“I am free because I know that I alone am morally responsible for everything I do. I am free, no matter what rules surround me. If I find them tolerable, I tolerate them; if I find them too obnoxious, I break them. I am free because I know that I alone am morally responsible for everything I do.”
— Robert A. Heinlein
Every Trader knows that he must have a high quality set of Simple Trading Rules.
However, assuming he does indeed have them, following said rules is the hardest part.
As traders, we constantly violate our rules, then wonder why our strategies fail us. Whether it’s
- moving a stop,
- taking a trade outside our Simple Trading Plan,
- trading against trend when history shows that we trade better with the trend, or
- risking an inordinate amount on a single trade because “it can’t lose”
Many beginning traders spend an extraordinary amount of time extricating themselves from bad situations resulting from a failure to stay within their rules. It’s not a stretch to say that the sooner you develop AND adhere to a good set of Simple Trading Rules, the sooner you can achieve consistent profitability.
WHY ARE SIMPLE TRADING RULES IMPORTANT?
So now that the significance of setting and following a set of Simple Trading Rules is obvious (and it IS obvious right?), let’s have a slightly deeper look at why these rules are so important.
Trading (more specifically, securities trading) is an arena with boundless, if unpredictable, opportunity. Unfortunately, that means it also has boundless, unpredictable risk.
In such an environment, humans (and most Traders are human notwithstanding rumors to the contrary) tend to become highly emotional and, as a result, as unpredictable as the market with which they are trying to interact. Despite their best intentions, they forget the rational, well-considered plan that assembled in the calmness before the market opened. They become transfixed by blinking lights, squiggly lines, and weird chart patterns (many of which are barely more discernible than constellations).
Before long they’re jumping in and out of positions basing decisions on everything from a whim to ascending triangles to upside down head and shoulders to the oscillator du jour. If they’re lucky, by day’s (week’s, month’s, or year’s) end, they’ve only lost a portion of their trading capital.
More often however, they’ve lost something much more important. They’ve lost their ability to interact with the market with confidence. The financial loss, while painful, can be overcome.
Loss of confidence, on the other hand, usually sounds the death knell for their trading.
Now I’m willing to bet they “is” you and you “is” them…
How does setting and following rules help preserve your belief in yourself?
WHEREFORE ART THOU CONFIDENCE?
Confidence is generally a function of certainty. Websters Dictionary defines confidence as:
“certitude; assurance: He described the situation with such confidence that the audience believed him completely.”
Study psychology in the most rudimentary way and you’ll learn that certainty is also one of humanity’s most basic needs. In a chaotic environment that need expands exponentially.
In the market (chaotic by definition), it is virtually impossible to have certainty about the future, or more precisely, the market’s future direction. This is true notwithstanding assurances to the contrary by gurus, portfolio managers, analysts, brokers and the like.
The best Traders (defined as the most profitable) will tell you that they’re “wrong” on their trades… FREQUENTLY, and that they are profitable overall ONLY because their Trading Rules (and strategies) account for those frequent losses by making sure the losses are small (in magnitude) relative to the wins.
So if it is impossible to have any real certainty about the market’s future behavior, and as a human Trader you need massive certainty, there’s only one alternative.
To be a successful Simple Trader you must have (or develop) certainty about how you will react to the market’s machinations. Magic tricks and mysticism aside, it is impossible to force, cajole, beg or will the market to do anything other than what it pleases. The only thing you can control in the market environment is yourself.
Uh Oh… most of you would rather try to control the market than control yourselves wouldn’t you?
That’s okay… feel free to give it your best shot.
Just do it with a tiny account. When you destroy that account (and you likely will), come back and resume your path toward learning to control yourself in the trading environment by developing a set of Simple Trading Rules customized to suit you and your goals.
Trading is similar to other areas of life and/or professions that require high levels of discipline and focus. For example, as part of her study rules, a law student may require herself to read a minimum number of pages each night. She may also require herself to independently brief (you don’t need to know what brief means except that it’s more work) every case that she reads before referring to study aids for further explanation. She does this as part of a broader set of study rules to help her stay on top of the massive amounts of information she must wade through. This, in turn, will help her achieve her ultimate goals of learning the material and performing well on exams. Notice that the student’s rules help keep her on the path toward her ultimate goals. They provide boundaries. They do not automate the learning process, but they do, in her estimation, (and in truth to be honest) give her the best chance of reaching her goals.
Similarly, your Simple Trading Rules do not guarantee success in the market environment…
But the rules do provide boundaries which can help keep you moving toward your ultimate goal…consistent profitability.
If you require yourself to ALWAYS use stops appropriately (one of my personal favorites) you don’t guarantee yourself success, but you do help minimize your chance of failure (also known as blowing up). Reduce the chance of failure and you increase your probability of success by giving yourself time to learn and accumulate profits.
Well developed and religiously applied Simple Trading Rules will:
* provide a consistent framework through which to view the market
* help you avoid catastrophic losses
* help you fully exploit your Edge
* soothe your emotional beast
* maximize certainty in an uncertain environment (you don’t know what the market will do, but you do know what you will do)
* free you to execute your Simple Trading Plan without hesitation
There is, of course, a caveat.
A DOG CAN’T BE A CAT
You must be sure to adopt Simple Trading Rules that support your style of trading. For example, as a Position Trader you need to have an idea of what is going on in the macro environment. You need to understand what is happening in other areas that can have a significant impact on the securities you trade.
As a Day Trader, on the other hand, you care much less about broad market themes as you are focused on the ultra short term. Thus chart patterns and indicators are more relevant.
As a result, a Simple Trading Rule that requires you to know and understand what is going on at the macro level each day (through news and other non-price data) would be more helpful to you as a Position Trader than as a Day Trader.
In fact, many Day Traders say they have to do the exact opposite (avoid paying too much attention to pre-open news) as the information tends to distort their view of price action. I talk about this particular idea in a discussion of my Simple Day Trading Principle DKDC .
Do yourself a favor…spend as much time committing yourself to a strong set of Simple Trading Rules as you do to searching for the Holy Grail strategy. You (and your account) will be glad you did.