Rules to Live By
Understanding trading online or DAT, market psychology and technical analysis is all very well and good, however, they all must be controlled to be useful.
Control, therefore, speaks of a plan, and the implementation of the plan is governed by discipline.
This whole concept of a systematic approach to trading is considered risk management.
Risk management involves two basic controls – discipline and capital preservation.
Developing a trading plan includes many different facets. To start, simply sit down and list your goals.
Our Investment Questionnaire can help you determine the strategy that best fits your individual goals, whether you want to focus on saving for retirement, generating income or both.
Once you have your goals down, start to look at how you will achieve them. Write down exactly how you will study, do research, select proper stock candidates and when you are going to this.
This is the beginning. While most of you do not "know" exactly what trading style is going to fit you, you need to start somewhere.
Perhaps the following is a beginning:
"Hi, my name is Jake and I am going to be a swing trader.
I understand that this is a serious profession and that I have a lot of learning to go through before I will be successful.
I will set up a program in which I will take a series of professional level classes to better understand this world.
I will set aside every Saturday morning from 10am to 2pm to read a book on swing trading.
I will watch the market everyday it is open to better understand how things work and why it reacts to specific news.
My goal is to be completely independent within one year with a net income equaling my current salary."
The next step is to set up rules that you can trade and survive by.
These rules must be yours. You must set them and then live by them. A breaking of these rules will cost you a great deal of capital.
While the following list is a starting point, you must write it in your own words and aim it at your personality.
Here are a few simple risk management rules to start with:
- Start with small share size. Share size is the single best control on risk.
If you trade only 100 shares (or even less) as a beginner, you will learn to trade. You will have losers but they won’t cost you much.
You will be able to concentrate on your trade plan without a lot of anxiety on how much you are losing.
Please understand that losing is every much a part of trading as research, hard work, patience and making a profit.
We know that you cannot make very much money (if at all) with only a hundred shares.
But you have a much better chance of surviving long enough to identify the flaws in your plans, and possibly in yourself.
- Learn to cut your losers quickly. Everybody says they know this – but most end up with very bad losses because they do not see the tables turning on them.
Once the trade starts to go bad, beginners tend to "hope" that it will turn in their favor.
Thus, any good trader always has a predetermined "stop loss." A stop loss is a price that you are obligated to close the trade at.
It is predetermined that if your plan does not seem to be working, then this is all you are willing to lose in this particular circumstance.
Stops can be placed mechanically or mentally. Which do you feel is the more solid way to operate?
Obviously, if upon opening a trade, you immediately set a stop loss, then you have already removed the temptation to change your mind and flirt with your emotions.
Whether mental or mechanical, stops MUST be used. When in doubt – get out!
- Trading is an assumption of risk and the control of it.
If you open a transaction, you must have a plan to see the trade through to the end – win or lose. As a novice, you will be tempted to
take a fast move based on news, yet not know the stock’s characteristics.
You will be tempted to hold a position overnight – you cannot control what happens overnight.
Earthquakes, floods, or bad earning reports can change the risk level to incredible heights.
The beginner should plan to be flat at the end of the day, otherwise they are taking unncessary risk, assuming that tomorrow will be "good".
Risk is equal to reward. If the risk goes up, did your trade plan account for a higher profit to warrant this increase?
- Stick with a couple of stocks. Each security has its own personality. It behaves in a specific manner most of the time.
If you are looking at 10, 20 or 100 stocks, there is too much information for you to research and retain.
Choose one or two equities to start with. Learn them inside and out.
You will hear some old traders say, "Oh, I don’t care who the company is, I can trade it if it moves."
This is wonderful for them, however, if you are reading this, you are not one of them – yet.
Both fundamental and technical analysis need to be used. You need to use every resource at your disposal so you learn how to understand stock behavior.
You need to know its ADV, its ATR, its Beta, who the major players are in that stock, what its specific price levels are, where support and resistance are – yes, and many, many more things.
By learning one or two stocks, you can become familiar with them very quickly, and have some valid insights as to where their prices are headed.
- Stick to your share size. Don’t be doubling up on share size to make up for a losing trade or a losing day.
Both will happen, so expect them. Go on with your plan. If you start jumping up your share size, your risk is being magnified.
The money you lost is gone. You will never see "that" money again. The market will provide you with endless opportunity to get "new" money, so don’t chase the old.
- Try to be aloof from the outcome of the trade. Emotions have little or no part in professional level trading.
You need to learn to trade for the sake of trading skill, not for the money.
You need to develop the ability to open a position simply to see how it comes out, regardless of whether you made money or lost it.
If you are focused on the money, then you cannot be focused on the trade. Winning can be just as detrimental as losing.
If your eyes start to spin because you are up in a position, then you might be thinking of how to spend the money when you should be looking for the turn against you.
Conversely, if you are getting near your stop loss and worried about the money – well, we have all heard the cliché, "Scared money never wins" – again you would not be focused on the trade itself.
- Never open a position just prior to a major market announcement.
Economic indicators, earnings reports, and the congressional hearings of Ben Bernanke, chairman of the Federal Open Market Committee, all offer the market a chance to flip into an entirely different direction from your calculations.
Instead, wait until the announcement is made and then move with the market.
- Stay away from extremely volatile stocks. This presupposes you recognize a volatile stock.
This caliber of stock has ruined more accounts for beginners than anything else.
Every one of us can give in to greed. We see a stock with a flying price of 25 points and say, "Wow, I could make a ton on that one!" The reality is that without the proper skills and experience, these high-flyers are more likely to lose you a "ton."
For several months (if not years), learn to play high liquidity, smooth trading stocks and go with the prevailing trend.
If you do not see the trend, then do not trade. Learn to identify volatile stocks through their percentage moves, their higher spreads and their limited liquidity.
These are just a taste of the many rules you will need to develop to help guide your trading plan.
Some seem trite; others have to be experienced to appreciate the full depth of their meanings.
No matter what the list ends up being, it is your force of character, your discipline to honor these rules, which make them worthwhile.
In the final evaluation, you are the only one responsible for your actions. The market cannot hurt you unless you let it hurt you.
You decided on the stock, you decided which direction to go, you opened the trade – nobody else did these things, only you.
If you allow the trade to go badly against you, it was not your broker’s fault, it was not that pesky darned stock, and it was not the chart that let it happen.
People who can quickly and decisively admit they were wrong to themselves have a good chance at being successful in this field of endeavor.
Those who continually blame others, the system or bad luck will wash themselves out through their very denial.