You have to learn the rules of the game. And then you have to play better than anyone else.
--Albert Einstein
Every trader knows that he must have a good set of trading rules. However, assuming he does indeed have them, following the rules is the hardest part. We constantly violate our rules, then wonder why our strategies fail us.
Whether it's moving a stop, taking a trade outside our Trading Plan, trading against trend when our 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 is not a stretch to say that the sooner a Trader develops AND adheres to a good set of Trading Rules, the sooner he will achieve consistent profitability.
The significance of setting and following a set of Trading Rules is simple. Trading is an arena with boundless, if unpredictable, opportunity. Unfortunately, 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 attempting to interact. Traders forget the rational, well-considered plan laid out in the calmness before the market opened. They become transfixed by blinking lights, squiggly lines, and weird chart patterns (many of which are as indiscernible as most constellations). Before long they are 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 lucky, by day's (week's, month's, or year's) end, the Trader has only lost a portion of his trading capital. More often, he has lost something much more important. He has lost his ability to interact with the market profitably. The financial loss, while painful, can be overcome. Loss of confidence, on the other hand, can sound the death knell for a Trader.
How does setting and following rules help preserve a Trader's belief in herself? 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 will learn that certainty is also one of humanity's most basic needs. In a chaotic environment, that same need expands exponentially. In the market (chaotic by definition), it is virtually impossible to have certainty about the future, or more precisely, the future direction of the market. This is true notwithstanding assurances to the contrary by gurus, portfolio managers, analysts and the like. The best Traders (defined as most profitable) will tell you that they are wrong... FREQUENTLY, and that they are profitable only because their Trading Rules (and strategies) take the resulting losses into consideration.
So if it is impossible to have any real certainty about the market's future behavior, and the human Trader needs massive certainty, there is only one alternative. The successful Trader must have (or develop) certainty about how he will interact with the market. 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 a Trader can control in the market environment is himself.
Uh Oh... most people would rather try to control the market than control themselves. Feel free to give it your best shot. Just do it with a tiny account. When you destroy that account (and you will), come back and resume your path toward learning to control yourself by developing a set of Trading Rules customized to suit you and your goals.
Trading is similar to other areas of life and/or work 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 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) give her the best chance of attaining her goals.
Similarly, a Trader's Rules do not guarantee success in the market environment...nothing does. But they do provide boundaries which can help keep a Trader moving toward his ultimate goal...consistent profitability. If a Trader requires himself to ALWAYS use stops appropriately (one of my personal favorites), he does not guarantee himself success, but he does help minimize his 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 Trading Rules will:
* provide a consistent framework through which to view the market
* help Traders avoid catastrophic losses
* help Traders fully exploit an edge
* soothe the 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 the Trader to execute his Trading Plan without hesitation
There is, of course, a caveat. A Trader must be sure to adopt Trading Rules that support his style of trading. For example, Position Traders need to have an idea of what is going on in the macro environment. They need to understand what is happening in other areas that can have a significant impact on the securities they trade. Day traders, on the other hand, care much less about broad market themes as they are focused on the ultra short-term, and thus chart patterns and indicators are likely to be more relevant. As a result, a Trading Rule that requires a trader 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 the Position Trader than to the 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.
Do yourself a favor...spend as much time committing yourself to a strong set of Trading Rules as you do to searching for the Holy Grail strategy. You (and your account) will be glad you did. For a free list of common trading rules to help you get started developing your own, visit us at TheArtofSimpleTrading.com.
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