General Trading Rules
Warning: Everything on this page is someone’s opinion.
You need to form your own opinion and validate it before acting on anything!
Here’s a few tips that
hopefully will help you in your trading:
- If
you have a system (here we assume that your system is profitable!), then
follow it – to the letter. Do not try to outguess the system. Just
what will tomorrow’s markets bring?
Regardless of current price, remember there will always be a good rational
argument that can be made to either sell now or buy now. There will always
be an emotional environment of doubt. No matter which asset sector, don't
worry about what the market is going to do or the stories surrounding
them. Worry about what you are going to do in response to those markets in
the present. You can’t undo the past and you can’t predict the
future. No one can consistently predict anything!
- Make
sure your system has a exit plan and a plan to minimize
your losses.
- Long
Term market success is simple but not easy: Long term market success is
simple...simply remove your ego and submit to the process of obeying the
orders of the mathematical models. This is not easy for some as they allow
external doubt and emotional mettling to
question their commitment. Submitting to the system and always obeying the
orders from the signals is what makes for a long term successful investor!
- Don't
sacrifice your position for fluctuations.
- Don't
expect the market to end in a blaze of glory. Look out for warnings.
- Never
try to sell at the top. It isn't wise. Sell after a reaction if there is
no rally.
- Don't
imagine that a market that has once sold at 150 must be cheap at 130.
- Don't
buck the market trend.
- Don't
look for the breaks. Look out for warnings.
- Don't
try to make an average from a losing game.
- Never
keep goods that show a loss, and sell those that show a profit. Get out
with the least loss, and sit tight for greater profits.
- Manage
your risk. Position liquidations are triggered by significant adverse
price action and are never pre-determined objectives. Concentrate on
managing the risk. The returns will take care of themselves.
- Do
not attempt to buy lows and sell highs. Buy market strength (highs) and
sell market weakness (lows).
- Manage
your risk: Concentrate on managing your risk. In life, it is not how much
you make that determines the winners, it is how
much you don't lose. Avoid the major losses and the returns will take care
of themselves.
- This
site has some good info http://invest-faq.com/fiveminute/
- “Trends
always go further than rational people expect, or even imagine. Most
investors don’t have the stomach for extended rallies or declines.
The philosophy of not having a predetermined profit objective allows us to
continue with a trend for its full duration and then some. We try very
hard to avoid the pitfalls of liquidating a trade too early, even at the
cost of giving back large profits...Trends exist and they endure for a specified
time, longer than most imagine. In a very uncertain world, perhaps nothing
makes more sense than simply following trends.” John W. Henry
A Possible Approach: Trading With Limited Money
Let’s face the fact right at the start – it’s
difficult. It’s difficult for a few reasons, including
- You
have no experience
- The
only way you can reduce your risk it to trade small. If you trade small
then broker commissions make it much harder for you to make a profit.
- If
you don’t trade small, you might get wiped out. On the other hand
maybe you’ll get lucky and put it all on the right stock.
- You
probably don’t have a proven profitable system to follow
Since you have no experience, you’ll need to do a lot
of reading first. After you’ve some idea of what to do (including the “system”
you should follow) you should start “paper trading”. Only once you
have completed a few months of this should you start trading real money.
Paper Trading
Paper trading is an educational tool. It’s probably a
good idea to move on to real trading only once you have “graduated”.
Its hard to define what graduation is but it probably should be after a few
months of paper trading where you have traded at least 10 or 20 times and
overall you have made a profit.
You need to make your paper trading as real as you can.
Assuming you are going to use an online broker once you start trading real
money, you can start paper trading by opening your brokerage account and depositing
all of your trading funds. This will give you access to real time quotes and
market depths and possibly other information which will help you. It also gives
you a chance to get used to the site before you really need it.
Make your trading a realistic as possible. Start your
trading diary. Document your intentions, the signals and the orders you “make”.
If anything make your buy and sell prices worse than they really would have
been. Remember to subtract commissions from each buy and sell order.
Always remember that it’s often really easy to make a
paper profit since you really have nothing at stake and this frees you to trade
as your system dictates. You’re never going to feel the real “feelings”
of stock market greed and fear until you actually start putting some of your
own real money on the line.
Real Trading
Once you’ve placed your first order and you actually
own some stock, then you’ll be exposed to the classic stock market
feelings of fear and greed. These might come out as “the stock price
keeps dropping but I won’t sell just yet because it might go back up”
or “the price has dropped so much now it’s a real bargain”.
