to enduring substantial losses that can overwhelm you. The financial aspect of a small loss is secondary to the preservation of mental capital that can be depleted when holding onto a losing trade. Accepting losses as a fundamental cost of doing business is essential, and the ability to do so is integral to becoming a successful trader. Refrain from rationalizing a poor trade by convincing yourself that it will eventually turn in your favor. Successful traders navigate through downturns with the understanding that they will encounter a series of losses at some point. While individual losses are part of the trading landscape, the ultimate objective is to achieve a net profit over a series of trades. Focus on consistently making the right decisions rather than dwelling on any single loss.
Rule 8: Do Not Add to Losses
This principle is revered by many successful traders: never, under any circumstance, add to a losing trade or average into a declining position. Whether you are buying or selling, each subsequent buy or sell price must surpass the preceding one. I previously mentioned an exception to this rule, which occurs when substantial traders strategically build large positions gradually, welcoming price drops to accumulate without drawing attention. However, for them, this is part of an overarching strategy, and it does not involve adding to a losing trade.
On the other hand, when correctly adding to a winning trade, it’s advisable to do so in smaller increments compared to your original trade. This precautionary measure helps mitigate the risk of losing the entire investment swiftly during a market downturn. The generally accepted range for such additions is between 25 percent and 50 percent.
Rule 9: When the Reason for the Trade Is No Longer There, Get Out
When formulating a trade plan, it’s essential to enter for a specific reason. If that rationale undergoes a change, rendering your trade invalid, it’s imperative to exit. Re-entering the trade is acceptable if a new, valid reason supports it. However, whether the trade is in a winning or losing position, it’s crucial to exit or, at the very least, reassess the trade when the initial reasoning is no longer applicable.
Rule 10: Use Volume to Help You Trade
The significance of volume is frequently underestimated, yet it can provide valuable insights into price dynamics. Robust volume can validate either a sustained price trend or a reversal, while feeble volume may suggest that a movement is concluding or that a reversal signal is not particularly reliable. It is worthwhile to invest time in understanding how to interpret and leverage volume, as this knowledge can significantly enhance your trading effectiveness.
Rule 11: Make Sure the Technicals Confirm the Fundamentals
Refrain from engaging in trades until both the technical indicators and fundamental factors align is a principle I partially diverge from. While it can be prudent advice, especially when the two converge, I lean towards using technical analysis to validate the impact of news. I believe that a remarkable trade emerges when the market reacts unexpectedly to news, allowing for a contrarian approach—fading the news. This strategy aligns with the timeless wisdom encapsulated in the saying, “buy the rumor; sell the news.” I place confidence in the charts as they represent reality, encompassing all news, and offer profound insights into market behavior.
Rule 12: Don’t Trade Illiquid Markets
Certain stocks and markets are thinly traded for a reason—simply put, there’s a lack of interest. It’s crucial not to question this rationale but rather to steer clear of such markets. Thin and illiquid markets have the potential to exhibit unpredictable and rapid fluctuations, making them precarious for trading. Focus on engaging only with active stocks or markets. While they don’t necessarily have to be the most active, they should be substantial enough to resist sudden spikes triggered by a substantial order or a significant move by a single participant.
Rule 13: Take a Break When Losing Big
When facing significant losses in equity, it’s advisable to contemplate taking a break. Close all existing trades and temporarily halt trading, whether for the rest of the day or an extended period. The mind can undergo psychological challenges after abrupt and substantial losses. Resisting the intense temptation to recoup the lost funds immediately is crucial, as succumbing to this urge may lead to reckless decisions and potential financial disaster.
Rule 14: When Trading Well Push It a Little
When trading successfully, it’s reasonable to amplify your level of aggressiveness slightly. Market dynamics often unfold in streaks, whether in winning or losing phases, and traders will inevitably experience notable streaks periodically. Capitalize on a positive streak, but remain mindful that every streak has its conclusion. Avoid becoming excessively confident or aggressive, as such behavior could potentially erase all your earnings in a single trade. The crucial term in this context is “little.” While it’s acceptable to enhance your approach, ensure it remains manageable, and steer clear of excessive greed.
Rule 15: Never Risk More than 5 Percent of Your Account Equity on a Trade
Among the various percentages often cited, 5 percent appears to be the most commonly recommended. While other figures like 1 or 2 percent are also suggested, a 5 percent risk on the size of a regular trader’s account is deemed acceptable. Adhering to this rule serves as a safeguard, preventing the risk of losing all your capital at any point. Additionally, it enables you to determine the appropriate number of contracts to trade and assess whether a particular trade carries an acceptable level of risk.
Rule 16: Trade Your Personality
It is advisable, as a general principle, to align your trading style with your personality. Attempting to adopt someone else’s trading style can be challenging if it doesn’t resonate with your thought process. I’ve delved extensively into this concept in a dedicated chapter, underscoring the importance of this alignment.
