The Day Trader’s Rules for Success

The Day Trader’s Rules for Success

"I had an aunt in Yucatan

Who bought a python from a man

And kept it for a pet

She died, because she never knew

These simple little rules and few

The snake is living yet."    

-HILAIRE BELLOC

Day traders are no different in their unwillingness to follow rules than are most traders. The good news is that if the day trader fails to follow the rules of successful trading, his or her end will come swiftly and decisively. The consequences will be quick and the lesson will be a definitive one. There will be very little waiting or wondering. Why is this good news? I say it's good news because when you break the rules of profitable day trading you'll get your feedback promptly. And this will give you an opportunity to change and to learn, provided you want to. The position trader, on the other hand, may often need to wait many weeks or even months before he or she realizes that a faux pas has been committed. And this will slow the learning process significantly.

It is impossible for me to overemphasize the fact that consistently profitable traders, and in particular, consistently profitable day traders, are great because they have mastered the discipline of trading as well as the necessary and reliable mechanical aspects of day trading. Throughout this book I have emphasized the great importance of self-discipline as a trader. Clearly, the weakest link in the chain of trading is the trader. There can be no consistent success without a mastery of self and self-discipline. There are many opinions as to what constitutes discipline. And there are many different opinions as to how one may undertake the often arduous and self-effacing task of acquiring self-discipline.

Different traders, different writers, and different behavioral   analysts will give you distinctly different opinions, all based in part on their observations and experiences. But take care if you heed any advice you are given by someone who has never traded. Unless the individual who is giving you assistance is a professional psychologist, counsellor, or behavioral therapist, take all points of view and all directions of assistance with a few grains of salt.

Know that the following suggestions and observations have been tempered and shaped by nearly 30 years of trading, market analysis, research, and observation. My trading has exposed me to every conceivable type of market and every conceivable type of news event. My trading has taken me to the highest of emotional highs and the lowest of emotional lows. I have been on all sides of the trading fence. I have broken practically every rule in the book, and I have even broken rules that were not in the book. My own losses and failures have forced me to develop an arsenal of time- tested methods, attitudes, opinions, and procedures, which I now share with you. The best way for me to convey this information is by listing, not necessarily in order of importance, what I have discovered.

Determine Your Orientation—Know Your Direction

One of the most important things a day trader can do is to arrive at a comfortable and confident place in terms of system, method, procedure, and orientation. It is important for the trader to find his or her place in the ever-growing world of day-trading possibilities. What markets should you trade? What systems or indicators should you use? What quotation system or data feed should you use? How often should you trade? Should you be a "scalper" or should you take things more slowly? Should you give up your job to trade full-time or should you wait and take things slowly?

There are many things a day trader can do, but only a limited number of them can be done at the same time. Using the information presented in this book and in The Compleat Day Trader, find one or several techniques that make sense to you. Try them out on paper or on a modest basis in real time until you feel confident with them. These will be the techniques you should use in your trading.

Once you have chosen your methods, use them consistently, day in and day out, whenever you have a signal or a trade. Make a commitment to trade the signals strictly by the rules for a certain amount of time, for a given number of trades, or for a given amount of risk capital.

You will find that certain techniques work best in certain markets: S&P futures, for example, are especially well suited to the many of the systems I have described earlier. However, you may not feel comfortable with S&P futures. T-bond futures are particularly well suited to the support and resistance, scalping-type methods I have discussed. Currency futures, given their sharp and fairly quick moves, are especially well suited to hit-and-run trading methods and/or to some of the spread indicators contained in this book. The gap methods I have presented herein also work well in currencies but with some variation on the theme. Determine which approaches suit you best and devote your time to those methods consistently and for a reasonable period. Find your place and rest in it for a while. Learn from your mistakes and from your visceral and emotional reactions. Make every loss count. Losses are your tuition.

Don’t Be Surprised If You Lose Money at First—Some People May Never Succeed

Many traders are disappointed and frustrated when immediate success in day trading isn't forthcoming. I urge you to persevere. Be persistent in giving yourself sufficient time to achieve success. We know from our evaluation of trading systems and methods that even the best system can lose money 7 or 8 or even 10 times in a row. It is the nature of the trading beast to bite you a few times before you show a profit.

