Trading Principles II: Fundamental Rules of Trading

Written by pawelskrzypek

In my next post to the eToro blog, I would like to give you the most important rules of trading, at least the most important for me. These rules are not connected to fundamental analysis or analysis at all, but are important for trading itself, independent of system or strategy. These rules are not something new or a brilliant idea of trading, but are fundamental, probably well-known knowledge. As I said they are my rules; you can have similar or completely different rules; let’s discuss it, here below this post or on my wall. It will be a very valuable discussion.

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1. Protect your capital

Sometimes called PPC (Protect Precious Capital). This is the most important rule for trading. Capital is to a trader what ammo is to a soldier. Without capital we can’t trade. Of course, the safest way to protect capital is not to trade and sometimes that is a very good choice, but we are traders, so we need to trade sometimes. There is no one method which protects our capital for sure, but always in trading we must remember this rule. Opening trades, setting SL, extending SL, not setting SL at break even, not closing trade in profit – whatever else you forget, always remember this rule. Please think about it when opening new position, if your capital is as safe as possible and trade has proper risk to reward ratio then this is not gambling.

2. Anything could happen

All people who read my wall know this very well because I repeat it very often.  I mean, that in trading we couldn’t be sure how prices will move. There is nothing like a sure move in trading; please remember this. Yes, some moves are high probabilistic moves, but we cannot be sure. So, don’t risk all your money in one “sure” trade, because there is no such thing. Whether we can risk less or more money in a particular trade depends of probabilities of such trade according to our analysis, but never can you be sure of something. So next time when someone said something about sure move, please remember it; when you think that this move is “sure thing” please remember this rule: there is no such thing as a sure thing.

3. Avoid losses

This rule is connected with rule 1, but I want to say something more. In our trades, we should focus on avoiding losses, and minimizing our risk. Of course, we need to risk money to trade, but we have to actively manage our risk and minimize it during trade. I’m using a special technique called rescue mode to avoid losses (you can read about it in my strategy at copy.me/pawelskrzypek). And please remember, using fixed 2% SL is not enough to manage risk; we could still lose our money this way, it will just take a bit longer. We have to focus in trading to control and minimize our risk. It is so important because after each loss you need to earn more percent of capital than you lost to come back to the previous point. That phenomenon is called Siegel’s Paradox; simply, if you lose 50% of your capital, you need to earn 100% to come back to original amount of capital. Plan your trade very carefully and actively manage it. At each point of trading consider your possible losses and remember that a loss is always possible due to some unexpected results. I will write much more about risk management in future posts.

4. Discipline and preparation

These are very important in trading. The first step is to prepare your strategy, back-test and forward test it (as I wrote in previous post) and then use it as designed. Do not open trades which are not within your strategy or plan. Better preparation means better results and it clearly can be seen in trading. And trading needs patience, there is no rush in trading; remember, it’s a marathon, not a sprint.

In my opinion, the worst things in trading are opening unplanned positions, extending stop losses which don’t follow your strategy and others similar ways of losing money. Please think about all of that during your trading.

5. Loss

One more thing; maybe not a rule so much but still very important: losses. Losses are part of trading, trading without a loss is impossible in the long term. Of course we have to do everything we can to avoid losses but sometimes we just have to take them. In your strategy or plan we need to consider the worst case scenario when the market goes against us. Then we have to take the loss. Extending our stop loss could wipe our account and it will be the end of trading. It’s very hard time for a trader when the market says to us that you’ve been wrong; our ego is hurt, and we don’t like to confirm that we were wrong, but it’s our biggest enemy and it is within us. We extend a stop loss and lose more just to prove that we were right and wind up taking even more losses. Finally, it is possible to lose everything. So, again, please think about it, remember about it in your trading.

As I said at beginning of this post, these are the most important rules of trading, in my opinion. You may not agree with me, but I’m open for discussion. And I apologize for any harsh language (English is not my native language), but I would like to emphasize the importance of these rules.

If you have any questions or your own opinion, please write it, here below or on my wall.