| 1 Introduction | | | | around. Given that trades are either winners or |
| In this article we cover the few important rules that | | | | losers, and this one is shouting 'Loser' at you, the |
| should never be broken in trading. If you can apply | | | | chances that it will turn around and become a large |
| these rules consistently, and with discipline, you will be | | | | winner is tiny. Why risk any more money on this |
| well on the way to being a profitable trader. | | | | losing trade, when you could simply close it out |
| The rules we cover are:o Have specific goals and | | | | (accept the loss) and move on. This will leave you in |
| objectiveso Be consistent and disciplinedo Let profits | | | | a much better place financially and mentally, than |
| runo Cut losses shorto Never add to a losing tradeo | | | | holding the position and hoping it will go back your |
| Don't take too much risko Only trade positive | | | | way. Even if it did do this, the mental energy and |
| expectancy systemso Minimize all trading business | | | | negative feelings from holding the losing position are |
| costso Be well educatedo Don't trade scared money | | | | not worth it. Always stick to your rules and exit a |
| Each of the rules will now be discussed. | | | | position if it hits your stop point. |
| 2 The Golden Rules of Trading | | | | 2.5 Never add to a losing trade |
| The following sections outline a set of rules that can | | | | One of the few trade management rules that we |
| significantly improve your chances of success if they | | | | can state we never break is 'Never add to a losing |
| are understood, practiced, and implemented | | | | trade'. Trades are split into winners and losers, and if |
| consistently in your trading. These rules have been | | | | a trade is a loser, the chances of it turning right |
| learned the hard way, by study, research, | | | | around and becoming a winner are too small to risk |
| trial-and-error, and the inevitable mistakes that | | | | more money on. If indeed it is a winner disguised as |
| everyone makes when they start a trading business. | | | | a loser, why not wait until it shows it's true colors |
| We hope that you can learn from the work we have | | | | (and becomes a winner)before you add to it. |
| done, and benefit from our experience. The rules will | | | | If you do this you will notice that nearly always the |
| now be discussed. | | | | trade ends up hitting your stop loss and does not |
| 2.1 Have specific goals and objectives | | | | look back. Sometimes the trade turns around before |
| Few things are more important to your trading | | | | it hits your stop and becomes a winner and you can |
| success than having set (i.e. written) goals and | | | | count yourself very fortunate. Sometimes the trade |
| objective for what you are aiming to achieve. It is | | | | hits your stop loss and thenturns around and |
| amazing to me how often we hit our targets, meet | | | | becomes a winner and you can count yourself |
| our objectives, and reach our goals only when we | | | | unlucky. Whatever the result, it is never worth adding |
| articulate them and write them down. | | | | to a loser, hoping that it will become a winner. The |
| For any business to be successful it must have | | | | odds of success are just too low to risk more capital |
| measurable objectives that are actually achievable. In | | | | in addition to the initial risk. |
| trading (obviously) the primary objective is to make | | | | 2.6 Don't take too much risk |
| money, but it is important to have other objectives | | | | One of the most devastating mistakes any trader |
| that are not purely cash-related. We must always | | | | can make is risking too much of their capital on a |
| remember that reward and risk go hand-in-hand in | | | | single trade. One thing is certain in trading and that is |
| trading and that we cannot expect to achieve high | | | | if you lose all your capital you are out of the game. |
| returns without planning for high risk (i.e. | | | | Why risk so much you could be prevented from |
| draw-downs). | | | | continuing? There is a saying inpoker than going all-in |
| Your objectives and goals will be very specific to | | | | (risking all your chips) works every time but once. |
| you, but they must have the following characteristics | | | | This is true of trading. |
| to be useful:o Be measurable (in completion and | | | | If you risk all your account on every trade it only |
| timeframe)o Be achievableo Be worthwhileo Be | | | | takes one loser to wipe you out (and no trading |
| positive | | | | method is 100% accurate), so you will be out of the |
| As an example, here are some of our current | | | | game at some point - it is only a question of time. |
| objectives (this is only a partial list):o Develop 2 new | | | | In general, we only risk 1-3% of the available capital |
| positive-expectancy trading systems each yearo | | | | allocated to a system on any individual trade. This is |
| Make fewer errors implementing our trading systems | | | | calculated using the size and, the difference between |
| each yearo Achieve a return to maximum | | | | our entry price and our maximum stop price, and the |