Both of those are signs that perhaps you are not following your system or maybe
your system needs to be revised because you are losing money!
Stock Selection
Sometimes this is called “stock picking”. But
make sure you don’t confuse this with “hot stock tips!”. There are many approaches to stock picking and this
is beyond the scope of this discussion. Choose wisely, do your research, and don’t
rely purely on a third parties picks.
Money Management and Position Sizing
“Preserve your capital”. This is a good adage
for all traders. However, if you have a small trading account then you are much
closer to having nothing than someone with a large account. In some ways you
have more on the line and hence you need to be very careful about minimizing your
losses.
You certainly need to always have a stop loss position
defined. This should be defined before you enter the trade. If you know that
you are about to purchase a stock at $1 then you should also know that you will
exit if the price goes below a certain amount e.g. $0.95. If possible use a
broker which allows you to place conditional orders. When you place a buy
order, also place a conditional sell order which will be automatically executed
on your behalf if the stock drops below a certain level.
One of the unique problems small accounts have is broker commissions.
You must size your trades such that the broker commission doesn’t make it
too hard to make a profit. Here’s an example.
You buy $500 of stock and the commission for the purchase
was $20. You have a stop loss at 5% to cut your losses.
In order to make a profit you must sell the stock and incur another
$20 commission.
So your total commission after you sell the stock is $40 or 8%
of your purchase price. This 8% overhead makes it harder for you to make a
profit and makes it easier to make a loss.
The stock must rise above $540 for you to make any money.
That’s an 8% gain. That’s a large gain before you even make
anything. If the stock rises 20% (to $600) and you sell, you’ve only made
a 12% gain.
If the stock is a loser, you’ve got a problem as well.
Your stop loss is at $475. The stock hits $475 and you sell. You’ve
actually lost a total of $65 because of commission. That’s a 13% loss. If
you set your stop loss higher, to say 2% ($490) to reduce this loss then you
have more of a risk that your stop loss will trigger the day you buy the stock
since the stock might easily fluctuate this amount in a day.
In summary:
|
Stock Purchase Price
|
$500
|
|
Commission Amount to Complete Trade
|
$40 (8%)
|
|
Breakeven Point
|
$540 (8% gain)
|
|
Maximum Loss
|
$65 (13% loss)
|
Here’s that same example for a $2000 purchase amount.
|
Stock Purchase Price
|
$2,000
|
|
Commission Amount to Complete Trade
|
$40 (2%)
|
|
Breakeven Point
|
$2,040 (2% gain)
|
|
Maximum Loss
|
$120 (6% loss)
|
In the $2000 example the stock only has to rise by 2% for
you to start making a profit. That’s significantly better than the 8% we
saw before.
Here’s what it looks like for a $20,000 trade. In this
case we assume that the flat $20 brokerage still applies.
|
Stock Purchase Price
|
$20,000
|
|
Commission Amount to Complete Trade
|
$40 (0.2%)
|
|
Breakeven Point
|
$20,040 (0.2% gain)
|
|
Maximum Loss
|
$840 (4.2% loss)
|
You should easily be able to see how larger trading accounts
instantly have a much smaller commission problem than small accounts.
So what have we determined? Larger trades are more
profitable than the same smaller trade. However, this then leads to the next
problem. Don’t go an put all of your money into one large trade.
“Spread your risk”. Another
good trading adage. It basically tells you that you should not put all
your “eggs into one basket” and do not buy just one stock so that
the commission charges are a lower percentage of your purchase. You should be
buying different companies in different market sectors. However, that’s not
so easy with a small trading account. What if you only have $10,000 to trade with?
At this level you can only be in 5 simultaneous trades at $2000 each.
There is no really good answer. You are going to have to
decide if you want to diversify into 10 stocks each at $1000 with lower chance
of profit or whether the 5 at $2000 suits you better. This really depends on
your risk profile. That is, how much risk you are happy to take. If you don’t
mind a higher risk (and potentially higher gain) then the 5 at $2000 is for you.
Risk adverse people should opt for the 10 at $1000.
Hopefully, over time (a short time!) your total trading
capital should increase. As it does, review the standard position size you use.
Even if you started with $10,000 using position sizes of $2000 (high risk with
only a stock spread of 5), once you reach $20,000 total capital you would want
to consider leaving your position size unchanged, since now you are capable of
diversifying to a more acceptable level of 10 different stocks.
Taking a careful approach such as discussed above will
enable you to gain more trading experience more quickly (you will execute more
trades and be exposed to more nuances of the markets) and still leave you with an
increasing trading capital account.