10 Trading Commandments

[Alchemist]

Daytrading, scalping, tape reading, rebate trading, swing trading, pairs trading, basket trading, trading the news, system trading. What do all these trading strategies have in common? Well, first of all, most of them are strategies aimed at capitalizing on very short term price moves of financial instruments, be it stocks, derivatives, or forex. Second, they don’t take into account fundamental analysis of the instruments traded. They are strictly technical strategies. However, third and foremost, all these trading strategies share a common trait of paramount importance: traders using them must adhere to a basic set of rules, if they want to be successful with them.

Over the week-end, I had some fun jotting down what I think are very simple but effective rules every trader should follow and build his trading career on. These rules have accompanied me for the last 9 years and helped me get to the point where I am.

• LEARN TO TAKE A LOSS

This may make you smile, but learning to take a loss is extremely important if you want to be successful at trading. Taking a loss means you have to admit to yourself you were wrong. Unfortunately, most people have a problem with that. It’s an ego thing. Trading is among a few endeavors in life in which every day you are faced with the possibility of admitting to yourself you are a loser. The sooner you are able to get your pride out of the way, the quicker you will be able to continue your trading journey. Losses are part of everyday life. Buy or short 100 shares of your favorite stock. Do nothing with it and wait until it goes negative on you. Then, take the loss and see how it feels. Repeat the process until you honestly feel comfortable with it. When you do, move on to the next step.

• TRADE WITH YOUR BRAINS, NOT YOUR HEART

Emotions, emotions, emotions. Emotions are trading’s worst enemy. In order to be successful at trading, you must have no feelings. Period. Keep your emotions out of the trading sphere. They bring about second guessing, make you feel personally attached to a trading position, and cause trade entry/exit misjudgments. You definitely don’t want any of those in your life from 9:30 to 4:00!!

• NEVER OUTSMART THE MARKET

The market is always smarter than you. What’s more, the market is always right. Don’t try to outsmart it. It won’t work. Learn to understand it. Listen to it and adapt accordingly.

• BE A TRADER, NOT AN INVESTOR.

Even though a trader can also be a longer term investor at the same time, he must never mix the two activities. To make a long story short: don’t let a trade become a long term investment. Sooner than you think you will find yourself tying up a large chunk if not all of your trading capital, having no money left to trade. A trade turned into a long term investment is usually a sign of an inability to take a loss and admit you were wrong. Keep the two activities separated and don’t fool yourself. Letting a trade turn into an investment means sabotaging your original plans for that particular trade.

• DISCIPLINE BRINGS PERFECTION

In order to make it at trading, you have to be an extremely disciplined person. If you are not already a disciplined person in your everyday life, I strongly urge you to reconsider whether trading may be right for you or not. Being disciplined means being able to set up a plan, be it a trading plan of whatever other life plan, and STICK to it, both in good and bad times. In other words, it means bringing the plan to life. Are you up for it?

• PLAYING WITH SCARED MONEY IS A LOSER’S PROPOSITION

Never ever play with scared money. I will repeat that: NEVER EVER PLAY WITH SCARED MONEY. Scared money is whatever funds you have not originally meant to be used as trading capital. It might be your life savings, your college money, your mortgage money. In other words, it’s money you CANNOT (and don’t want to) afford to loose. Playing with scared money means you will most likely allow emotions to get into the trading game. This, in turn, will sabotage your trading plan and your discipline will suffer greatly from it. Consequently, your odds of making it at trading will be greatly reduced, especially during your learning curve. A possible solution to this would be not to live trade until you have apportioned enough risk money and are comfortable with the possibility of loosing it all.

• TRADING THE PLAN

To be successful at anything in life, you have to have a plan. Trading is no exception. Before taking the leap, make sure you have devoted enough time to developing a proper trading plan. Winning trading plans all share several common traits. For example, they should lay out clearly WHAT your goals are for a particular trade or strategy. This includes listing your risk tolerance and skill assessment. Then, they should set forth HOW you are going to achieve those goals. Last, they should outline all possible outcomes and relative course of action, in case things don’t go as planned. Trading must be treated as a business, and every business must have a plan to be successful.

• BUY WHEN TIMES ARE BAD AND SELL WHEN TIMES ARE GOOD

Fortunes are made when you buy at dirt cheap prices (i.e. in bad times) and sell at dear prices (i.e. in good times). Not only does this apply to long term investing, but to intraday and shorter term trading. Learn to take the other side of what the amateurs are doing. If everyone is buying, it’s time to start distributing some. If everyone is selling, it’s time to start accumulating some. Be a pro, not an amateur!

• PERCEPTION BECOMES REALITY IN THE MARKETS

In the markets, it’s not “what is” that keeps them moving. Rather, it’s what is perceived to be. Most of the times, things are not as they seem to be. Being able to discern between the two is the key to understanding the psychology that moves the markets and make it all happen.

