Trading Rules

If you trade for a while, you will see a lot of rules lists. These are guidelines put together by individuals so they can attempt to, bluntly stated, avoid screwing up like they have in the past.

There is a lot of overlap among rule lists, and most of these lists aren't worth much, particularly in cases where they comprise dozens of different rules. On reading these, one can conclude the writer of the list has made a glittering variety of errors that he believes he can circumvent if only he has a lengthy-enough document to follow.

I've got my own list, but it is short and sweet. I ignore some of these rules from time to time, and virtually every time I do, I regret it.

It has cost me a huge amount of money to formulate these "trading laws", and I offer them up - as I do everything on this blog - for free, with the hope that it will help some of you. If one day I can follow these rules absolutely consistently, I'll be a much better trader for it. An acronym for the rules below is SOB FEES, which is appropriate considering how many tears were spent attaining them.

Stops - a stop price must be in place at all times for all positions.

Opening Bell - no new positions should be initiated in the first 30 minutes of any trading session. In addition, after-hours trading is to be avoided altogether, since the volume is terribly thin and thus prone to easy manipulation.

Brakes - if you are a swing trader, as I consider myself to be, you need to periodically "brake" your portfolio. By that I mean, at times of a short-term trend change, take on a position equal in size to the whole of your positions, but in the opposite direction. An ETF, such as SPY, is the most efficient way to do this. In this manner, if there is a short-term trend change, you can ride it out with more neutral risk. If the change doesn't materialize, you will be stopped-out, and the loss will be your insurance premium for insulating yourself against a contra-trend.

Freshness - positions should be regularly refreshed for the sake of updated stops. This is especially important when the market has moved in your direction a meaningful amount so that you can lock in some profits with tighter stops.

Emotional Awareness - use emotional awareness to your advantage, understanding fear often accompanies reversals in your favor and hubris often accompanies reversals against your positions.

Exits - the only acceptable exit is either being stopped out of a position or reaching a target price which has a clear technical rationale, and even in cases of the latter, partial exits are preferable to outright closes.

Sizing - initial position sizing must be consistent among instrument types irrespective of anticipated opportunity.

Following these rules consistently isn't easy. But every year I get a little better at it, and every year I do better in my trading. I urge you to consider making these rules an important part of your trading life.