| draw-down ratio of 1.5:1o Take 2 weeks vacation | | | | amount of capital allocated to the system. With the |
| each year | | | | win probabilityand ratio of size of winning trades to |
| Note that only one of them is about making money, | | | | losing trades we are almost certain never to lose all |
| and that has a measurable objective that is relative | | | | of our trading capital. In fact, the chance of us hitting |
| to draw-down, not absolute (i.e. make 100% per | | | | our maximum drawdown for the year is tiny. |
| year). If you know what you are trying to achieve, | | | | All trades should be of a size that almost seems |
| and when you are trying to achieve it, the whole | | | | insignificant. If you are worried about the size of a |
| business will be focused on meetingyour objectives | | | | trade then it is too big and you should reduce the |
| and help guide you to only pay attention to things | | | | size immediately. Remember that longevity is the key |
| you really want to achieve with your limited time and | | | | to making money by trading - slowly over a long |
| resources. This will also give you a way to measure | | | | time with minimal risk, is always preferable to rapidly |
| the success and progress of your trading. Generally | | | | with too much risk. |
| traders with well-defined objectives will be much | | | | 2.7 Only trade positive expectancy systems |
| more successful than those that do not have | | | | If you have a positive expectancy trading system, |
| pre-defined goals. | | | | the only factors that determine how much money |
| 2.2 Be consistent and disciplined | | | | you will make per year are the number of trades the |
| In order to realize the full potential of your trading | | | | system generates, how much capital you allocate to |
| systems it is critical that you take every trading | | | | the system, and how accurately you implement the |
| entry, adjust every stop, and close out every trade | | | | trading signals. If you do not know whether your |
| as and when your system says you should do. This | | | | trading system is positive expectancy then why are |
| takes extreme confidence in your trading systems, | | | | you trading it? Expectancy is calculated using the |
| good robust reliable technology, and the mental | | | | profit or loss on each trade (net of trading |
| discipline to stick to your trading plan whatever | | | | implementationcosts) divided by the initial risk (using |
| happens (assuming it is complete). | | | | your stop loss) and then taking the average of this |
| An underlying assumption about being consistent and | | | | number of a series of trades. Systems that have |
| disciplined is that you have a pre-defined plan for | | | | positive expectancy will make money on average and |
| every situation you may face in your trading, so that | | | | those with negative expectancy will lose money. |
| you know how you are defining what being | | | | Successful traders only trade systems where the |
| consistent is. Your plan needs to include at least the | | | | odds of success are in their favor (i.e. the system is |
| following items:o All your trading rules for entering, | | | | positive expectancy) so they know that making |
| adding to, and exiting positionso What you will do if | | | | money is the result of accurately implementing the |
| your trading computer, internet connection, broker, | | | | system and not just pure luck. |
| power, telephoneetc. failso What you will do if you | | | | 2.8 Minimize all trading business costs |
| are unable to tradeo What you will do if you lose | | | | Some trading systems have only marginal profitability, |
| X% of your accounto What you will do if all the | | | | and trading implementation costs (commission, |
| markets are closed and you can't exit your positions | | | | spread, and slippage) can be the difference between |
| Unless you write the answers down to all these | | | | profitability and making a loss. With the easy |
| issues, you cannot be consistent and disciplined in | | | | availability of modern electronic brokers, and |
| your approach to trading and if you lose money you | | | | fully-automated trade processing andexecution, it is |
| will not know whether it is because you didn't follow | | | | definitely worthwhile looking for a very low cost way |
| your plan, because your plan is incomplete, because | | | | to implement your trading system. High commission, |
| your systems do not work, or simply because you | | | | wide spreads, and large amount of slippage can be |
| are going through a losing period. | | | | reduced considerably simply by carefully choosing a |
| 2.3 Let profits run | | | | broker. This can be the difference between a |
| This simple rule is the key to being a successful | | | | system |
| trader. It is three simple words that are very hard to | | | | (especially a high frequency one) being useable or |
| actually implement. When we get a profitable trade | | | | not. Paying too much for trade implementation is an |
| our natural fear of losing the unrealized cash kicks in | | | | avoidable way to lose money. |
