Rule 1: Always Use a Trading Plan
A trading plan is a set of rules that specifies a trader's entry, exit, and money
management criteria for every purchase .
With today's technology, test a trading idea before risking real money. Known
as backtesting, this practice allows you to apply your trading idea using
historical data and determine if it is viable. Once a plan has been developed
and backtesting shows good results, the plan can be used in real trading.
Sometimes your trading plan won't work. Bail out of it and start over.
The key here is to stick to the plan. Taking trades outside of the trading plan,
even if they turn out to be winners, is considered poor strategy.
Rule 2: Treat Trading Like a Business
To be successful, you must approach trading as a full or part-time business,
not as a hobby or a job.
If it's approached as a hobby, there is no real commitment to learning. If it's a
job, it can be frustrating because there is no regular paycheck.
Trading is a business and incurs expenses, losses, taxes, uncertainty, stress,
and risk. As a trader, you are essentially a small business owner, and you
must research and strategize to maximize your business's potential.
Rule 3: Use Technology to Your Advantage
Trading is a competitive business. It's safe to assume that the person on the
other side of a trade is taking full advantage of all the available technology.
Charting platforms give traders infinite ways to view and analyze markets.
Backtesting an idea using historical data prevents costly missteps. Getting
market updates via smartphone allows us to monitor trades anywhere.
Technology that we take for granted, like a high-speed internet connection,
can increase trading performance.
Using technology to your advantage, and keeping current with new products,
can be fun and rewarding in trading.
Rule 4: Protect Your Trading Capital
Saving enough money to fund a trading account takes time and effort. It can
be even more difficult if you have to do it twice.
It is important to note that protecting your trading capital is not synonymous
with never experiencing a losing trade. All traders have losing trades.
Protecting capital entails not taking unnecessary risks and doing everything
you can to preserve your trading business.
Rule 5: Become a Student of the Markets
Think of it as continuing education. Traders need to remain focused on
learning more each day. It is important to remember that understanding the
markets and their intricacies is an ongoing, lifelong process.
Hard research allows traders to understand the facts, like what the different
economic reports mean. Focus and observation allow traders to sharpen their
instincts and learn the nuances.
World politics, news events, economic trends—even the weather—all impact
the markets. The market environment is dynamic. The more traders
understand the past and current markets, the better prepared they are to face
the future.
Rule 6: Risk Only What You Can Afford to Lose
Before using real cash, make sure that money in that trading account is
expendable. If it's not, the trader should keep saving until it is.
Money in a trading account should not be allocated for college tuition or the
mortgage. Traders must never allow themselves to think they are simply
borrowing money from these other important obligations.
Losing money is traumatic enough. It is even more so if it is capital that
should have never been risked in the first place.
Rule 7: Develop a Methodology Based on Facts
Taking the time to develop a sound trading methodology is worth the effort. It
may be tempting to believe in the "so easy it's like printing money" trading
scams that are prevalent on the internet. But facts, not emotions or hope,
should develop a trading plan.
Traders who are not in a hurry to learn typically have an easier time sifting
through all of the information available on the internet. If you were to start a
new career, you would need to study at a college or university for at least a
year or two before you qualify to apply for a position in the new field. Learning
to trade demands the same amount of time and fact-driven research and
study.
Rule 8: Always Use a Stop Loss
A stop loss is a predetermined amount of risk that a trader is willing to accept
with each trade. The stop loss can be a dollar amount or percentage, but it
limits the trader's exposure during a trade. Using a stop loss can take some
of the stress out of trading since we know we will only lose X amount on any
given trade.
Not having a stop loss is bad practice, even if it leads to a winning trade.
Exiting with a stop loss, and therefore a losing trade is still good trading if it
falls within the trading plan's rules.
The idea is to exit all trades with a profit, but not realistic. Using a protective
stop loss helps ensure that losses and risks are limited and that you have
preserved enough capital to trade another day.
Rule 9: Know When to Stop Trading
There are two reasons to stop trading: an ineffective trading plan and an
ineffective trader.
An ineffective trading plan shows greater losses than anticipated in historical
testing. That happens. Markets may have changed, or volatility may have
lessened. For whatever reason, the trading plan simply is not performing as
expected.
Stay unemotional and businesslike. It's time to reevaluate the trading plan
and make a few changes or start a new trading plan.
An unsuccessful trading plan is a problem that needs to be solved. It is not
necessarily the end of the trading business.
An ineffective trader makes a trading plan but is unable to follow it. External
stress, poor habits, and lack of physical activity can all contribute to this
problem. A trader not in peak condition for trading should consider taking a
break. After any difficulties and challenges have been dealt with, the trader
can return to business.
Rule 10: Keep Trading in Perspective
Stay focused on the big picture when trading. A losing trade should not
surprise us; It's a part of trading. A winning trade is just one step to a
profitable business. It is the cumulative profits that make a difference.
Once a trader accepts wins and losses as part of the business, emotions
have less effect on trading performance. That is not to say that we cannot be
excited about a particularly fruitful trade, but we must keep in mind that a
losing trade is never far off.
Setting realistic goals is an essential part of keeping trading in perspective.
Your business should earn a reasonable return in a reasonable amount of
time. If you expect to be a multi-millionaire by next Tuesday, you're setting
yourself up for failure.
What Do I Do If My Trade Is in the Money, i.e., Profitable?
In bull markets, it can be easy to make money in the market. Knowing when
to take profits takes practice. One way to take the emotion out of closing a
profitable position is to use trailing stops.
How Much Should I Risk on Any Given Trade?
First off, the answer to that question should already be part of your trading
plan in the form of a stop loss. As a stop loss, you can use a financial stop,
e.g., $500, or a technical stop price, such as if the 50-day moving average is
broken, or new highs are made. The key is to remember that you always
need a stop loss as part of your trading plan.
What Are the Key Elements of a Trading Plan?
The starting point is the impetus for the trade. If from a fundamental
development, such as an economic data report or a comment by a Fed
official, your trade is based on those fundamental factors, and your trading
plan should reflect that. If your trading plan relies on technical analysis, such
as remaining above the 50-day moving average, again your strategy should
rely on that. The key is to adjust your position size to give yourself enough
room to stay within the stop loss and not risk everything in a single position.
How Much Money Should I Commit to a Single Trade?
Position size is the primary determinant of the outcome of any trading
strategy. You want to be sure your stop loss can tolerate a minor loss relative
to your trading capital. If your stop is $1.50 away from the current market,
you'll want a position size relative to your stop loss that does not consume
too much of your trading capital.
Say you're only willing to risk $500 on the trade, and your stop is $1.50 away,
based on a technical price level, from the $20 current market price. That
dictates a position size of approximately 333 shares.
$20-$18.5=$1.50; $500/$1.50=333.33 shares to fit your trade strategy, which
would require $6,660 in tradeable capital (333 shares x $20 current market
level).
Note that a smaller position will use less of your trading capital while allowing
you to pursue a specific strategy.
