Golden rules of trading

Traders should take steps, prior to embarking on every trade, to limit the impact that an unprofitable trade could have on their capital.

Protect your capital

Traders should take steps, prior to embarking on every trade, to limit the impact that an unprofitable trade could have on their capital. For any trader their capital is their life blood and therefore should be protected as a priority. Without it they are not only unable to make money but are unable to trade. Therefore limiting risk, even if this means elongating the time taken to achieve ones targets, is a must. The key tools that can be used to do this are Stop Losses and Limiting Exposure.

Stop losses should always be used and never moved away from the market A stop loss should always be used and just as importantly should be used correctly. The golden rule of Stop Losses is that they should never be moved away from the market once the trade is opened. If a trader feels that their stop loss is incorrectly placed, they are recognising that the foundations of their trade are incorrect and therefore they should close out. The best way to place a stop loss is to take the mindset of ‘If this stop loss is touched, I have judged the market wrongly and I should close out’. Once closed out, the trader can always re-evaluate the situation and go back into the market if the market conditions are favourable.

Limit exposure

Limiting exposure simply means limit the percentage of your capital that is exposed both to one sector and to the market as a whole at any one time. This will usually mean limiting your exposure to approximately 5% of capital. The theory behind this is that, should the market go against you in all your positions on the same day, you will still be able to trade in the same manner as before.

Never average down

Every trade should have a well thought out structure in regards to entry and exit. A trader should never average down. Averaging down is a method used to try and double up on a losing position in an effort to lower the average entry price obtained during a losing move.

This is not the same as averaging in, which involves entering the market slightly early with half of the position size in order to take ensure that ,should the market bounce prematurely, the trading opportunity is not lost.

Let profits run and cut losses short Stop losses should never be moved away from the market. Be disciplined with yourself, when your stop loss level is touched, get out. If a trade is proving profitable, don’t be afraid to track the market. Theoretically a trade should never be simply closed out manually; it should always be closed out by a stop loss. This allows the trader to lock in profit but never prevent further profit from being made.

Employ a risk reward ratio

The use of a minimum risk: reward ratio when planning a trade is imperative. The actual ratio that traders use will vary depending on their experience. A typical Risk: Reward ratio that a trader might look for when assessing a trade is 1:3 or £/$ 1 of potential loss in the trade for every £/$ 3 of potential profit. Even if you are trading on a moving average crossover or another imprecise method, you should still be aware of what your potential losses are and what your potential reward could be.

Never stop learning

A trader should never stop learning. As the markets are dynamic and are constantly evolving, any trader that becomes stagnant will eventually start to lose money.

Never trade scared

Trading scared or undercapitalised is one of the leading causes of unnecessary losses. Emotions such as greed and fear often cause errors in judgement and are always present however they are heightened when trading under pressure.

Don’t be afraid to go home

No trader should ever be hesitant to stop trading and if necessary walk away for the day. A morning losing streak is more often than not compounded by the trader that continues to trade. By walking away, you are not being lazy, but being mindful of the fact that something is wrong that day and that you are not in tune with the markets. Walking away is nothing to be ashamed of. Come back fresh the next day.

Plan your trade and trade your plan

All trades should be planned with risk, reward and capital allowances taken into account. Any trade that is taken on the fly is nothing more than a gamble.

Don’t look too hard for your trades, wait for the good ones to come to you

There are so many markets to trade that there are endless supplies of really good quality high probability trades. If you are looking too hard for trades, you will end up moving into positions which you have falsely convinced yourself are high probability trades. The better a trade, the more it will jump out of the charts at you.

Every loss is a learning opportunity, take time out to take advantage of it

Every loss making trade is a learning opportunity. By definition, if you have made a loss, you have misjudged the market. Therefore to move on to the next trade without fully reviewing the last will only increase the likelihood that you will repeat the mistake.

Don’t trade blindly from others trade ideas

Traders new to the markets frequently place trades based on others recommendations. Any trading activity should always be researched in depth. Not doing so will prevent the trader from being able to react to any changes in the market during the life of a trade. Remember positive information being released about the market can still have a detrimental effect on price and anything that you read in the papers is old news, as professional traders will have heard about it and reacted accordingly the previous day.