| and we truly want to close it out now and take the | | | | 2.9 Be educated |
| money. Most trading consists of long periods of small | | | | In order to compete at the highest level in the |
| winners and losers followed by a few huge winners | | | | trading business and be one of the few truly |
| that make the difference between overall profitability | | | | successful participants you must be well-educated |
| and simply breaking even or losing due to trading | | | | about what you are doing. This does not mean |
| costs(commissions, spread, and slippage). | | | | having a degree from a well-respected university - |
| It is our ability to let the huge winners become just | | | | the market doesn't care where you were educated. |
| that - huge - that determines how we will perform | | | | Being well-educated means that you have thoroughly |
| overall during the year. The key to letting winners run | | | | researched and tested your trading ideas and know |
| is to have trailing stops that are outside the daily | | | | why your trading system worked in the past and is |
| noise of the market so that they are not tight | | | | continuing to work now. It means understanding all |
| enough to get stopped out during 'normal' trading. | | | | the technology and applications that your system |
| This means being prepared to give up a significant | | | | needs to perform accurately. |
| portion of a winning trade's open profit and is the | | | | It means understanding your goal and objectives and |
| thing that makes this so hard to implement. In fact, | | | | how trading will achieve these. It means |
| we should be adding to a winner and widening stops | | | | understanding yourself and how your personality |
| rather than working out how tight our stops can be | | | | affects your results. It means understanding the |
| to capture maximum profit. The trade has already | | | | markets and instruments you trade. |
| shown you that it intends to be a winner, and the | | | | In order to succeed you really need to become an |
| chances are it is a low-risk idea to add to the position | | | | expert in your own trading business to understand |
| now rather than 'strangle it' with stops that are too | | | | how it all fits together, when it is broken, and how it |
| tight. | | | | can be improved. As with all worthwhile endeavors, |
| It is very important that your position management | | | | this takes commitment, hard work, dedication, and |
| rules allow for large winning trades, and that the rules | | | | more hard work. |
| are pre-defined and understood before you place the | | | | 2.10 Don't trade scared money |
| trade. This will allow you (if you have confidence in | | | | Lastly, no one ever made any money trading when |
| your method and discipline) to stick to your rules | | | | they had to do it to pay the mortgage at the end of |
| when you do get the bigwinner. | | | | the month. Having a requirement to make X dollars |
| 2.4 Cut losses short | | | | per month or you will be financially in trouble is the |
| This is the sister rule to the previous one, and is | | | | best way I know to completely mess up all trading |
| usually just as difficult to implement (although itis | | | | discipline, rules, objectives, andleads quickly to |
| very easy to define). In the same way that | | | | disaster. |
| profitability comes from a few large winning trades, | | | | Trading is about taking a reasonable risk in order to |
| capital preservation comes from avoiding the few | | | | achieve a good reward. The markets and how and |
| large losers that the market will toss your way each | | | | when they give up their profits is not under your |
| year. Setting a maximum loss point before you enter | | | | control. Do not trade if you need the money to pay |
| the trade so you know before-hand approximately | | | | bills. Do not trade if your business and personal |
| how much you are risking on this particular position is | | | | expenses are not covered byanother income stream |
| relatively straightforward. You simply need to have a | | | | or cash reserve. This will only lead to additional |
| exit price that says to you 'this trade is a loser and I | | | | unmanageable stress and be very detrimental to your |
| will exit before it gets any bigger'. Due to gaps at the | | | | trading performance. |
| open, or limit moves in futures we can never be | | | | 3 Summary |
| 100%certain that we can get out with our maximum | | | | In this article we have covered the rules that we |
| loss, but simply having the rules, and always sticking | | | | believe should never be broken in trading. If you |
| to it will save us from the nasty trades that just | | | | work on never breaking them, your trading should |
| keep on going and going against our position until we | | | | improve dramatically. |
| have lost more than many winning trades can make | | | | We sincerely hope this information has helped you to |
| back. | | | | improve your trading performance. |
| If you have a losing position that is at you maximum | | | | Good luck in your trading. |
| loss point, just get out. Do not hope that it will turn | | | | |