Most people who are interested in learning how to become
profitable traders need only spend a few minutes online before reading
such phrases as "plan your trade; trade your plan" and "keep your losses
to a minimum." For new traders, these tidbits of information can seem
more like a distraction than any actionable advice. New traders often
just want to know how to set up their charts so they can hurry up and
make money.
To be successful in trading, however, one needs to understand the
importance of and adhere to a set of rules that have guided all types of
traders, with a variety of trading account sizes. Each rule alone is
important, but when they work together the effects are strong. Trading
with these rules can greatly increase the odds of succeeding in the
markets.
Rule No.1: Always Use a Trading PlanA trading plan is a written set of rules that specifies a trader's entry, exit and money management criteria. Using a trading plan allows traders to do this, although it is a time consuming endeavor.
With today's technology, it is easy to test a trading idea before risking real money.
Backtesting, applying
trading ideas to historical data, allows traders to determine if a
trading plan is viable, and also shows the expectancy of the plan's
logic. Once a plan has been developed and backtesting shows good
results, the plan can be used in real trading. The key here is to stick
to the plan. Taking trades outside of the trading plan, even if they
turn out to be winners, is considered poor trading and destroys any
expectancy the plan may have had. (Learn more about backtesting in
Backtesting: Interpreting the Past.)
Rule No.2: Treat Trading Like a BusinessIn
order to be successful, one must approach trading as a full- or
part-time business - not as a hobby or a job. As a hobby, where no real
commitment to learning is made, trading can be very expensive. As a job
it can be frustrating since there is no regular paycheck. Trading is a
business, and incurs expenses, losses, taxes, uncertainty, stress and
risk. As a trader, you are essentially a small business owner, and must
do your research and strategize to maximize your business's potential.
Rule No.3: Use Technology to Your AdvantageTrading
is a competitive business, and one can assume the person sitting on the
other side of a trade is taking full advantage of technology. Charting
platforms allow traders an infinite variety of methods for viewing and
analyzing the markets. Backtesting an idea on historical data prior to
risking any cash can save a trading account, not to mention stress and
frustration. Getting market updates with smartphones allows us to
monitor trades virtually anywhere. Even technology that today we take
for granted, like high-speed internet connections, can greatly increase
trading performance.
Using technology to your advantage, and keeping current with available
technological advances, can be fun and rewarding in trading.
Rule No.4: Protect Your Trading CapitalSaving
money to fund a trading account can take a long time and much effort.
It can be even more difficult (or impossible) the next time around. It
is important to note that protecting your trading capital is not
synonymous with not having any losing trades. All traders have losing
trades; that is part of business. Protecting capital entails not taking
any unnecessary risks and doing everything you can to preserve your
trading business. (See
Risk Management Techniques For Active Traders for more.)
Rule No.5: Become a Student of the MarketsThink
of it as continuing education - traders need to remain focused on
learning more each day. Since many concepts carry prerequisite
knowledge, it is important to remember that understanding the markets,
and all of their intricacies, is an ongoing, lifelong process.
Hard research allows traders to learn the facts, like what the different
economic reports mean. Focus and observation allow traders to gain
instinct and learn the nuances; this is what helps traders understand
how those economic reports affect the market they are trading. (Read
about 24 different economic reports in our
Economic Indicators Tutorial.)
World politics, events, economies - even the weather - all have an
impact on the markets. The market environment is dynamic. The more
traders understand the past and current markets, the better prepared
they will be to face the future.
Rule No.6: Risk Only What You Can Afford to LoseIn
rule No.4, I mentioned that funding a trading account can be a long
process. Before a trader begins using real cash, it is imperative that
all of the money in the account be truly expendable. If it is not, the
trader should keep saving until it is.
It should go without saying that the money in a trading account should
not be allocated for the kid's college tuition or paying the mortgage.
Traders must never allow themselves to think they are simply "borrowing"
money from these other important obligations. One must be prepared to
lose all the money allocated to a trading account.
Losing money is traumatic enough; it is even more so if it is capital that should have never been risked to begin with.
Rule No.7: Develop a Trading Methodology Based on FactsTaking
the time to develop a sound trading methodology is worth the effort. It
may be tempting to believe in the "so easy it's like printing money"
trading scams that are prevalent on the internet. But facts, not
emotions or hope, should be the inspiration behind developing a trading
plan.
Traders who are not in a hurry to learn typically have an easier time
sifting through all of the information available on the internet.
Consider this: if you were to start a new career, more than likely you
would need to study at a college or university for at least a year or
two before you were qualified to even apply for a position in the new
field. Expect that learning how to trade demands at least the same
amount of time and factually driven research and study. (Refer to
Day Trading Strategies For Beginners for a primer on picking the right strategy.)
Rule No.8: Always Use a Stop LossA stop loss
is a predetermined amount of risk that a trader is willing to accept
with each trade. The stop loss can be either a dollar amount or
percentage, but either way it limits the trader's exposure during a
trade. Using a stop loss can take some of the emotion out of trading,
since we know that we will only lose X amount on any given trade.
Ignoring a stop loss, even if it leads to a winning trade, is bad
practice. Exiting with a stop loss, and thereby having a losing trade,
is still good trading if it falls within the trading plan's rules. While
the preference is to exit all trades with a profit, it is not
realistic. Using a protective stop loss helps ensure that our losses and
our risk are limited.
Rule No.9: Know When to Stop TradingThere are two reasons to stop trading: an ineffective trading plan, and an ineffective trader.
An ineffective trading plan shows much greater losses than anticipated in historical testing. Markets may have changed, volatility
within a certain trading instrument may have lessened, or the trading
plan simply is not performing as well as expected. One will benefit by
remaining unemotional and businesslike. It might be time to reevaluate
the trading plan and make a few changes, or to start over with a new
trading plan. An unsuccessful trading plan is a problem that needs to be
solved. It is not necessarily the end of the trading business.
An ineffective trader is one who is unable to follow his or her trading
plan. External stressors, poor habits and lack of physical activity can
all contribute to this problem. A trader who is not in peak condition
for trading should consider a break to deal with any personal problems,
be it health or stress or anything else that prohibits the trader from
being effective. After any difficulties and challenges have been dealt
with, the trader can resume.
Rule No.10: Keep Trading in PerspectiveIt
is important to stay focused on the big picture when trading. A losing
trade should not surprise us - it is a part of trading. Likewise, a
winning trade is just one step along the path to profitable trading. It
is the cumulative profits that make a difference. Once a trader accepts
wins and losses as part of the business, emotions will have less of an
effect on trading performance. That is not to say that we cannot be
excited about a particularly fruitful trade, but we must keep in mind
that a losing trade is not far off.
Setting realistic goals is an essential part of keeping trading in
perspective. If a trader has a small trading account, he or she should
not expect to pull in huge returns. A 10% return on a $10,000 account is
quite different than a 10% return on a $1,000,000 trading account. Work
with what you have, and remain sensible.
ConclusionUnderstanding
the importance of each or these trading rules, and how they work
together, can help traders establish a viable trading business. Trading
is hard work, and traders who have the discipline and patience to follow
these rules can increase their odds of success in a very competitive
arena.
Ok, let's begin with the first one...
You'll notice that all of these bearish patterns are the opposite of
the bullish patterns. These patterns come after a rally and signify a
possible reversal just like the bullish patterns.
You can see in the above graphic why this pattern is so explosive.
Like most candle patterns there is a bullish and bearish version. In
the bullish version, the stock is moving down and the last red candle
closes at the bottom of the range.