Learning day trading from a book is like learning how to ride a bicycle by reading a book. Once you try to do it on your own, you have to be prepared for a few falls. But with care, precautions, and consistency you'll avoid breaking your neck when you fall. 

Even if you have more than a slight amount of experience in position trading, you may still find yourself initially losing as a day trader. Although you may feel that your position-trading experience will serve you well, it may actually prove detrimental, since you have approached day trading with preconceived notions that may stand in your way, clouding issues and confounding your thinking. You will need to abandon these dysfunctional ideas in favor of those that I have offered in this book, if what I've said makes sense to you. Remember that this process takes time. Some failures at first are unavoidable. You will need to fall off the bicycle a few times before you can ride it. At first your riding will be shaky and slow. After a while, however, you will feel at home on the day-trading bicycle, and it will take you where you choose to go, provided you follow a smooth road.

How long will it take you to become a successful day trader? There is no answer other than perhaps more than 2 weeks and less than 2 years, perhaps never; however, these are certainly not hard-and-fast rules. Some of you will become successful day traders in several weeks, whereas others will never achieve consistent success.

There are too many books on positive mental attitude that tell you to have great expectations. They tell you to visualize success. They encourage you to engage in affirmations. They push you to see yourself as a highly profitable trader or investor. I take issue with all of these books, and I caution you against having unrealistic expectations. Try not to have great expectations. Expect to lose. Expect that with time you should begin to break even. Expect that with more time and with more experience you will begin to show profitable results.

Do not expect profits at first. Rather, expect that learning the game will cost you tuition both in terms of time and money. Therefore, you must understand the reasons for your every loss and you must learn from them. There are hundreds if not thou-sands of traders who begin their trading with unrealistic expectations, a few thousand dollars in risk capital, and a total lack of discipline or method. They soon leave the markets beaten, broke, and broken. In the meantime, their money has been gobbled up by professional traders who thrive on the losses of tyros. If you have any expectation, then expect failure while hoping that through your learning experiences you can minimize the failures and maximize the successes.

Shut Out the Input of Others—Play Your Game by Your Own Rules

Should you allow yourself to be exposed to, pandered to, and intimately influenced by the many fantastic claims for perfect trading systems and "Holy Grail" seminars, then you will be diverted on your road to success. There is nothing wrong with attempting to improve on what you are doing, but the act of endless searching will distract you from your goal. Don't get side tracked on your journey. If you are confident with your trading methods and rules, then use them and profit by them. Persevere and ignore the claims and opinions of others as much as you can.

Those who purport to have better systems, better methods, fool-proof indicators, outstanding results, and fail-safe risk management will constantly barrage traders with their claims. Before you give any of these serious attention, make sure that what you're doing is not better. Every system you test, every seminar you attend, every piece of software you buy, and every path you take may prove to be a costly excursion away from your final destination. Each takes time, effort, and money. And these are the most precious commodities in the world. They are limited resources not easily replaced.

Therefore, I suggest you find a methodology and commit to it for a predetermined length of time. And during this period of time do not allow yourself to become distracted by anything else, even if it means that you need to close your eyes and ears to the magazines, newspapers, and mail you receive.

Take Your Losses When Your Signals So Dictate—Don’t Make Excuses!

Riding losses is the worst thing a trader can do. Not taking a loss when you should take the loss is the worst thing you could do. I have stated repeatedly throughout this book that the single worst offense a day trader can commit is to carry a position beyond the end of the trading day, particularly if it is a losing trade. At times a profitable trade carried overnight may become even more profitable on the next opening. This issue has already been discussed objectively as the FPO exit (first profitable opening) and the nth profitable exit. But a losing trade usually gets worse if not closed out. If you fail to exit a trade at the end of the day, then you are violating the essence of day trading and you therefore risk exposure to everything that a day trader seeks to avoid. Do not, under any circumstances violate this cardinal rule regardless of what the excuse or excuses may be.

