10 rules successful traders follow
Trading is an easy business to get into: No degrees or specialized training are required, start-up costs are relatively low and it can be done from the comfort of home. The logistical ease of getting started, however, should in no way imply that becoming a profitable trader is simple.
Most experienced traders would attest that success depends on many factors including hard work, research, planning, and discipline and being a lifelong student of the markets. As with many businesses, there are certain principles that, when followed, can greatly increase the chances that a trader will be successful.
Here, we explore 10 timeless rules that are an important part of successful trading, no matter the techniques, markets or time frames you trade.
1: Treat trading like a business
As a hobby, trading quickly gets expensive: Just dabbling can prevent traders from gaining the proficiency and experience they need to become consistently profitable. As a job, trading can be discouraging because there is no such thing as a regular paycheck: Traders can work 10-hour days all week and end up empty handed on Friday. Rather than thinking in terms of a hobby or job, it is important to approach trading as a business.
Like any business, trading incurs expenses, losses, taxes, uncertainty and risk, and these factors must be taken into account. The key to developing a successful trading business is good planning, both for the overall business and for the actual trading. Traders who want to weather the learning curve and stay in the industry for the long haul will put in the time and effort to research and develop strategic plans that encompass short- and long-term goals and the details of trading: What will be traded and how it will be traded.
2: Always use a trading plan
A new trader would not have to look far to come across the well-known saying, “Plan your trade and trade your plan.”
The first part — plan your trade — is accomplished through a trading plan: A written set of rules that defines entry, exit and money management criteria. Good trading plans often are based on experience or market observations and developed through research and exhaustive testing. While it is time-consuming and challenging to develop a profitable plan, a major advantage is the consistency it delivers.
The second part of the adage — trade your plan — is, for many traders, as difficult as developing a trading plan. Trade your plan means following your trading plan exactly, without making excuses, second-guessing or otherwise deviating from the rules that were so painstakingly created. Taking trades that fall outside the plan is considered bad trading, even if they turn out to be profitable.
Often, invalid trades are the result of our emotions: Fear, greed, impatience, overconfidence, etc. Other times, they stem from our mistakes, or pilot error as it is often called. Trading your plan is not as easy as it sounds, and most traders must work hard to develop the necessary skills over time. Consistently following the rules of an effective trading plan is part of what allows a trading business to make money over time.
3: Risk only what you can afford to lose
While traders plan on making money (that’s why people trade, after all), it is important to acknowledge that it does not always work out that way. It is essential that the money used to fund a trading account be what can be lost without impeding the ability to meet other financial obligations. Losing money is difficult enough, but it is even more so if it is capital that never should have been risked in the beginning.
It should go without saying that a trading account should not be funded with money earmarked for the kids’ college funds, the mortgage or day-to-day living expenses. Aside from being a terrible idea that can lead to disastrous financial losses and unfortunate circumstances, trading with money that is not expendable can put a trader under an extraordinary amount of pressure to succeed.
Often, this type of pressure leads to bad decisions and, ultimately, losses. Prior to trading, it is important to make an honest assessment that the money in the trading account is truly expendable. If it isn’t, traders should keep saving until it is.
4: Use technology to your advantage
Electronic trading has been around for a while, but the tools that are available to modern traders are constantly improving and evolving. Faster computers, high-speed Internet, all-electronic markets and direct-access trading all have helped the independent retail trader. Additional technologies, such as trade automation, innovative market research tools and the ability to test trading systems accurately on historical data have given traders even more powerful tools. Mobile trading apps make it possible to scan for trading setups, enter orders and manage positions from a smart phone or tablet, giving traders a tremendous amount of previously unseen flexibility.
Using outdated technology can put a trader at a severe disadvantage. Trading is a competitive business, and it is best to assume that other market participants are taking full advantage of available trading technology. As with many other businesses, being (and remaining) competitive in trading means keeping up with technology.
5: Develop a trading plan based on your own research
A trader’s own research, not emotions or speculation, should be the driving force behind developing a trading plan. With so much information readily available in the public domain these days, it may be tempting to rely on someone else’s work or research. This can backfire for a few reasons.
First, whatever methodology is being promoted actually may not be profitable. Second, even if it is profitable to someone else, it does not guarantee that it will be to other traders. Different trading styles and risk tolerances mean that trading plans are not one-size-fits-all.
Finally, traders should fully understand the logic behind a trading plan; otherwise, it is possible to lose trust in a plan, making it easier to deviate from the rules.
6: Know your exit strategy
Before entering any position, traders should have an exit strategy in place. This should be included in the trading plan and define how the trader will get out of both winning and losing positions. Many traders agree that money is made in the exit. This means that regardless of where a position is entered, it’s the exits that determine if it will be a winning or losing trade.
