Specialty Skills

Set Rules and Keep Them – Your Path to Trading Success

Dr. Woody Johnson

I am sure you have heard this saying, “Rules are made to be broken.”  Well, it might make some sense in other parts of life, but in trading this is plain and simple hogwash.  Rules, and of course by that I mean effective rules are close to if not at the top of the list of essentials for trading.  Let’s consider the types of rules that we’re referencing here.  There are rules for strategies, planning, charting, entries, targets, stops and exits.  Additionally, there are rules for money management and risk management; along with many, many more.  Part of the definition of “rule” is that it is a “governing action” or “procedure.”  When you consider governing action a rule just summarizes the way that rule based trading relates to results oriented trading.  This is because rules are essential to the trading process.  Actually, if you are trading either without rules, or if you are not following the rules that you have then it is unlikely you will be profitable. It is that plain and simple.  Trading rules can be said to govern because they represent the scaffolding of your thoughts, emotions, behaviors, setups, and trade management.  In this way, well thought out rules make the difference between being successful and blowing up your account.

Rules for trading

Now, the other thing to consider as we discuss rules is that humans live by the stories that they have constructed from early in life much like a script to a play.  These stories or scripts can be termed rules as well.  They form the foundation of your behavior.  In fact, as humans grow, they develop a set of typical response patterns to reoccurring events.  These typical responses or patterns of behavior could be termed a list of rules that you live by.  For example, if you incur a debt, you are expected to pay it back.  If you are driving, there are rules to follow for both safety and the orderly movement of traffic.    These lists of “rules” are reflected in your every decision.  These rules or life stories also involve the lessons learned from your earliest years, and those lessons have created the lenses through which the world is seen and judged – rules about money, privilege, and power; along with rules about worthiness, winning and losing.  Therefore, not only are rules essential to trading, but these rules must be in your best interest.

Another important point to consider is that your core rules (those deeply programmed and conditioned beliefs about you and life) are below your awareness level.  You make critical choices based upon these life rules, and when you get results that you do not want, changing those results can be extremely difficult if you are not also changing the rules that those results were based upon in the first place.  In other words, if your choices go unchallenged then the awareness of why you made the choice remain out of conscious touch.  However, once the rule is identified, it can be confronted and changed.  Also, as you challenge each rule you uncover other assumptions; assumptions that turn out to be myth rather than truth and that were based upon that rule.  The interesting thing about mythology is that if you believe it to be real, it is not mythology; it is truth to you, even as it does not serve you.  Consider this example: trader Debbie believes in “taking advantage of every opportunity in life.”  This belief becomes truth in her mind and generally may not be a problem for her.  However, in the markets if at every turn of the price action you are looking to impulsively enter then there is a distinct susceptibility to the disadvantage of overtrading.  In fact, this simple yet powerful “myth” can cause your downfall in trading even though it can serve you in other parts of your life.  This ineffective rule leads to behavior that is not your A-Game.  It can be termed a “Fool’s Rule.”  Fool’s Rules are beliefs and biases that are outgrowths of bad programming and conditioning.  Consider some other “Fools Rules” or trading myths:

  • Do not use stop losses
  • Try to use economic news releases as trend indicators
  • Only try to catch market tops and bottoms
  • Trade just before the news to make hundreds of points in a couple of seconds
  • Trade at least 50 positions a day to make a ton of cash
  • On a price action pattern, jump in early to make the most profit
  • Keep all of your losing trades open and add to your losing positions until the market comes back and get out at break even or small profits
  • Make sure your position size is big in order to make big money

So, it’s important to ensure that your rules support your A-Game, your highest and best trader while in the markets. That’s why you’ll want to have a list of rules that are geared toward your Internal Data (thoughts, emotions, and behaviors that underlie your trade) as well as your Mechanical Data (everything that has to do with the mechanics of the trade – setups, price action, indicators, news, economic reports, etc.).  In other words, you want to support your trading mind-set and emotional stability in order to have a fierce focus on what-matter-most.  Below are a number of rules that are designed to support your Internal Data

  • Learn to exit when necessary:  If you find that you are violating a rule, exit the trade…even if you are making a profit.  If you stay in you are only reinforcing bad behavior. Especially if you are making a profit.
  • Hope is a 4 letter word: Refuse to take that trader drug “hopium” and putting your hard earned money up to pure chance.
  • Move your perspective: Flexibility is the key (both literally and figuratively).  Learn to change when necessary. If you always do what you’ve always done, you’ll always get what you’ve always gotten.  And, if you always think what you’ve always thought, you’ll always do what you’ve always done.
  • Know your risks: Always calculate your risk to reward ratio and stick to the parameters.  This is the way you can have a 33% hit rate and still be profitable.
  • Be accountable for your performance:  Set goals and document your thoughts and emotions (Internal Data) and as well your Mechanical Data (the mechanics of the trade).  You are responsible for your own decisions.  Own your mistakes.
  •  Mind-Set:  Learn to manage your negative emotions and harness your positive emotions (ex. Determination, inspiration, passion, joy, etc.) and understand the emotions of those around you.  Always remember what General Patton said: “if everyone is thinking the same then someone isn’t thinking.”   Also the famous Buffett quote: “Be fearful when others are greedy and greedy when others are fearful.”
  • Remain Consistent:  Do not adjust a strategy, a rule or principle in order to conform to the market. Instead, let the market conform to your strategy. Have a target, set a rule, let a particular part of the market conform to this rule, follow the rule without deviating. “If you stand for nothing, you’ll fall for anything.”  Alex Hamilton
  • Your Clan (the what-matters-most in your life): There is more to life than trading and investing.  Don’t live to trade.  Trade to live.  Being the richest man or woman in the graveyard does nothing for your quality of life.

When you think through your rules look at them as though they were your landmarks or signposts along a dangerous and uncharted journey to point you to your destination.  In other words, your rules are critical to your long-term trading survival.  Remember, trading from your highest and best self is all that matters to your trading results.  The trading trenches are not a place to venture into unprepared and unfocused.  Trading is a 90 – 95% mental game and if you don’t have mental and emotional tools it is like driving without a steering wheel – you’ll crash and burn without it.  So, let your rules be your guide to drive consistent trading results. This is what we teach in “Mastering the Mental Game” Online and On-location courses; ask you Online Trading Academy representative for more information.   Also, get my book, “From Pain to Profit: Secrets of the Peak Performance Trader.”

Happy Trading,

Dr. Woody Johnson

This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.