Market Related Articles » Success and What it Takes » Financial Survival
Most people would not go on a Safari alone because they may not survive, however, many stock and futures traders fail to follow any rules and expect a positive outcome in their business. Rules in trading are your guidelines to basically "cut losses" and to "prolong winning trades".
I doubt that any of these Trading Survival Rules will be new to you and they all most likely have been around for hundreds of years. They should however, all be embedded into your memory and your Trading Plan.
1. If Price "looks cheap", there is probably a good reason for it
There is no rule that says price cannot become cheaper. Many significant named companies have dragged once successful traders down with them.
In 1999-2001 there was CMG, Inc. (CMGI), a tech stock that traded to $160 per share in January 2000. Then, after the Internet bubble burst, CMGI eventually traded under $2.00 per share. At what point did it "look cheap"?
As recent as 2008, General Motors Corp., (GM) stock traded to nearly $30.00 before trending lower. It eventually priced under $4.00 in November of that same year. At what point did it "look cheap"? This was a company that many professionals watched closely and owned because it was an American barometer of success.
The best rule here and a popular trader's saying is, "Don't try to catch a falling knife". Consider buying only stocks that are trending up and that do not have technical tops threatening in their charts. Don't try to pick the low in a stock - look for stocks that have reversed and are trending higher.
2. A Trend is your friend
This rule goes hand in hand with Rule #1 above. Why buy something that is heading in the wrong direction? Although technically there are reasons to buy at Major support levels, but only with a tight stop-loss in place. This old saying is a golden rule. There are often powerful trading houses like Goldman Sachs at work when momentum is in a stock or future contract. This is especially true if there is some negativity surrounding the issue and the "smart money" is dumping shares. Don't try to fight it - be patient and wait until it starts to build a base before buying.
3. Liquidity is the life-blood of a stock
Liquidity is the ability to trade in a stock without adversely affecting it's market price. We target stocks that we expect to trade at least 500,000 shares per day so we have sufficient buyers and sellers to provide liquidity to us. One of the worst feelings a trader can experience is entering a trade and then finding that exiting it is challenging. There is not a thing you can do but wait for a buyer or seller to take your order. This may take many minutes, hours, days, or in extreme cases - never at all.
There are hundreds if not thousands of high volume trades available each day. Take a pass on the lower volume companies - no matter how good they look.
4. Stay away from Uncle Ronnie's stock pics!
This always starts with a conversation about a friend of a friend's brother who works for a company that has a ground breaking product and "their stock is going to fly - you have to get in now!" These pumped stocks also pop into your email box with some wonderful story written about how well the featured company is doing - and of course, "You have to buy now or you'll miss the rally!"
What you will find most of the time is that their trading volume will be extremely low. The game here is to convince enough people to buy this stock so that those who are promoting this push - and may be trapped in it - can get out. Often this is accompanied with a handsome profit for them, but others who took the bait are now stuck in a horrible trade.
Never react quickly to a tip, as they rarely are profitable. Treat these as you would any stock that you might trade. Follow your Trading Plan and do your homework first. The trap in trading a tip often ends with a large loss because as the stock starts to move against you, you are more inclined to break your rules and hold it. Human nature is the trap, because of the so-called "reliable information" that you have been told about the company's future. Trade smart.
5. Long, Short, and Cash - "The Three Positions"
This is a rule that I have taught for years. "Cash is the third position!". There frankly are days that are very difficult to trade and "cash is king". It takes patience to refrain from trading when conditions are not quite right, but this is one of the traits that molds a so-called normal trader - into a great trader. Don't trade for the sake of trading and never force a position. If you are not comfortable, then stay in cash.
Never forget that CASH IS A SAFE POSITION!
6. Keep Position Size in-check
I have a personal friend who lost over $2.3 million dollars in a single year by ignoring this lesson. Failure to understand and manage position size will severely hurt your chances of long term success. This comes back again to developing a Trading Plan and strictly following it.
Your position-sizing model will ensure that you do not commit too much of your trading capital to any single position. As an example, if you generally trade $5,000 on a position, then only increase dollar size in a direct proportion to how your trading account is growing. You should never have all of your capital in a single trade.
7. Cut Your Losses
If we were to take a poll of successful traders, we probably can bet that many would select this rule as being the most important practice they follow. A sure death in this business is to allow your bad trades to continue to eat your capital away. If your Trading Plan has a 2% loss rule, then follow it. Whatever it is do not second guess it - get out if your rules are tested! To preserve capital, is a primary function of trading stocks and futures that you must always follow.
8. Let Your Profits Run
This is the other side of the "Cut Your Losses" rule. Mastering these two rules will allow you to build your business while winning trades less than 50% of the time. Yes, you can lose more than half of your trades and still prosper! While this certainly is not what we hope for at TradeSeven.com, it should open your eyes to how important these two rules are.
You need to ensure that when you have a profitable trade, that you obtain the most out of the move. You should work to not close a position prior to seeing a reverse in direction or a signal from a technical indicator(s) on your system. Don't simply exit just to "take the money". Some up-trends and down-trends take time to develop. One good trade can outweigh many small losses over time.
9. Summary
One thing we know is that human nature likes to test the boundaries of rules. Unfortunately in the business of trading stocks and futures this can be a death sentence to your account. Again, I can not emphasize enough how important it is to create a Trading Plan and to follow your Trading Rules.
The ultimate achievement you are after is to be able to trade in a "totally mechanical manner". A lack of discipline and the involvement of emotion must be controlled - and once this is done - it will allow your trading to be a lot of fun and will provide to you a wonderful feeling of accomplishment in your life!