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We offer you a list of 12 fundamental principles that have been commonly referenced by market players across trading styles, time frames and markets. One thing you’ll notice is there is no mention of specific strategy or system rules. The second thing you’ll notice is that you’ve probably heard or read about these concepts somewhere before. That is because the “keys” to trading are hardly state secrets. The trick is to actually believe in such principles and use them in your day-to-day work. You can draw your own conclusions. The intention here is to shed light on the popular concepts that are commonly referenced keys to profitable trading. What do they mean and how can you use them? The answers are not always cut-and-dried, but they will expand your perspective.

1. Let your winners run, cut your losers short.

What it means: Just like it sounds – get out of losers quickly and make the most of winners. This is the granddaddy of them all. Profitable trading isn’t necessarily about having more winning trades than losing trades, although many traders base their methodologies on high winning percentages. It’s about making more on your winners than you lose on your losers. Some professional traders have more losing trades than winning trades, but they made money because their average winning trade is significantly larger than their average losing trade. The only way to attain that average win/average loss ratio is to nip losing trades in the bud and let winning trades realize their maximum potential.

Why it’s important: Having a high winning percentage is great, but the bottom line is the larger your winning trades, the more money you will make – regardless of the number of winners or losers you have. Keep two things in mind: First, one big loss can wipe out weeks or months of hard-earned profit. Second, practically every large loss starts out as small loss.

How to do it: First, always have a stop-loss in place to reduce the risk of a catastrophic loss. Another idea is to focus on finding trade setups for which the risk - determined by a technical level or some other factor - is limited and easily identifiable, and the potential reward is much greater. For example, entering a long trade when identifiable chart support is 1 point away and the nearest resistance level is 6 points away represents a low-risk trade opportunity relative to the potential profit. The stop can be placed on the opposite side of the support level, providing a quick exit and small loss if the market reverses.

2. Don’t add to losing positions.

What it means: «Dollar-cost averaging» may work for a diversified, long-term investment portfolio, but for traders, buying more when the market is moving down (or selling more when the market is moving up) only makes the equity hole you’re in deeper and harder to climb out of. This  rule is directly related to Rule №1. Keeping your losses small dictates getting out of positions as quickly as possible when the market moves against you. If you’re going to add to a position, do it when the market is moving in your favor, not against you.

Why it’s important: Again, large losses start out as small losses. Losing trades should be treated like weeds in a garden: Kill them quickly when they water and fertilizer and encourage them to grow.

How to do it: Honor thy stops!

3. Don’t fight the trend/tape

What it means: Place your trades in the direction of the prevailing trend, not against it.

Why it’s important: For most traders, trading against the trend is like swimming upstream - you may get somewhere, but it takes a lot more work than going with the flow. Markets trend less than they fluctuate randomly, but identifying trends - regardless of the time frame - still offers the best odds of profit for most traders. Countertrend trading requires much more discipline and execution experience. This doesn’t mean every trader must be a long-term trend follower. Short-term traders swim downstream - that is, they put momentum on their side - by placing trades in the direction of the larger trend. Trading corrections (pull-backs) within longer-term trends is the basis for many short-term approaches. With apologies to random walkers, trends do exist - and efficient traders capitalize on them, one way to another.

How to do it. Use trend filters - technical tools or calculations that allow you to determine the prevailing trend on whatever time frame you-re trading - and only act on trade signals in the direction of that trend. Also, determine what the trend is on the time frame longer than the one you-re trading (i.e., daily if you’re trading intraday, weekly if you’re trading on daily charts, etc.) to make sure you know if you-re trading the short-term, intermediate or long-term trend. In other words, know where your trade fits into the context of the larger market picture.

4. Buy strength and sell weakness, not the other way around.

What it means: Buy markets that are exhibiting strength and have the potential for more upside movement. Sell markets that are showing weakness and have the potential for more downside movement. In other words, avoid the impulse to try to catch tops and bottoms. Instead, buy new highs and sell new lows, which is contrary to the intuition of most inexperienced traders. When a market pushes to new highs, it is, by definition, exhibiting strength - precisely what you’re looking for in a buying opportunity; vice versa for a market making new lows.

Why it’s important: This rule keeps you trading with the momentum instead of fighting it.

How to do it: Find markets with trends and place trades in the direction of that trend. Also, find stocks with strong relative strength compared to the rest of the market. Of course, it is necessary to exercise caution when markets make extreme, climatic moves, or approach historical high or low levels. However, practicing the kind do risk control guidelines referenced in this article will limit the risk of catastrophic loss.

5. Trade your personality.

What it means: Trading is not a one-size-fits all proposition. While certain basic principles (particularly regarding risk control) are relatively universal, successful traders run the gamut from long-term stock investors to intraday futures traders. What do they have in common? They use approaches that fit their psyches.

Why it’s important: We all have different tolerances for risk, and perceptions regarding which markets to trade and how  to trade them. You have to find an approach that fits your personality and market outlook. If you don’t understand, believe in and fell comfortable with what you’re doing, you won’t be able to execute your strategy consistently over time. Instead,  you’ll get nervous and abandon your strategy the minute you have a few losing trades. Every trading approach or system will have its rough patches; you have to be able to trade through them to survive in the long run. The same trading strategy in the hands of two traders will yield entirely different results if one trader is comfortable to make money using someone else’s profitable trading system).

How to do it: Research, test and trade small until you find an approach - and an execution process - that makes sense to you and that you can apply consistently given your market outlook, financial resources and time commitment. 