• OVERTRADING LEADS THE WAY TO THE POOR HOUSE

Overtrading is the second worst trading’s enemy. Overtrading, usually undertaken during dead zone hours (i.e. 11 AM to 14 PM), is mainly caused by boredom. Market activity and volatility usually subsidizes during those hours. As a result, traders are constantly looking for (unnecessarily) for money-making trading opportunities which, in reality, are very hard to materialize. Consequently, most traders tend to give back most if not all of early trading gains. You don’t have to take every single trade, especially those with poor risk-reward ratios. Enjoy staying on the sidelines every now and then and, if you feel bored, just go take a walk or do some shopping!

[OverTheTop]

here I am again, congratulating you on your third article. I enjoyed reading your 10 Trading Commandments, which brought to my attention a few important points which go well beyond the usual "cut your losers, and let your winners run" kind of advice.

I especially like your "Learn to take a loss" and "Playing with scared money is a loser's proposition" commandments, as I feel once again, they discuss a certain trading approach very similar to mine.

I'm learning to take losses myself, and you know what, it's starting to feel right, finally. I can feel my trading fears are fewer and fewer and I hope to soon improve even more.

thank you!!

[MomentumTrader]

Alchemist,

your 10 trading commandments are golden. As OverTheTop says, they are not the usual trading maxims everybody knows. They provide a valuable insight into what trading is all about. "Trade with your brains, not your heart" couldn't be any truer than that. If I only learnt that sooner.....

nice articles!

[hansi1337]

Originally Posted by Alchemist

Taking a loss means you have to admit to yourself you were wrong. Unfortunately, most people have a problem with that. It’s an ego thing. Trading is among a few endeavors in life in which every day you are faced with the possibility of admitting to yourself you are a loser. The sooner you are able to get your pride out of the way, the quicker you will be able to continue your trading journey.

I disagree with that point. There is no concept or strategy without any drawdown. The big picture counts. Rigorously following a profitable system and taking losses as expected within the historical bounds is as good as it can get. You are neither a loser nor making anything wrong then and therefore don’t have to admit that to yourself. Taking a loss can be absolutely the right thing to do and accomplishing that makes you a winner.

Overall your guidelines are good I think.

[Alchemist]

Originally Posted by hansi1337

I disagree with that point. There is no concept or strategy without any drawdown. The big picture counts. Rigorously following a profitable system and taking losses as expected within the historical bounds is as good as it can get. You are neither a loser nor making anything wrong then and therefore don’t have to admit that to yourself. Taking a loss can be absolutely the right thing to do and accomplishing that makes you a winner.

Overall your guidelines are good I think.

By saying "Taking a loss means you have to admit to yourself you were wrong.", I meant on a per-trade basis. Of course, your system can be profitable overall. Actually, there are systems which only win 60% of the time, and still manage to make money, thanks to rigid money management rules.

Are you aware that a good percentage of new traders have a problem taking a loss even on a per-trade basis?

It's good to get as many perspectives as possible, though.

[Leth]

Originally Posted by hansi1337

I disagree with that point. There is no concept or strategy without any drawdown. The big picture counts. Rigorously following a profitable system and taking losses as expected within the historical bounds is as good as it can get. You are neither a loser nor making anything wrong then and therefore don’t have to admit that to yourself. Taking a loss can be absolutely the right thing to do and accomplishing that makes you a winner.

Overall your guidelines are good I think.

I believe you may have taken alchemist's post out of context. what i mean by this is that i freely admit to being a loser and do so everyday....i actually make it a point to do so. i do this because knowing how to be a good loser makes me able to be a consistant winner. being able to admit to being a loser in the market is definately humbling to your ego. humble traders make the best traders. just my perspective though....take it as you will.

[hansi1337]

I think it’s about a positive attitude. Your mind limits you to everything you can be. If you think of yourself as a loser you will be a loser. I always try to think only the best of myself. If you want to achieve the extraordinary your thoughts need to be extraordinary. Your thoughts control what you do and that controls who you are.

"For most people, it's not what they are that holds them back, it's what they think they are not." - John Maxwell

My opinion is if you follow your trading plan, concept, system or strategy and take a loss, it’s still all good. Of course even the best strategies may fail. Bad ones fail very quickly. So you need rules when to abandon your system before starting to trade.

[visz963]

"BUY WHEN TIMES ARE BAD AND SELL WHEN TIMES ARE GOOD"

That cannot be considered a general rule. There are strategies doing just the opposite. All depends on the details in that case. Instead of this I would say dont play when the opportunity is already gone.

The rest looks good.

[HighBid]

Great read.