Trading is an easy business to get into: No degrees or
specialized training are required, start-up costs are relatively low and
it can be done from the comfort of home. The logistical ease of getting
started, however, should in no way imply that becoming a profitable
trader is simple.
Most experienced traders would attest that success depends on many
factors including hard work, research, planning, discipline and being a
lifelong student of the markets. As with many businesses, there are
certain principles that, when followed, can greatly increase the chances
that a trader will be successful.
Here, we explore 10 timeless rules that are an important part of
successful trading, no matter the techniques, markets or time frames you
trade.
1.TREAT TRADING LIKE A BUSINESS:
As a hobby, trading quickly gets expensive: Just dabbling can prevent
traders from gaining the proficiency and experience they need to become
consistently profitable. As a job, trading can be discouraging because
there is no such thing as a regular paycheck: Traders can work 10-hour
days all week and end up empty handed on Friday. Rather than thinking in
terms of a hobby or job, it is important to approach trading as a
business.
Like any business, trading incurs expenses, losses, taxes,
uncertainty and risk, and these factors must be taken into account. The
key to developing a successful trading business is good planning, both
for the overall business and for the actual trading. Traders who want to
weather the learning curve and stay in the industry for the long haul
will put in the time and effort to research and develop strategic plans
that encompass short- and long-term goals and the details of trading:
2. ALWAYS USE A TRADING PLAN:
A new trader would not have to look far to come across the well-known saying, “Plan your trade and trade your plan.”
The first part — plan your trade — is accomplished through a trading
plan: A written set of rules that defines entry, exit and money
management criteria. Good trading plans often are based on experience or
market observations and developed through research and exhaustive
testing. While it is time-consuming and challenging to develop a
profitable plan, a major advantage is the consistency it delivers.
The second part of the adage — trade your plan — is, for many
traders, as difficult as developing a trading plan. Trade your plan
means following your trading plan exactly, without making excuses,
second-guessing or otherwise deviating from the rules that were so
painstakingly created. Taking trades that fall outside the plan is
considered bad trading, even if they turn out to be profitable.
Often, invalid trades are the result of our emotions: Fear, greed,
impatience, overconfidence, etc. Other times, they stem from our
mistakes, or pilot error as it is often called. Trading your plan is not
as easy as it sounds, and most traders must work hard to develop the
necessary skills over time. Consistently following the rules of an
effective trading plan is part of what allows a trading business to make
money over time.
3.RISK WHAT YOU CAN AFFORD:
While traders plan on making money (that’s why people trade, after
all), it is important to acknowledge that it does not always work out
that way. It is essential that the money used to fund a trading account
be what can be lost without impeding the ability to meet other financial
obligations. Losing money is difficult enough, but it is even more so
if it is capital that never should have been risked in the beginning.
It should go without saying that a trading account should not be
funded with money earmarked for the kids’ college funds, the mortgage or
day-to-day living expenses. Asidefrom being a terrible idea that can
lead to disastrous financial losses and unfortunate circumstances,
trading with money that is not expendable can put a trader under an
extraordinary amount of pressure to succeed.
Often, this type of pressure leads to bad decisions and, ultimately,
losses. Prior to trading, it is important to make an honest assessment
that the money in the trading account is truly expendable. If it isn’t,
traders should keep saving until it is.
4.USE TECHNOLOGY TO YOUR ADVANTAGE:
Electronic trading has been around for a while, but the tools that
are available to modern traders are constantly improving and evolving.
Faster computers, high-speed Internet, all-electronic markets and
direct-access trading all have helped the independent retail trader.
Additional technologies, such as trade automation, innovative market
research tools and the ability to test trading systems accurately on
historical data have given traders even more powerful tools. Mobile
trading apps make it possible to scan for trading setups, enter orders
and manage positions from a smart phone or tablet, giving traders a
tremendous amount of previously unseen flexibility.
Using outdated technology can put a trader at a severe disadvantage.
Trading is a competitive business, and it is best to assume that other
market participants are taking full advantage of available trading
technology. As with many other businesses, being (and remaining)
competitive in trading means keeping up with technology.
5. DEVELOP A TRADING PLAN BASED ON YOUR RESEARCH:
A trader’s own research, not emotions or speculation, should be the
driving force behind developing a trading plan. With so much information
readily available in the public domain these days, it may be tempting
to rely on someone else’s work or research. This can backfire for a few
reasons.
First, whatever methodology is being promoted actually may not be
profitable. Second, even if it is profitable to someone else, it does
not guarantee that it will be to other traders. Different trading styles
and risk tolerances mean that trading plans are not one-size-fits-all.
Finally, traders should fully understand the logic behind a trading
plan; otherwise, it is possible to lose trust in a plan, making it
easier to deviate from the rules.
6. KNOW YOUR EXIT POSITION:
Before entering any position, traders should have an exit strategy in
place. This should be included in the trading plan and define how the
trader will get out of both winning and losing positions. Many traders
agree that money is made in the exit. This means that regardless of
where a position is entered, it’s the exits that determine if it will be
a winning or losing trade.
