Rule 1: Always Use a Trading Plan
A trading plan is a set of rules that specify how a trader enters, exits, and manages funds for each transaction. Use technology to test a trading idea before risking real money. This process is known as backtesting. It allows you to implement your trading idea using historical data and determine if it is working. The program can be used in real trading after it has been developed and the returns show good results.
- The key here is to stick to the plan. Taking trades without a trading plan deviates from your predicted performance and destroys the value of your plan even if they are winners.
- Sometimes your trading plan will not work. Exit it and start over.
Rule 2: Treat Trading Like a Business
You must look at trading as a full-time or part-time business, not as a hobby or career, if you are going to be successful. There is no real commitment to learning if it is approached as a hobby. It can be frustrating because there is no pay every time it is work.
Trading as a business allows you to clearly identify all your expenses and losses. This helps you reduce uncertainty, risk, stress, and even taxes. Most of the time marketers think they are in the guesswork business. This point of view often creates an unproductive effort. Traders who realize they are in the business of managing risk begin to focus their efforts in a more productive way.
Rule 3: Use Technology to Your Advantage
Trading is a competitive business so it is safe to assume that the person on the other side of the trade is making full use of all available technology.
Charting platforms offer traders endless ways to view and analyze the markets. Supporting a hypothesis using historical data prevents costly missteps. Getting market updates through your smartphone allows you to monitor trades from anywhere. A high-speed Internet connection can increase trading performance. Using technology to your advantage and staying up to date with new products can be fun and rewarding.
Rule 4: Protect Your Trading Capital
Saving enough money to fund a trading account takes time and effort. It can be even more difficult if you have to do it twice.
Protecting your trading capital is not the same as not recovering from losing trades. All traders have losing trades. Protecting money means not taking unnecessary risks and doing everything you can to protect your trading business.
Rule 5: Be a Reader of the Markets
Traders should always focus on learning more each day. It is important to remember that understanding markets and their complexities is an ongoing, lifelong process.
Extensive research allows traders to understand facts such as what economic reports mean. Focusing and observing allows traders to sharpen their instincts and learn nuances. World politics, news events, economic trends and even the weather can all affect the markets. The more traders understand past and present markets, the better prepared they are to deal with the future.
Learn about Investopedia's 10 rules of investing by picking up a copy of our special print edition.
Rule 6: Risk Only What You Can Afford to Lose
Make sure the money in that trading account is spent before spending real money. The trader should continue to save until it happens.
Money in a trading account should not be allocated to college tuition or a mortgage. Traders should never allow themselves to think that they are simply borrowing money from these other important obligations. Losing money is traumatic enough. It's even more so when it's capital that shouldn't have been at risk in the first place.
Rule 7: Develop a Fact-Based Approach
Taking the time to develop a sound trading strategy is worth the effort. It may be tempting to believe in the "it's as easy as printing money" trading scams that are prevalent on the Internet but facts should form a trading plan, not emotion or hope.
Traders who are not in a hurry to learn usually have an easier time sifting through all the information available. You will probably need to attend college or university for at least a year or two before you are eligible to apply for a job in a new field if you want to start a new career. Learning to trade requires the same amount of time as research and fact-driven learning.
Rule 8: Always Use a Stop Loss
A stop loss is a fixed amount of risk that a trader is willing to accept on each trade. The stop loss can be a dollar amount or a percentage. It limits the trader's exposure during the trade. Using a stop loss can take some of the stress out of trading because you know you're only losing X amount on any given trade.
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Not having a stop loss is a bad habit even if it leads to a successful trade. Stop loss exits and losing trades are still good trades if they fall under the rules of your trading plan.
The idea is to exit all trades with a profit but this is not true. Using stop loss protection helps ensure that losses and risks are minimal
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