Why You Need Strict Trading Rules
The further I get in my trading career the more I am relying on objectivity and the less I am relying on subjectivity. When I first started trading I spent my time working out how to be right more often than I was wrong. What I now realise is that the goal must be to never be ‘wrong’ at all. And the key to this is trading rules!
Before you choke on your Frosties, I am not saying that I never have a failed trade – far from it! But by utilising strict trading rules I am attempting to never be in a position where I have to make a subjective call. This eliminates the possibility of me being ‘wrong’, the subsequent kick to my psychology and the destructive behaviour that follows.
The work I have been doing with Traders Support Club has been tremendously eye-opening. Their top traders all work to very strict trading rules, with very little wiggle room. As a result, I have never met a group of traders more relaxed about their trades, either winners or losers!
Objectivity vs Subjectivity
It is a natural instinct for many traders to believe that they ‘have what it takes’. This means they try to trade using their own personal intuition. Unfortunately for these new traders (and it usually is new traders), trading is an inherently counter-intuitive sport. It is a world where common sense often means little or nothing. The right-thinking but inexperienced trader can often find themselves sat staring at their screens screaming “but the markets should not have done that!!” This way insanity lies.
There are famous examples of traders using subjectivity and instinct and making good dolla in the process. If Reminiscences of a Stock Operator is an accurate reflection of Jesse Livermore’s life and career, then it is fair to say that he largely traded by ‘feel’. Perhaps it is no surprise that although he made a number of vast fortunes, he lost just as many. Andre Minassian, the self-styled ‘Intuitive Trader’ with whom we did a podcast interview recently, clearly makes a great deal of money using his personal instincts. He doesn’t have a clear set of trading rules.
But as you will hear in the interview with Andre, what is clear is that the ‘intuition’ Andre has is largely based on experience. Andre believes that intuition can be taught as a skill – you’ll have to take his course to find out if he is correct! But for new traders with no experience, there is nothing to base this ‘gut feel’ intuition on.
Intuition = Experience
Daniel Kahneman won a nobel prize for his work on human decision making process. You can read a summary of his work in his book ‘Thinking, Fast and Slow‘. He made it clear that ‘intuition’ comes from personal biases and heuristics. These are drawn from our experiences of the world to date, as well as inbuilt human thought processes. The ability to make snap judgements correctly comes from subconscious prompts based on our experience.
The financial markets are counter-intuitive and seem to operate wholly outside of our general world view. Without deep experience with the markets themselves, your subjective opinion on what is going to happen with the markets is likely to be total bollocks. No offence; I count myself as chief amongst these sinners.
Why You Need to Stop Being ‘Wrong’
In trading, as in all walks of life, there is a fine line between confidence and arrogance. Being confident in your ability to make money in the market is essential to achieving just that. But the trading arrogance that pushes you to believe you ‘know’ what the market is going to do will likely become hubris – pride before the fall. Unless you have the experience and skill of an Andre Minassian, your intuition is more likely to lose you money than make it.
For me I have spent my first year in trading veering wildly between confidence, arrogance and it’s distant cousin: crushing doubt. This is all mixed up in the psychology of trading; the number one skill to master. The Market is a cruel mistress. Just when you think you can predict her actions, that is when you are most likely to suffer. Coming back from a string of losing trades is hard. But when you have used your personal, subjective, analysis to make your trading decisions it becomes even harder. This is because you have set yourself up for a situation where you can be ‘wrong’.
Destructive trading behaviour can almost always be traced to losses, specifically loses where you feel you have been ‘wrong’. Or worse, where you believe you were ‘right’ but the market was ‘wrong’! Chasing losses, doubling down, reckless gambling, self-sabotage, overtrading, undertrading, fear of clicking the button, skipping research, giving up altogether and going crying to Mummy – all can often be traced to the stress of being ‘wrong’ when your losses build up.
Trading Rules Stop You Being ‘Wrong’.
There is no way that you can eliminate losses (although recent podcast interview guest David Peddle disagrees with me!) Instead, think about changing the nature of the psychological effect of losses. If you can take a loss and not feel that you were ‘wrong’, then you are on the fast-track to good trading psychology.
The easiest way to achieve this is to take as much of the decision making out of your own hands as possible. Make your trading decisions objective, rather than subjective, and you can remove Ego from your trading.
Ego is an absolute killer in trading. Most of the traders I know are blokes, and I suspect that Ego is more of a male problem. My wife has subtly referred to the ‘delicate male ego’ on more than one occasion. I am beginning to suspect that she manages my delicate little ego a lot more than I ever realised…but I digress.
Trading Rules, Big and Small
Trading rules mean something different to everyone. I don’t feel the need to go into detail here on which trading rules I use or which I would recommend. Your trading rules can be either big or small. Big ticket rules like ‘don’t trade after 5pm’ (this is just an example…) are good, but I am talking here about the detailed rules.
I recently attended a webinar as part of our learning course with Traders Support Club which prompted this whole thought process. In the webinar we were told about Support and Resistance Lines and Consolidation Patterns. Fairly basic stuff aimed at beginners. But what was interesting to see was that the way they drew support and resistance or consolidation patterns was subject to very strict trading rules. If a price bounces off a level more times than it breaks through, then that is a S/R line. If it bounce four times in a day that is a level, unless it breaks through five times. Most traders I know would call it a S/R level if it bounced four times regardless of the breaks, because it just intuitively seems like it must be, but not TSC.
The same applies to consolidations. Price must bounce off the top and bottom twice to be considered a consolidation. Two and one? Nope, not a consolidation Pal! This seems like it might miss a number of levels and consolidations, and thereby trading opportunities – everyone knows that trading is messy and never works perfectly right? But the beauty is that is removes subjectivity from your trading. Want to take a breakout trade from a consolidation with the next S/R level as the target? Well then, there’s some pretty black and white rules for you!
The Zen of Trading Rules
These are just some illustrative trading rules. Whether you agree with these specific rules or not, the point is that they give the trader a beautiful sense of Zen. With these strict rules I either have a trade I can take, or I do not. If the setup meets the criteria and I enter. If the trade is a loser, so what? I wasn’t ‘wrong’, it was just a failed trade. Great, on to the next one please!
By reducing the possibility of being ‘wrong’ you reduce the possibility of going on tilt and trading destructively. The elephant graveyard of traders is littered with people who gradually built an account, slowly but surely. Then, they had a string of losers, got angry and revenge traded before, obviously, blowing up their account. Don’t become one of them!
These specific trading rules come into their own with the next piece of the puzzle – back testing! This is what we are learning next with Traders Support Club. We have already conducted some back testing of our own trading strategies. But the scientific approach that the people at TSC take is something else entirely.
Come back next week to see how these specific trading rules are perfect for back testing and building confidence in your trading system.
Click here to join Tom and I on our trader training journey with Traders Support Club.