As a trader, one of the things I like to do is take notes onobservations, both trade specific and trader specific. I was flipping through some of my notes and wanted to share some of the rules I have followed which generally apply to all traders.
- Develop your own philosophy and guiding principles
- Never trade on other's advice
- Define your trades before entering them and constantly reiterate your reasons
- Keep a record of your market observations
- Do not be afraid of taking risks (or losses)
- Make a risk control plan and follow it
- Accept failure and persevere
I will go into detail below, Let me know if you have any more tips that you would like to contribute.
Develop your own philosophy and guiding principles
There is no single path for succeeding in the markets. I am a firm believer that anyone can be a profitable trader if they work hard enough. It is important to know yourself and find a suitable strategy for your personality. Develop your own philosophy and guiding principles in an approach that is comfortable to you. Master your approach by methodologically improving it over time.
The key thing to note is that you need a plan and a direction. As many before me said, “trading is not a hobby, hobbies cost money”. If you are really serious about trading in the markets, make a business plan. Treat your endeavor as an enterprise and work at it until it generates thegoals that you set. Once you meet your goals, set higher goals.
Never trade on other's advice
I can not stress enough the importance of doing your own research. If you do not put in the time to truly understand the securities that you are trading and the reasons for your trades, then you will certainly miss important factors.
Some may note this bullet as “Never trade solely on other's advice”, but I really mean is to never trade on other's advice at all. If you hear advice from a professional source and its not inside information, then you can be sure that either the optimum risk-reward relationship has already passed or that they are not telling you about something. If you read or hear about an investment opportunity in publicly traded securities in the media, its old news and probably not a good trade.
If you hear advice on something that is not published and looks like it has not come to fruition yet, then you should do a great deal of research but should still be cautious. The investment likely doesn't conform to your style and because you did not originally identify the entry opportunity, it is likely that you will not be able to identify the exit opportunity as well.
Define your trades before entering them and constantly reiterate your reasons
One of the biggest mistakes people make is that they spend too much time trying to discover a great entry strategy and not enough time on when to exit. Make an argument or stock pitch for everything you plan on trading. Know why you are making the bet, what can go wrong, and where your outlook tells you a security can go. Make entry and exit points based on this research. When you do your research, focus on the drivers of the stock (i.e. the catalysts) and embed those drivers into your argument for making a trade.
After you have done your research and executed a trade, let the market decide if you are right. Remember, the market is not biased, and if the market tells you that you are wrong by going against you, you should not be stubborn. If the trade has not hit its exit or entry point, constantly reiterate your reasons for the trade on a daily or weekly basis. Do the same drivers or catalysts still hold true, or put in other words, are you still in the trade for the same reason that you entered it for?
It should be noted that sometimes entry or exit points are not hit. If you are investing in “deep value” stocks for example, a stock might not move out of a tight range for weeks or months. These could be considered value traps and may require specific types of events to occur for their unrealized value to be recognized. In those cases, it may also be helpful to define a time constraint on your trades as well.
Keep a record of your market observations
Trading is a lifelong process of learning and gaining experience. Times change and so do trading environments, but patterns do repeat. It can be hard to remember exactly how you perceived different environments at the time that they were occurring. Keeping notes (personally or in blog form) can be an effective way of recalling past environments and situations.
Another important way to take notes to is analyze your past trades. Looking back at your past trades, you can analyze your mistakes and find ways to improve your decision making. If you take detailed notes and really ingrain what happened, how you reacted, and what good or bad decisions you made, you will be better equip to handle similar market situations in the future.
Do not be afraid of taking risks (or losses)
Do not confuse risk control with fear of risk. Understanding risk-reward scenarios is an essential trait for a trader. Despite all of the conventional wisdom about being conservative with your money, it doesn't directly apply to trading. If you have proper risk controls, have done your homework, and have great conviction behind an idea, then you have an obligation to make a trade despite the sentiment of others. The key thing to remember again is having proper risk control.
Sometimes too much market experience will shy people away from taking risks. The key to not becoming scared after taking losses is to fall back on your convictions. Identify and execute on your high conviction strategies (over 60% probability situations) and remember to eliminate the emotion from the trade.
There is also a great deal of conventional wisdom surrounding the importance for diversification. While diversification is an essential tool for managing portfolios over longer periods of time, there is also the risk of being over diversified and eliminating the possibility of generate. Do not fall for the trap of over diversification. Use common sense when taking risks. There is never a need to make all or nothing portfolio bets.
Make a risk control plan and follow it
Most traders are only right 50 to 60 percent of the time. What really makes traders profitable is knowing how quickly admit when you are wrong and eliminate risk. For most people, knowing when you are wrong comes with experience trading. Regardless of your experience level, you should develop a plan for minimizing risk that is ingrained into your strategy. Some examples of the things you can plan:
- Define the degree of diversification (correlation, beta) in your portfolio
- Define the use of leverage
- Define your bands of net exposure
- Define the usage of hedging, shorting, or options
- Set limits on position size
- Set points that you are willing to take a profit or loss
That is just a taste of some of the rules you can set, but it is just as important to follow the rules that you set. Never fall victim to making emotional decisions. If a trade hit a point where you defined taking a loss, then take the loss without thinking about it. Carefully set your rules and follow them without doubt. This is how you preserve your capital from excessive losses.
Accept failure and preserve
Although you may know someone who was successful from the start, countless other traders who faced early failures have gone on to achieve unbelievable success. Accepting failure is about understanding that nothing in life or trading comes easy. It takes patience and perseverance to develop a system that works for you. One of the ironic things about trading is that many people get into it because they view it as a way to make easy money; however, once people learn the amount of work that it takes to research ideas and the degree of discipline it takes to successfully execute on ideas, they quickly shy away.
If you want to be a successful trader or really be successful at anything you need to learn humility. You need to develop the patience to learn and develop. And you need to develop the courage to follow your ambitions.
If you have anymore rules that you define your trades by, please let me know in the comments!