But what if you are locked into a position due to a limit move against you? In such an event you have no choice but to carry your position. You could spread a position off (take an opposite position in a different contract month if possible) in order to avoid the exposure; however, there is still danger, even in a spread. Remember that you are either a day trader or you are not a day trader. There is nothing wrong if you choose not to be a day trader. But note that you must not change horses in midstream, since this will, in the long run, cause you losses. In the short run, you may be very pleased with the results. But in time, your lack of discipline will haunt you.

In the event of a limit move in your favor, you may be tempted to hold your position overnight, expecting that there will be more profits in the morning. Even this is a dangerous procedure because a limit move in either direction on any given day does not necessarily guarantee follow-through in the same direction on the next day. You will note from some of my research in the preceding chapters that holding a day trade until the nth profitable opening may in certain very specific circumstances prove more profitable on than exiting on the close of the day. But note that these are very specific conditions that are related to the day-trading systems and indicators being used.

My research has shown that over the next several days there may be follow-through; however, what happens between now and then may wipe you out. I have already given you certain very specific conditions under which a day trade may be kept overnight, but beyond these suggestions, I emphasize once again that a day trade must be closed out by the end of the day unless there is statistical evidence to support carrying the trade overnight or to the nth profitable opening.

Your Goals as a Day Trader

Your first goal every day of your life as a day trader is to end the day with a profit. Place no dollar amount on the profit. To set a goal too high would be unrealistic and to set a goal too low might be aiming too low. Another type of goal—the goal of following your rules and being true to your methods—is the major goal oi the day trader. However, if you do need to establish a goal for yourself in terms of dollars, then try to end each day with a small profit at the very minimum. As a secondary goal, you should attempt to follow all your rules and methods. In fact, your goal o: ending each day with a profit will not be possible unless you have been true to your systems and methods.

Don’t Exit Trades Too Soon

Too many traders exit their profits too soon. Note that the historical results and statistics on the indicators and systems presented in this book are based on exit at the end of the trading day or on £ trailing stop loss. To exit trades before the system or methods dictates is to violate the rules that I have presented to you. All too often you will exit a trade based on a whim, a hunch, a fear, a concern, or a news item, and you will be very sorry later that you did so. A good trade is a good trade. Do not exit a profitable day trade either until the end of the day or unless your trailing store loss is triggered according to the rules. I cannot stress this toe strongly.

At times you will want to exit a trade, but you will follow the< rules and avoid the temptation. At the end of the day you wild realize that breaking the rules would have resulted in a large profit. Instead, you followed the rules and took a small profit. This is the nature of the markets. For every one time that you break the rules, at least twice as often you will find that following the rule would have been more profitable.

Furthermore, not following the rules teaches you nothing. Every time you break a rule you will have a different excuse. The only thing that breaking the rules will teach you is to break the rules As a result, your trading will deteriorate and you will quickly become one of the thousands of undisciplined traders who inhabit the vast wasteland of losses.

Don’t Hold a Profitable Day Trade Beyond Its Ideal Exit Point

Many a good day trade has become a bad day trade, turning from a profit into a loss, because of poor intraday risk management or to the tenacity of the trader. Holding on to a winning trade beyond its exit point (i.e., trailing stop loss) can also get you into trouble. Please remember the rules I have given you about trailing stops based on the systems presented herein. This is an important rule that you must not violate. Preservation of capital is quintessential to consistent success as a day trader, and preservation of profits is equally as important. The mere fact that a trade looks too good to exit is just as much a violation of the rules as is exiting a trade because it looks bad. Remember that "looking good" or "looking bad" are subjective and intuitive responses that have no place in the repertoire of a day trader unless that day trader is a bona fide psychic with a proven track record of trading success.