While we often think of trade exits in terms of dollar-based profit
targets and stop losses, there are other methods for determining exits. A
trading plan could utilize a time- or activity-based exit, such as
closing the trade after a certain number of bars have printed, after a
specified amount of time has elapsed, or at the end of the trading
session (“EOD” or end-of-day close). Exits also can be based on some
type of market activity or technical analysis. For example, a trade
could stop-and-reverse if a technical indicator gives an opposing
signal.
Regardless of approach, it is important to have an exit strategy in
place before entering any trade. It can mean the difference between not
only a winning and losing trade, but a winning and losing business.
7. MANAGE RISK AND PROTECT YOUR CAPITAL:
Properly managing risk and protecting trading capital is what keeps
traders in the game. They also should avoid risking too much on any
single trade. The generally accepted industry standard is to risk no
more than 2% on any single trade. Many traders with smaller accounts
find this limits their ability to make substantial profits and may, as a
result, risk far more. All it would take is a series of losing trades
to destroy the account.
Trading with a stop loss is another way to manage risk and protect
capital. A stop loss limits the risk that a trader is exposed to for
each trade. We all would like to always exit with a profit, but that is
not realistic. Because losing trades are inevitable, it makes sense to
know how big those trades are going to be. If the trade moves in the
wrong direction, it is closed and the trader moves on to the next
opportunity.
Being undercapitalized — not having enough money — is perhaps the
primary reason why many traders fail. This is for a couple of reasons.
One is that traders need money to make money. Imagine a trader makes a
30% gain in one year. That might be enough to live off if it’s based on a
$200,000 account. However, 30% of a $5,000 account is not enough to pay
the bills. Being undercapitalized also is detrimental because it
becomes impossible to withstand the inevitable drawdowns. Again, it
wouldn’t take many losing trades in a row to wipe out a small accout.
8. KNOW WHEN TO STOP TRADING:
There are two primary reasons to stop trading.
The first is that the trading plan is ineffective and losing more
than anticipated in historical testing. Markets change, interest and
volume in particular trading instruments vary and trading plans simply
may not perform up to expectations. It may be time to take a step back
and reevaluate the trading plan, remaining businesslike and unemotional
throughout the process. An ineffective trading plan is a problem that
needs to be solved; it does not necessarily mean the end of the
business.
The second reason to stop trading is that the trader is ineffective.
Factors such as emotions, external stress factors and bad health can
have a negative impact on trading performance. A trader could develop a
winning trading plan, but it still could fail if he is unable to execute
the plan properly. It is beneficial to both the trader and the business
to recognize any personal challenges and take measures to improve the
situation. If a trader has trouble with emotions, for example, he may
benefit from using some type of strategy automation.
9. ACCEPT YOUR LOSSES – BUT LEARN FROM THEM:
Although most traders inherently focus on winning, trading is mostly
about losing. In fact, successful traders think of trading not in terms
of how much they can win, but how much they can afford to lose.
Losses are a certainty in trading, and despite claims that some
trading plans or systems are 100% profitable, the reality is that many
successful plans win only about 40% of the time. The key is to make more
on each winning trade than is lost on each losing trade. This is what
allows traders to make money over time.
Although traders must be willing to accept losses, it is important to
learn from them as well. One method for this is to maintain a trading
journal or diary. A journal can help traders gain important feedback and
detailed information about individual trades that performance reports
cannot show. Typically, a journal includes the date, time, price,
direction, reasons for the trade and individual trade notes. This
provides a record of activity that can be used to evaluate the overall
performance of the trading plan.
10. KEEP TRADING ON PERSPECTIVE:
While it is important to remain focused each and every trading day,
it is equally important to remain focused on the big picture. One losing
trade (or day) should not be a surprise. It is a part of trading. Nor
should one winning trade (or day) be cause for a celebration. It’s just
one step along the path to long-term profitability. Because trading is a
business, it is the cumulative profits that matter.
Win or lose, trading is just another day at the office. Once a trader
accepts that wins and losses are part of the business, it is easier to
keep emotions in check.
Setting realistic goals is an essential part of keeping trading in
perspective. If a trader has a small trading account, for example, it
would not be reasonable to expect huge returns: a 30% return on a $5,000
account is much different than a 30% return on a $1 million account. It
is helpful to remember that the multimillion-dollar traders are the
exception, not the norm. Most traders who survive the tough part of the
learning curve are able to make a comfortable living.
Some of these rules are directly related. For example, part of Rule
No. 1: Treat trading as a business depends on Rule No. 2: Always use a
trading plan. And Rule No. 9: Accept your losses can help traders
fulfill Rule No. 10: Keep trading in perspective.
Together, these rules make up general guidelines that can be used by
discretionary and system traders alike. Traders who have the patience
and discipline to follow these rules can increase their odds of success
in the challenging and competitive business of trading.
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