6. Plan your trade and trade your plane.

What is means: Have a plan for everything - when you’ll get in, how much you’ll risk, where you’ll take a profit, where you’ll take a loss, what you’ll do if this happens. Then, execute your plan. Also, it’s important to know why you do these things. If you don’t, you won’t really understand your approach and you won’t be able to follow it consistently (see Rule №5).

Why it’s important: In a business where so much (e.g., the behaviour of the market) is out of your hands, bringing structure and discipline to what you do is essential. How to do it: Map out your strategy in detail, then test it and paper trade before you ever place a trade for real money. When you start trading, use a small trade size to limit risk. Adhere to your trading rules, and judge your performance initially not by dollars made or dollars lost, but by how efficiently you execute your plan. Keep in mind that trading plans can and should be analyzed and adjusted as time passes. Trading is not a static process: it’s an ongoing learning curve.

7. When the reason for entering a trade is no longer valid, get out.

What it means: Having a trading plan implies you have an objective, logical reason for putting on a trade: a signal generated by a mechanical trading system, the completion of a chart pattern and so on. Market conditions at a certain time suggested it was advantageous to put on a position. When those conditions no longer exist, there’s no reason to be in the trade.

Why it’s important: Knowing when and why to get out of a trade is just as important as knowing why to get into one in the first place. Letting losers run and not capturing profits are the end results of not having an exit plan or a stop-loss strategy. Setting up your trading guidelines or system rules in advance gives you a map of action before you put on a trade.

How to do it:  It goes back to having a plan. Know what to do regardless of what the market does. Set your stop-loss to get out of a position when the original trade premise has been negated. In other words, learn to take a loss automatically and unemotionally.

8. Don’t be the weak money

What it mean: Don’t be undercapitalized! Have enough money is your account to trade your strategy comfortably and not get shaken out of the market unnecessarily. You should get knocked out of a position when idea for the trade was wrong, not because you didn’t have enough money to survive the trade’s inherent risk.

Why it’s important: Trading without sufficient capital is one of the top killers of new traders. It takes more money (and time and effort) than most people imagine to make a living in the markets. Turning a $5,000 grubstake into millions is, by and large, market fantasy. Remember: Weak money tends to be scared money, which usually becomes someone else’s money.

How to do it: Back-test and paper trade your strategy to determine its risk and likely drawdown (which will always be bigger in reality than it is testing). If your research indicates you need $50,000 to trade your strategy comfortably, don’t try to trade it with only $20,000. Alternately, you may consider decreasing your trade size and risk proportionally.

9. Keep a trade diary.

What it means: Keep a written record and analysis of your trades: when and why you put them on, what the results were, what actions you did and didn’t take.

Why it’s important: Those who forget market history are doomed to repeat it. Keeping a record of all your trades will reveal patterns - good and bad - in your trading (as well as tendencies in the markets themselves), helping you eliminate negative habits and reinforce positive ones.

How to do it: It’s easy. Log the elements of every trade you make - entry, initial stop, adjusted stop, exit, profit or loss - and throw in a chart to boot, if you can or the system it was based on. Analyze what you did right, what you did wrong and what you can do better next time. Note the broader market conditions or circumstances surrounding the trade. If you’re a very active trader and cannot log every trade, consider summarizing the session’s trading at the end of the day. Review your records on a regular basis to keep lessons fresh and develop ideas for improving your trading.

10. Never risk more than 5 percent of your account equity on a trade, and try to stay in the 1-to 2 - percent range.

What it means: Never expose more than 5 percent of your total account equity on any one trade. For example, if you have $50,000, you should never risk more than $2,500 on a position; more conservatively, you should not risk more than $1,000.

Why it’s important: Many traders, especially beginners, risk too much on their positions. This runs counter to Rule No 1, which dictates avoiding disasters by keeping losses small. By limiting your risk to a small percentage of your total account equity, you reduce the odds of being ruined by one or two bad trades.

How to do it: Don’t trade until you have enough money in your account to trade in accord with this kind of conservative guideline. If you find you don’t have enough money for a trade, you have to make a decision to: 1) increase your equity; 2) reduce your trade size; or 3) not take the trade.

11. Risk a fixed percentage of capital on every trade.

What it means: This is really just an extension of Rule №10. Just as it’s better to add to winning trades than losing trades, it is also better to increase your trade size as your account equity grows, and decrease it as your equity drops. However, the percentage of your equity risked stays the same.

Why it’s important: Consistency (striving for it, if not always achieving it) is a key characteristic of profitable trading. Keeping your risk consistent across your portfolio (of trades) helps ensure that you don’t risk too much on any one position. Your risk will be consistent no matter how high or low your  account goes.

How to do it: Risk a fixed percentage of your account equity per trade. Or increase your trade size only when your account equity grows to a certain level (do the opposite if your account shrinks), keeping your risk in the line with the previously described parameters.

12. Focus on market selection.

What it means: Find the markets that give your trading strategy the best chances of success.

Why it’s important: Some people are so focused on the «how» of trading - e.g., where to enter - they almost forget the «what». In a universe of thousands of stocks, futures, options and currencies, it’s necessary to concentrate on instruments with the most potential. Identifying those markets most likely to move - up or down - makes applying your strategy that much easier. For example, is the market you trade liquid? Does it fall within your volatility parameters? A stock that has been stuck in a 6-point trading range for five months with average daily volume of 20,000 is not a particularly attractive trading candidate for a large, active swing trader.

How to do it: Screen potential trade candidates based on the criteria for your strategy - e. g., whether they’re trending, whether they-re showing strength (or weakness) relative to the rest of the market, whether they’re in strong or weak market sectors, etc. - and concentrate your trading to them.

  © Samant Inc.