All the knowledge in the world is of little help to the trader who lacks discipline and patience. I cannot stress this enough to both novices and professionals. The following 14 guidelines should help traders maximize their gains and minimize their losses.
These are areas that every trader should cover both BEFORE and DURING a trade.
1. Don’t go to fast or you may never reach your financial destination.
Given the tremendous leverage available in these markets, it is natural for a trader to become fully margined as possible. As a result, if the market moves adversely, there is a significant chance that a substantial portion of your equity in the trading account will be wiped out. Similarly, if you take too much risk (read leverage) then any minor price movement will be greatly magnified psychologically, leading to emotional rather than rational decision making.
2. Don’t make a trade unless you know where you are going to get out.
If a position is taken and the trader has not decided where to get out if the market moves adversely, he or she will not have assessed the risk-to-reward ratio of the trade. Under these circumstances, there will be a tendency to hang on and let your losses run.
3. Set a stop loss and take profit.
If either of these two points are reached, stick with your trading plan and liquidate your position. Only, in the most exceptional circumstances does a reevaluation justify running the position. Our general tip would be that traders should set Stop Loss orders closer to the opening price than Take Profit orders. Where the trader places the Stop Loss and Take Profit orders will depend on how averse they are to risk. Stop Loss orders should not be so tight that normal market volatility triggers the order. Similarly, Take Profit orders should reflect a realistic expectation of gains based on the market’s trading activity and the length of time you want to hold the position.
4. If the market goes against you, liquidate the position and look for a better opportunity elsewhere.
If such a development occurs then the chances are that your judgement was incorrect. It is always hard to take a loss but small losses have a habit of turning into big ones, as many traders have found out.
5. Never answer a margin call.
A margin call usually results either from an unexpected adverse market move or from having too many positions. Either way, it means that developments have not gone according to plan. Liquidation is the only sensible solution because throwing good money after bad rarely works.
6. Try to maintain cash reserves at all times.
While cash will not earn a return sitting in your trading account, it is always a good idea to maintain some reserves since an outstanding buying or selling opportunity may arise at any time when it would be inconvenient to liquidate an existing position.
7. Diversify as much as possible.
Even the best laid plans can fail to bring success, so it is a good idea to diversify into several different markets. In case luck goes against you in one area, good judgement will save you elsewhere.
8. Do not assume that you have to be active at all times.
There are often periods when it is not clear which way the markets are going or when the trader is not in tune with the markets. In such cases you will make more money by sitting on your hands than by being active. Psychologically you will be in a stronger position to recognize the next major move, since you will be far more objective emotionally.
9. Always wait for a near perfect situation.
In most markets important long-term buying or selling junctures come two to four times a year. Given the plethora of markets, it does not involve a tremendous amount of patience to wait out such situations until either the technical or fundamental signs (or better both) look favorable for a long or short position. There is always risk in any situation, but if you can isolate and minimize such risks, the chances of success are much greater.
10. Do not over-trade.
This rule is a natural extension of the previous one. Over-trading indicates that the trader is not really sure what to do. The trader is often trying to pick the minor moves, which tend to be random anyway, and may become so involved that he or she fails to see the big picture.
11. Avoid counteractions to the main trend.
If traders think they have determined the direction of the main trend, they should stick to that trend and not attempt to play the counteracting corrective movement to that trend by reversing positions. This is because intermediate corrective movements are notoriously difficult to predict and by definition, are of smaller magnitude than intermediate movements of the main trend.
12. Never commit more than you can afford to lose.
If you cannot afford to lose the money at risk, and the market goes against you, chances are that you will be “psyched out” of the position for no reason at all and you will be unable to ride out any unexpected setbacks.
13. Do not let success go to your head.
If you find that your positions are continually making profits, it is time to move some of those profits out of the account. Since nobody is in tune to the markets at all times, chances are that you are about to hit a losing streak-and there is nothing like newly won profit to breed complacency. One of the largest problems facing professional traders is not in making money, but in avoiding giving a substantial portion back. Therefore it is best either to take money out of the account and drastically reduce trading activity, or temporarily withdraw altogether.
14. Listen to the opinion of others, but only take action based on your own assessment of the situation.
Since you are managing your own account it is you, not others, who have to bear the loss if things go wrong. Only by forming your own conclusions can you hope to have the psychological fortitude to outlast temporary setbacks.
The guidelines given above are purely commonsense, but it is amazing how many of us can start off with good intentions and then fall into bad habits. If you find that things are going against you, it is a good idea to analyze where you have been going wrong and make a definite effort not to make the same mistakes again. It also makes sense, after a cooling-off period, to try again by using a much smaller portion of your risk capital until confidence and good judgement return. Even if your temporary withdrawal causes you to miss a major opportunity, you should always remember that another one lies just around the corner.