Don’t “Force” Day Trades If There Are No Signals

Many traders have the personality type that thrives on action and withers on inaction This fatal flaw causes them to search out trading opportunities where none exist. If you have day-trading signals but find yourself anxiously searching through your screens and intraday charts for trading opportunities, then you're headed for a disaster. If you find yourself looking at markets that you never trade for opportunities that you have not seen previously in the day, then you are most likely headed for trouble. Do not attempt to create an opportunity where one does not exist. Be patient. There will be trades tomorrow or the next day. The market always provides opportunities over time even though none may exist today. Don't ever, ever force yourself to trade if an opportunity does not exist.

One excellent way to overcome this problem is to use a software program such as Trade Station™, Future Source™, Commodity Quote Graphics™, MetaStock™ or Aspen Graphics™. These trading software programs will gather your intraday data for you and, once set up with your parameters and/or signals, alert you to trading opportunities. If there are no signals, then there are no trades. You will save time and errors, and you will improve your trading discipline by using such programs. I highly recommend them.

Hesitate and You Lose!

Hesitation is one of the worst enemies of the day trader. The age- old expression "he who hesitates has lost" is truer in the futures markets than in any other venture other than life-and-death situations. Since day trading occurs within a circumscribed period of time, every moment you lose in entering or exiting a position is a moment that may cost you money.

If you choose to hesitate, then do so with premeditation and calculated caution. Never allow yourself to hesitate out of fear or indecision. Hesitation subsequent to a clear trading signal or opportunity indicates a lack of confidence, and a lack of confidence indicates that you are not comfortable with your choice of systems and/or methods or with your skills as a day trader. Hesitation can be costly. Fortunately, you will know that you are hesitating the instant you do so. Use this as a trigger to let yourself know that you are about to make a potentially expensive error.

Keep a Record of Your Trades the Good, the Bad, and the Ugly

I pointed out earlier in this book—in fact, I noted a number of times—that every loss you take is an important learning experience. But a loss can be of no value unless you know why you took the loss and what you will do in the future to avoid making the same mistake. Clearly not all losses are a result of breaking rules. Many losses are a simple result of your system being wrong. But you must know when your system was wrong and when you were wrong. There is a significant difference between the two.

Therefore, I urge you to keep a log or a diary of your trades, noting each trade with a brief commentary as to whether the trade was a profit or a loss due to following your system or due to breaking your rules. A profit that resulted from breaking your rules will teach you something wrong. A loss that has occurred as a result of breaking your rules may be very instructive. A diary should not only be kept, but it should also be referred to both at the end of each trading day and at the beginning of the new day. Refer to everything you did the day before and learn from it.

Don’t Day Trade Unless You’re Properly Informed

Some of the techniques I have discussed in this book are almost entirely mechanical. In order to trade them, your presence is not required and live price quotes are unnecessary. In most cases a broker can actually do the trades for you, depending upon the ground rules and understandings you have established with that broker. Other methods, however, require your presence and close attention. If a situation arises during the day that requires you to leave your quote system, then either close out your positions immediately or give your broker stop close only or market-on-close orders. Do not attempt to keep in touch with the markets by calling frequently for quotes or by using a portable quotation system. This is not a good way to operate.

And this brings me to the question of whether a trader should attempt to trade when on vacation or when separated from his or her quotation system or computer. Clearly, my reply is no, unless you have a partner or broker who can follow the trades for you.

When in Doubt, Stay Out

The old expression "when in doubt, stay out" is especially appropriate for the day trader. Not all indicators or signals will be completely clear all the time. Furthermore, some other developments such as news, reports, or short-term fundamentals make signals unclear or market response uncertain. In such cases my best advice is to stay out; do not trade. There will always be plenty of trades, and there is no need to enter a trade unless its potential outcome is relatively clear and free from the erratic influence of news or other fundamental events.

You Can’t Succeed Unless You Do Your Homework

I have found few traders who are consistent and conscientious about doing their market homework. All too often they slip into the abyss of laziness in the hope that they have somehow internalized their system rules. But the fact is that they expect to show a profit without having to work for it. There can be no success with a system unless you follow the system. And you can't follow the system unless you perform the necessary daily calculations or procedures.