Rule 17: Prices Have Memory
Here’s an aspect I appreciate but haven’t discussed much. Prices often exhibit a tendency to recall specific levels, gravitating back to well-defined support or resistance levels visible on a chart. It’s not the prices themselves with memories, but rather the traders who take note of particular price points. These traders then influence the market by consistently trading in one direction until a predetermined target is reached, at which point they exit their positions.
Rule 18: Trade What You Trade Best
Focus your trading activities more on the stocks or markets that exhibit positive results and reduce involvement in those that do not. If you excel in trading crude oil, concentrate on that market without feeling compelled to diversify excessively. In managing multiple positions, evaluate each one and consider increasing exposure to the trade yielding the highest profit, while reducing exposure to either unprofitable trades or those showing minimal gains. This approach also aligns with the strategy of “letting your profits run.”
Rule 19: Monitor Yourself
The most effective method for gauging your performance as a trader is to meticulously record your activities. Maintaining a trading diary that comprehensively documents each trade, including the reasons for initiating them and your subsequent actions, can provide valuable insights into your trading patterns. By keeping a detailed record, you may identify recurring trends that facilitate the elimination of unfavorable trades, allowing you to focus on more successful ones. Additionally, this practice enables you to gain self-awareness, recognizing both your strengths and weaknesses in the trading arena.
Rule 20: Know Your Markets
The most successful traders typically specialize in a select few indices, futures, or stocks, developing an intimate understanding of them. Diversifying too broadly can diminish your market knowledge significantly. As emphasized earlier in this book, studying and actively trading a market daily enables you to comprehend its reactions thoroughly, providing a valuable edge in trading. Spreading yourself too thin jeopardizes this advantage and may lead to a loss of your trading edge. It’s worth noting that even seasoned professionals often focus on one or two markets, prompting the question: why assume you can outperform them by trading a broader array?
Rule 21: Don’t Be Greedy
Greed is a detrimental emotion in trading; once your trade concludes, it’s prudent to exit. There’s no necessity to extract every possible penny from a trade, as attempting to do so often results in giving back some gains. Additionally, greed can be perilous if you endeavor to generate excessive profits by trading a position larger than your financial capacity allows. Opting for steady and consistent results is a more prudent approach than succumbing to the pitfalls of greed.
Rule 22: Don’t Trade Scared
Similar to greed, fear is a perilous trait in trading. Individuals driven by fear often make poor decisions, such as prematurely exiting profitable trades in an attempt to secure gains. Some are hesitant to initiate trades, observing opportunities without taking action, while others find themselves unable to exit positions once they’re in. The fear of incurring a small loss, which might escalate into a substantial one, or the anxiety of needing to recover from a significant loss can also be crippling. If fear is influencing your trading decisions, it’s advisable to take a break from trading until you can address and mitigate those fears. Ignoring this may lead to further financial losses.
Rule 23: Hope Is Not a Trading Strategy
This is another principle I value highly. The term “hope” should have no place in a well-structured trading plan. The moment this word begins infiltrating your trading decisions and thoughts, it’s a clear indication that your trade has likely veered off course, and you find yourself in an unfavorable position desperately seeking an exit. When hope becomes a factor, the best course of action is to exit the trade promptly and move on.
Rule 24: Keep It Simple
I’ve come to understand that simplicity is often the key to success. Relying on straightforward methods tends to yield better results. When you start depending on multiple and intricate indicators, the complexity can overwhelm you, making it challenging to make rational decisions. It may lead to conflicting signals from various indicators, creating confusion rather than clarity. It’s akin to having too many cooks in the kitchen trying to prepare a stew—they end up getting in each other’s way. Some of the most successful traders keep it simple, using just a chart and a trend line. They prefer avoiding unnecessary complexity that could clutter their decision-making processes.
Rule 25: Take a Part of the Profit to Reward Yourself
Lastly, when you achieve profits, allocate a portion of that gain for a reward; it enhances your self-esteem and satisfaction with your trading endeavors. Treating yourself with something special, like a $4,000 Martin acoustic guitar, using trading profits can be particularly gratifying.
Trading rules serve as the foundation of your fundamental trading approach. They dictate your buying and selling decisions and risk management strategies. Developing and adhering to a set of rules is imperative for success in this field. These rules not only provide guidance for your trades when applied consistently, but they also serve as a tool for evaluating and monitoring your trading performance. They help you differentiate between right and wrong decisions. Once you establish robust trading rules, you can review your trades, take notes on whether you followed them, and assess your performance based on adherence. Lacking these fundamental rules leaves you without a benchmark for self-evaluation, introducing an unnecessary obstacle on your path to becoming a successful trader.
