Many people mistakenly think that the behavior of markets is truly predictable. They open up the trading platform, draw a few lines, add some indicators, perhaps also pay attention to news and announcements, and expect the market to duly submit to their price targets. Well, of course, if they last long enough, they’ll come to realize that it’s all nonsense. In reality, the market couldn’t care less that you just bought this break-out with an expected 1:3 risk: reward ratio. There will be periods when you’ll be wrong so often that you’ll be tempted to think of the market as a person who acts just to spite you.
Trading is all about odds, and in order to be successful, you must always keep the odds in your favor. To do this, you have to have rules, and stick to them. What you see below is by no means an exhaustive list, just the most important points that I could think of this morning:
- Always use stop losses. You should always know the point at which the market proves you’re wrong before opening the trade.
- Trade with a plan. Even if you’re on the demo, you have to understand why you do things the way you do.
- Be patient and don’t over-trade. You can program an EA or flip a coin – heads means a long position, tails a short one – and take ten or more trades a day. But if you do this, only your broker will be happy at the end of the month. The way to make money is to watch the markets you are interested in and wait until as many factors as possible are in your favor before taking a position. Each currency pair, stock index or commodity has its own unique pace and trading characteristics. Don’t trade until you feel familiar with the price action of your market and then wait for opportunities to bank large profits if you are right and small losses if you are wrong.
- Cut losses short, let your profits run. This rule has been commonly stated for so long that one would think by now everyone follows it, right? Wrong! It’s one of the most violated rules of all, both by beginners and more advanced traders.
- Don’t let a profit turn into a loss. Once you’re profitable on a trade, you should raise your stop to break-even as soon as the price action indicates that it’s possible (usually once you’re up at least 1 risk). One of the most painful personal experiences that imprinted this rule in my mind took place in November 2008 when after being up some 200 pips on an EUR/JPY short I watched in disbelief how in a matter of hours it turned into a -300 pips loss after a speech of Tim Geithner.
- Don’t average losers. This is just a corollary of rule 4. Averaging down is just postponing and aggravating the loss you’re unwilling to take right now. Of course, on a few occasions, you’ll get away with it. But eventually not even the ‘Queen’s Bank‘ will be able to save your account.
- Don’t trade on tips or on a guru’s analysis. Nowadays, we’re inundated with trading tips, fundamental and technical analyses. Free or paid, you’ll find them on a large number of websites or forums. The overwhelming majority (+98%) come from persons who don’t trade at all, dabble a bit in trading or are failed traders. You don’t have to actively look for them like in the old days, on the contrary, it takes the effort to insulate yourself from all this noise.
- Always analyze your mistakes. Here’s an important distinction: A losing trade isn’t necessarily a mistake, and a mistake isn’t necessarily a losing trade. In other words, you can make a good trade and lose money, or you can make a mistake and still bank a profit. If you can truly and honestly identify the reasons why you made a mistake, then your chances of making it again are much slimmer. Mistakes are usually our best teachers; they reinforce the fact that you should always follow the rules.