Here are THE rules for all of you. 1) KISS - Keep it simple stupid. Something you 5 years old understand and able to execute it. 2) Profits & Losses - Know them before you enter a trade. Keep it greater than 2:1 3) Monitor it when you in the trade.
You are forgetting the 2 most important that can't be stressed enough 1. Discipline-either have it to follow you plan or the market will in short fashion impose it on you and your account balance. 2. Money management. If your method doesn't show positive expectancy then you might as well stop. It doesn't matter how good your set up or entry method is if you don't have the 2 above.
That's how I used to think, but my views have changed over the years. I'd suggest the following refinements: 1) Generally trade in the direction of the major trend. However, be aware that as a move gets to extremes, the fade trade starts to become a superior odds play. Recognising and then timing such reversals is an art form that requires considerable experience and balls. 2) Set a good stop, but recognise that many trading opportunities are exploiting a kind of subtle market drift, where there is no clear buy point or clear place to set a stop, and pretty much any close stop is likely to get taken out by noise. Often you just have to get in, and rely on a combination of mostly being right, along with conservative position-sizing, for your risk control (Buffett-style trading/investing, basically - be right more than wrong, and don't get faked out by noise). A perfect example is crude oil - there is no stop that would have kept you in from $25 all the way to $125. When the market fell from $77 to $50 in 2006/07, anyone using a stop would have been squeezed out. There were only two ways to stay on for the ride - either accept that you can't quintuple your capital without accepting 30-40% corrections, and therefore just buy & hold; or have amazing timing skills, and get in and out at the right time. Almost no one can do the latter, so the best plan for most traders is do the former, and accept that you can't score outsize returns without taking reasonable risks. A 400% return in 5-6 years, with only a 35-40% drawdown, is still a reward:risk ratio of 10:1, after all. 3) Set a target when the market is within a range. But when the market is making new 52-week highs or lows, and there is no clear support/resistance ahead, then do not set a target - just let the trade run as far as you can. 4) Entry at low risk is only useful for a very short period, because as soon as the market has moved a bit in your favour, the risk point (below support) is now further away, and the target (below resistance) is nearer, so your win/loss ratio goes down pretty much right away. For example, if you bought at 1260 in the S&P in March, you had about 20 points risk maybe. But once the S&P hit 1330, you now had 90 points risk, and only 60-90 points upside. Yet staying long was still the right thing to do. CONCLUSION: risk is unavoidable in the markets. You can't make good profits unless you are prepared to give back some of your gains. Just identify when the market is set up in your favour, place your position, then stay in until the market stops acting in your favour. At S&P 1375 recently, despite resistance being 25 points away, and support 125 points away, staying long was still the correct thing to do. Why? Because the market was acting bullish, NOT because you had a "low-risk" entry point with big upside. I would add the following: 5) When a market has made a substantial move over a long period of time, and then the move goes parabolic and experiences a buying frenzy along with sentiment excess (or a selling panic, for down trends), then no matter how bullish you are long-term, a short or medium-term top is near. Start booking profits, scale out of your positions into the ramp up, and buy puts (or calls for down moves) to hedge your core long-term investment positions. 6) The best trades are those where the price action is moving contrary to sentiment. For example, a grinding bull market where everyone keeps thinking the price is too high and must correct (oil recently has been a *great* example of that). Or when everyone panics, yet the price rebounds hard and keeps going. Therefore try to look for price action/sentiment divergences.
I have a 5th rule and it's called 'the rule of the dog'. It states simply that the best trades are those that are 'sniffed out' in a maddeningly patient style of sniffing sniffing sniffing sniffing ... walking walking .... sniffing sniffing sniffing .... walking walking ...; repeated far too many times and then finally ... Marking. (buying or selling). Actually, I'm not quite that patient because if I were, I'd never make any trades or money but our dog teaches me every day that patience is one of the very biggest strengths in trading/life. Good dog.
It depends on what your trading, we have trend trading stocks like GOOG, BIDU, RIMM, AAPL, etc. and one should tailor a specific strategy for momentum stocks. On the other hand, Copper is a great fade play: Fade it evertime it hits 4.00 or higher cover at 3.88----range instrument for awhile now. If you played the breakout trade on copper, it hasn`t really payed off much, you are fading the range, even though it is against the longer term bullish trend, but it is the highest risk reward trade within the instrument. Much better than buying copper on the pullback trade, as it can drop back to 3.00 like it tends to do sometime during the year. BTW--Great Thread folks!
I really liked your post. I just have one question on the above. How would you know there was a 400% potential return back when oil was at 25 dollars? It was totally unchartered territory. Anyone who owned it when it at 10 would have been tickled pink to sell at 25. Once it reached 80 you could see there was a chance it could make it over 100, but it was a hell of a lot of risk to take at that level. It would seem to me the only way to have traded oil would be the latter as opposed to the former you mentioned because the 10:1 r/r was an huge unknown.
Great post - this is helpful to those of us who don't have the benefit of years of experience. Thanks for taking the time to share.