While we often think of trade exits in terms of dollar-based profit targets and stop losses, there are other methods for determining exits. A trading plan could utilize a time- or activity-based exit, such as closing the trade after a certain number of bars have printed, after a specified amount of time has elapsed, or at the end of the trading session (“EOD” or end-of-day close). Exits also can be based on some type of market activity or technical analysis. For example, a trade could stop-and-reverse if a technical indicator gives an opposing signal.
Regardless of approach, it is important to have an exit strategy in place before entering any trade. It can mean the difference between not only a winning and losing trade, but a winning and losing business.
7: Manage risk and protect capital
Properly managing risk and protecting trading capital is what keeps traders in the game. They also should avoid risking too much on any single trade. The generally accepted industry standard is to risk no more than 2% on any single trade. Many traders with smaller accounts find this limits their ability to make substantial profits and may, as a result, risk far more. All it would take is a series of losing trades to destroy the account.
Trading with a stop loss is another way to manage risk and protect capital. A stop loss limits the risk that a trader is exposed to for each trade. We all would like to always exit with a profit, but that is not realistic. Because losing trades are inevitable, it makes sense to know how big those trades are going to be. If the trade moves in the wrong direction, it is closed and the trader moves on to the next opportunity.
Being undercapitalized — not having enough money — is perhaps the primary reason why many traders fail. This is for a couple of reasons. One is that traders need money to make money. Imagine a trader makes a 30% gain in one year. That might be enough to live off if it’s based on a $200,000 account. However, 30% of a $5,000 account is not enough to pay the bills. Being undercapitalized also is detrimental because it becomes impossible to withstand the inevitable drawdowns. Again, it wouldn’t take many losing trades in a row to wipe out a small account.
8: Know when to stop trading
There are two primary reasons to stop trading.
The first is that the trading plan is ineffective and losing more than anticipated in historical testing. Markets change, interest and volume in particular trading instruments vary and trading plans simply may not perform up to expectations. It may be time to take a step back and reevaluate the trading plan, remaining businesslike and unemotional throughout the process. An ineffective trading plan is a problem that needs to be solved; it does not necessarily mean the end of the business.
The second reason to stop trading is that the trader is ineffective. Factors such as emotions, external stress factors and bad health can have a negative impact on trading performance. A trader could develop a winning trading plan, but it still could fail if he is unable to execute the plan properly. It is beneficial to both the trader and the business to recognize any personal challenges and take measures to improve the situation. If a trader has trouble with emotions, for example, he may benefit from using some type of strategy automation.
9: Accept your losses – but learn from them
Although most traders inherently focus on winning, trading is mostly about losing. In fact, successful traders think of trading not in terms of how much they can win, but how much they can afford to lose.
Losses are a certainty in trading, and despite claims that some trading plans or systems are 100% profitable, the reality is that many successful plans win only about 40% of the time. The key is to make more on each winning trade than is lost on each losing trade. This is what allows traders to make money over time.
Although traders must be willing to accept losses, it is important to learn from them as well. One method for this is to maintain a trading journal or diary. A journal can help traders gain important feedback and detailed information about individual trades that performance reports cannot show. Typically, a journal includes the date, time, price, direction, reasons for the trade and individual trade notes. This provides a record of activity that can be used to evaluate the overall performance of the trading plan.
10: Keep trading in perspective
While it is important to remain focused each and every trading day, it is equally important to remain focused on the big picture. One losing trade (or day) should not be a surprise. It is a part of trading. Nor should one winning trade (or day) be cause for a celebration. It’s just one step along the path to long-term profitability. Because trading is a business, it is the cumulative profits that matter.
Win or lose, trading is just another day at the office. Once a trader accepts that wins and losses are part of the business, it is easier to keep emotions in check.
Setting realistic goals is an essential part of keeping trading in perspective. If a trader has a small trading account, for example, it would not be reasonable to expect huge returns: a 30% return on a $5,000 account is much different than a 30% return on a $1 million account. It is helpful to remember that the multimillion-dollar traders are the exception, not the norm. Most traders who survive the tough part of the learning curve are able to make a comfortable living.
Some of these rules are directly related. For example, part of Rule No. 1: Treat trading as a business depends on Rule No. 2: Always use a trading plan. And Rule No. 9: Accept your losses can help traders fulfill Rule No. 10: Keep trading in perspective.
Together, these rules make up general guidelines that can be used by discretionary and system traders alike. Traders who have the patience and discipline to follow these rules can increase their odds of success in the challenging and competitive business of trading.