It never ceases to amaze me how few traders consistently do their market homework. Even though they have developed good market indicators and effective trading techniques, they fail to consistently keep up-to-date on the markets and allow a good methodology to turn into a bad one by virtue of their laziness. This makes no sense to me whatsoever. The fact is that if you develop something that works, and if it is making money for you or facilitating your ability to make money, then by all means you ought to continue with it. Too many traders become complacent about their market studies, fail to do their homework, and then wonder why they lose money. If you intend to succeed, then you must do your homework no matter how simple or complex it may be.

Perhaps you have developed a trading system that requires homework. This is certainly possible. A number of the techniques described in this book do not require homework. However, yon will still need to work on your trading diary, and you will still need to keep in close touch with trading opportunities that may develop during the next trading day. The only way to do this is the study the markets. This is what I mean by homework, and this is why it must be done.

Keep Close Track of Your Results

Some traders refuse to monitor their trading results as a form of defence against being distressed by bad results. This is neurotic behavior, and you should not engage in it. It will cost you money Know where you stand and keep in touch with your results always comparing them to what your systems should ideally be generating. Always keep close track of your results on a trade-by- trade and day-by-day basis. If you know how your systems arc performing, you will have effective and valuable feedback about the techniques you're using.

Unless you know your trading results, you will not have sufficient information about how well or how poorly your methods arc performing. I suggest you use one of the many computerized accounting programs to keep track of your results, or at the very minimum, a spreadsheet that is updated manually will certain do the job. Pay especially close attention to your average winning trade and your average losing trade. Your average winners should be consistently larger than your average losers. If they are not, then you are risking too much and getting too little for your efforts. This is an indication that change is necessary.

Another good reason for keeping track of all your trades and their results is to determine if and when your trading technique, system, or indicators have deteriorated and are in need of change or review. Unless you check your performance, you will not be cognizant that change is necessary, other than perhaps a vague feeling that all is not going well.

More Complicated Is Not Synonymous with More Profitable

There is no doubt that you will be tempted many times to use more complicated trading systems. You will be tempted to build more and more rules into your system, feeling, erroneously, that your system will work better if it has more rules. You may feel that if your system takes more market variables into consideration, you will trade more profitably. My experience strongly suggests otherwise. With the exception of artificial intelligence-based systems that can process vast amounts of data in exceedingly complex ways by relating data to market patterns and relationships, adding new inputs or variables to your own analytical techniques does not necessarily improve them and may in fact cause them to deteriorate.

I have found that if there is a relationship between complexity of system and profitability of system, then it may well be an inverse relationship. The simpler a system is, the more likely it is to be profitable. So, please, don't confuse apparent complexity with profitability.

The Danger of Market Myths

Be careful what you believe. Be careful whom you believe. Be careful what you read. Be careful who influences you. The markets are forever subject to the emotional influence of traders. Through the years traders have come to believe that certain relationships exist in the markets when in fact these relationships do not exist at all. Statistically, few consistent market relationships have persisted over many years. Therefore, be careful not to get caught up in the cycle of hope that perpetuates market myths.

In this respect, you must also be careful about the information you allow to filter into your unconscious mind. The lure of fantastic claims and outstanding new discoveries about trading will always be there to play with your insecure side. Don't give in to any of these claims. If your systems are making you money, then don't look for greener pastures. This does not mean that you can not or should not engage in ongoing research. But remember that there is a big difference between productive and objective research and emotional response to a claim. Should you be attracted by a claim, a system, or a promising indicator, test it before you use it.

The Dangers of Pyramiding

Pyramiding is the act of adding increasingly larger units to your position as a market moves in your favor. Therefore, you may begin by buying one unit and adding two additional units once the trade has moved in your favor. If the trade continues to move in your favor, you may add four new units, and then, assuming that it continues in your favor, you might add six or eight units. The upside of this methodology is that you will accumulate a very large position consistent with the trend and you will use the capital available in open profits to margin new positions.

The danger of pyramiding is that this is a pyramid clearly built upside down. It is heaviest at the top and rests on only one unit at the bottom. It is therefore subject to violent collapse at the slightest indication of a trend reversal. If you intend to build a pyramid, then do so by establishing your largest position first and follow it up by successively smaller numbers of units.

