There is a lot of trading literature which professes to outline rules for successful trading. A lot of these are very general statements which sound good but lack anything specific to be of any use to a novice or even an experienced trader. One such example is "cut your losses quickly and let your profits run" There is no quantitative measure that by how much and how quickly you should take and cut your loss and for how long you should run your profit. Should you risk loosing half or all your profits on a trade before closing it for example? I am putting up this post to ask the Elite Trader members what are the most important trading rules that contribute to your success and perhaps give some quantitative examples in each case. Below are some examples of rules that I have come across in the trading literature. It is by no means meant to be an exhaustive list and please feel free to add your own unique contributions. 1 Cut your losses quickly and let your profits run 2 Never let a profit turn into a loss. (Q. How much profit is a profit?" 3 Go with the trend. (Q When is a trend a trend) 4 Donât try to catch a falling knife. 5 Try and be a contrarian (Q. Catch a falling knife??) I am sure there are a lot more that you have heard or can think of. I hope this can trigger fruitful debate here. Bob
Don't start before you're sure you'got a winning strategy. I think we focus too much on psychological aspects on forums. A winning strat is the raw material, the psycho is important when it come to apply it, but that's easier to get than the technical edge...
Excellent post. I've felt the same for a long time - a lot of these trading aphorisms are vague generalities that honestly have no use whatsoever and may even be misleading. The problem is that an experienced trading saying one, knows exactly what he means; whereas an inexperienced trader has no idea of the real meaning, and takes them literally. Taken literally, these sayings are mostly BS. I'll give my take on the favourite ones. 1. Cut your losses and let your profits run. If you are right about a trade, and time it well, more often that not you will get a profit within a reasonably short period of time. This is a good sign that the trade, and trade timing, are good, which should increase your confidence in the trade. Whereas if a position hands you a more sizeable loss fairly quickly, chances are higher that your trade is a bad one. As a general rule of thumb this one isn't too bad, the trouble is there are lots of exceptions and you can't just follow it rigidly. The exceptions: loads of excellent trades can have an initial modest loss. You simply can't time entries that perfectly with consistency. Also, if you are a bit early and take a loss, that doesn't mean that now is the time to exit - it may actually be a screaming buy. Even very good profitable trades eventually have a time where you must sell. "Letting your profits run" means you would never exit a position - clearly a ridiculous proposition. 2. Never let a profit turn into a loss. Taken literally, this rule is ridiculous. It means the moment you have a 1 tick profit, you must raise your stop to breakeven. You would get stopped out of a huge majority of your trades, leaving you mostly with losers. In reality, what it means is that once a trade is working out well, it's only likely to become a loser if something goes seriously wrong with the trade. Therefore if your trade starts of working out well, and moves a decent amount in your favour, then you should be moving your stop up - and usually this will mean that you will exit before the market goes back below your initial entry price. 3. Go with the trend Begs the question what is a trend. Another problem is that by the time a trend has become obvious enough that it is definitely not noise, a large move has already taken place, and you may be risking an entry just as the move comes to an end. Overall I think that with experience and good judgement, trends can be identified a long way before they end, and often early in their life. And, on balance, your risk reward is improved significantly by trading in the direction of the main prevailing trend, rather than against it. So I broadly agree with this bit of trading wisdom. The main exception is when the trend has reached a climax - then you should actually be fading the trend. But most of the time this won't be the case, and trend-following will be the odds play. 4. Don't try and catch a falling knife. Going long in a market with powerful downward momentum is very risky if you don't know what you are doing. So, unless you have excellent bottom-picking skills, you should avoid this. However, once you do have those skills, catching a falling knife offers some of the best trading opportunities in the market. Going long stocks in Jan 22-23 or March 17 this year was a great trade - low risk, high reward over a very short period of time. Thus, this is a saying promulgated mainly by people who have no talent for spotting market bottoms. So - don't try it on anything other than a very small experimental position, unless you have a proven track record of successfully picking bottoms. If you do have that ability & record, then go ahead and once you get the buy signal, pile in on maximum size and reap the rewards. 5. Try and be a contrarian. I don't agree with this one. Just being a contrarian alone is not enough, and will often result in you being on the wrong side of a powerful, entrenched trend with strong fundamentals in its favour. If the market is at a P/E of 4 and has fallen 75% in the last 2 years, then it's not a short just because everyone is saying how cheap it is. I would say that the time to be a contrarian is when the only reason why people have a certain view is pure sentiment/speculation. If valuations are extremely cheap, prospects are better than expected, and the market is starting to show signs of strength - yet everyone is bearish (for example, because the stock or market has collapsed over the last 2-3 years), then that is the perfect time to be a contrarian. You want to be a contrarian when the market tone, the fundamentals, and the technicals point one way, and sentiment points another. Being a contrarian can thus often mean buying at new highs. Going long oil above $100 was a classic example - even Boone Pickens was sceptical of the move. Yet the market action, technicals, and fundamentals were all very bullish (new all-time highs, breakout above the $100 level, demand still exceeding scarce supply, US crisis fears were fading).
Be quick Winners should work right away, if you have a good trade. Don't be affraid the scratch a trade that isn't working, opportunities are easier to make up then losses. By scrathing a trade that isn't working I meen you don't need to wait for a trade to be a winner or loser to take it off, if you aren't getting what you were looking for and the prices aren't really moving get out, you can always put it back on.
But what frequently happens in these kind of situtaitons is that you keep entering the same trade at an increasing more unfavourable price where as if you had not scratched it your second or third entry price would have given you a reasonable profit had you given the original trade more time. ?How quick is quick. How often does a trade go immediately in your direction and meet your profit target?
I guess my advice was vauge. Let me start off by saying that I make 50+ trades a day, so for someone looking to make 3-5 swings trades, my advice is useless. For active scalpers the bigggest mistake they make is not dumping trades that stall after they get in. Hope that clears things up.
There are many threads at ET where traders have already revealed the quantitative aspects of their methodologies (ex. see the journal section). http://www.elitetrader.com/vb/forumdisplay.php?s=&forumid=29 In fact, you can see many of those generalities you mentioned being discussed in quantitative ways without even mentioning the generalities. Same thing is true for the Technical Analysis, Trade Management and other threads. Mark
I understand what you are saying and, in principal, agree with it. But does this apply to trades that have gone well but are stalling at a certain profil level or do you close the trade as soon as the market becomes inactive (stalls). If we are to adopt the doctrine of "let your profits run" we have to contend that even for intraday trades many big moves include quite a lot of stalling periods.
Depends on where you think the trade is going and how strong your conviction is. For me I may hold trades through "stalls" 2-3 times a day, usually I "surf" in and out of postions towards what i percieve to be magnet areas.