Avoid Inactive Markets

I have already given you guidelines on which markets to day trade and how to determine if a market should be day traded. Follow those rules. By trading active markets only, you will avoid the problems that come with thinly traded markets and the relatively poor price executions that are so common in such markets. As a day trader, you must have liquidity in order to move into and out of your positions easily and without too much slippage. Moreover, if you intend to trade large positions, then liquidity is absolutely essential for success. As a day trader, you do not have the time to wait too long for price executions to be reported to you, nor will you have the time to go back and forth with different price orders in an effort to have your positions either entered or closed out.

Since markets wax and wane in terms of trading activity, you will need to evaluate this on an ongoing basis in order to make certain that you are participating in actively traded markets. If you find yourself trading thin markets and experiencing all the difficulties that go along with such markets, then I assure you that you have no one to blame but yourself, since you have violated one of the cardinal rules of day trading.

As this book is being written, the active futures markets are as follows: S&P 500, Treasury bonds, Swiss franc, Deutsche mark, yen, British pound, crude oil, and heating oil. Coffee has spurts of activity. Some of the European markets also make good day-trading vehicles. As you can see, the number of vehicles open to the day trader is rather small. But this, I assure you, is a blessing in disguise.

Don’t Run with the Lemmings

Some of the largest intraday moves occur when they are least expected. The general trading public and a vast majority of professionals will be on the wrong side of the market when these moves happen simply because they get blindsided by their collective lemming instincts. Mob psychology is a very important factor that may be used to the advantage of the day trader. If you find that the market sentiment is skewed to one side of the market or another, then watch closely for timing indicators that will give you market entry on the opposite side of majority opinion.

Watch for Day-Trading Opportunities Following Major Events or News

Many outstanding day-trading opportunities occur on the heels of a major news event such as a political upset, a financial panic, unexpected news, natural disasters, the threat or actuality of armed conflict, or other emotion provoking news. When these events occur, the markets are highly emotional, and opportunities for the disciplined day trader abound.

The Value of Correct and Timely Price Data

Some traders will attempt to save money by subscribing to delayed price quotes or to low-cost real-time quotes. My advice: don't do it. Day trading is difficult enough with good data. Why decrease your odds of success by using incorrect data or delayed price quotations?

A Few Thoughts about Commissions and Brokers

Traders have a choice of dealing with either full-service or discount brokers. The price difference between dealing with a full-service broker and a discount broker can be significant. But so can the service. If you're an experienced trader who is skilled at order placement and who is trading a system that does not require immediate reporting back of price executions, then a discount broker will suite your purposes well. However, if you're a newcomer to trading and if you require instruction, hand-holding, and coaching, then the additional service you'll get from a full-service broker may be well worth your while. Once you have learned your lessons well, you can graduate to a discount broker if you like. Note also that some discount brokers are not particularly prompt in reporting your price executions to you. Some of the systems presented herein require you to know where you have been filled so that you may place your stop loss, training stop loss, or reversing stop. In such cases you will need to make certain that your broker, whether discount or full-service, understands the importance of reporting your price executions to you promptly. In most cases, trading only active markets will minimize the delay in reporting order fills.

While these are just a few of the important rules to remember when you trade, they are by no means the only prerequisites to success. Develop and maintain your own list or rules. Your list should be based on your own experiences as a day trader, since your personal list will be more meaningful to you. The rules I have give you are merely a beginning, a base upon which I suggest you build and expand.

Summary

This chapter highlighted the rules I consider important for success as a day trader. While you may disagree with some of my rules at first, I can assure you that in the long run you will come around to my way of thinking and doing. You may want to keep a list of your own rules as your experience with day trading develops. Note that the rules in this chapter have been gleaned not only from years of experience in trading but also from the observation of other traders. Every loss you take as a trader is an expensive lesson from which much can be learned. However, in the absence of attention and study, nothing will be learned from your losses and there will be no progress. Success can often teach you as well; however, as in the case of failure, lack of attention to the reason(s) for your success will mean that valuable information has been lost or not recognized.