Trading rules: Should they be followed?
-
- 0
- 1093
- 0
To succeed on the stock market, we often hear that you have to follow very precise trading rules. Being disciplined and able to follow strict rules is undeniably the key to success in making money on the stock market. Among the trading rules, the best known is "Cut your losses and let your profits run". This advice for stock market investment is given by most experienced traders. If you do not respect this rule, you are promised tears, ruin and regret. To succeed on the stock market, should you follow this trading rule?
It is obvious that if you never take your losses and you cut at the slightest small gain, you cannot win in the stock market. This is what most novice traders do. This behaviour can be found on all financial markets. Let's take an extreme case with a stock market crash. It is noted that the majority of traders didn’t ever cut their positions during the subprime crisis. Worse, they cut their positions when the stock market was at its lowest, weary of seeing prices go down. Explanations for such behaviour are easy to find.
Nobody wants to lose money on the stock market. When a trade loses, traders often focus on the hope that the trade will one day become a winner. They often tell themselves while they have not cut it, anything is possible. That's true, but in the majority of cases, not taking your losses leads you to lose even more.
Novice traders also see a loss as a personal failure. It means they were wrong, and to take the loss is to make the fact that they were wrong official but losing a trade doesn't necessarily mean you made a mistake. This is often very hard for novice traders to comprehend, but good analysis does not guarantee a trade’s success. In the end, it is always the market that has the last word, it is the market that makes your trade win or lose. A trader only tries to exploit the probabilities of a scenario. So you should not see loss as a personal failure, but simply as a stroke of bad luck (if of course your analysis was good in the beginning). Losing trades is inevitable for all traders, it's part of trading.
If you combine the desire not to lose money with the refusal of failure, this explains the behaviour of the majority of novice traders never cutting their losses. Ironically, this behaviour ends up leading them to the loss of all their invested capital.
For this reason, always use a stop loss. It is there to force you to take your losses. The sooner you take your losses on your losing trades, the sooner you make money on the stock market. You do not have to wait until your stop loss is triggered. If you no longer believe in your scenario, if you are only waiting for a miracle, then cut your trade as quickly as possible. It's these sort of details that make the difference.
Up to this point, the saying cut your losses and let your profits run, seems to be true. But what about the profits?
Letting your profits run implies not taking your profits too quickly on a winning trade. However, it is better not to let your profits run too much, this is the best way to lose them. The only important thing is that your winnings exceed your losses. If you accept taking losses without flinching, it is not necessary to let your profits run. When trading on the stock exchange or Forex, it is important to set price objectives. Once a goal is achieved, take your profits quickly. If you still see bullish/bearish potential in your trade’s direction, you can cut just a portion of your position and let your winnings run on the other portion. This way, you are sure to come out a winner from trading.
There is nothing worse, in terms of accounting and psychology, to have had a winning trade and to see it cut with a loss just because you were too greedy. Greediness is often the weakness of novice traders. They're looking to capture large movements, they're looking for the coup of the century. It's a mistake you shouldn't make. There are large trend movements, but it's difficult to capture them. Why?
With large trend movements, there are also large correction movements. These movements generally make you exit your trade by triggering your stop loss (even if it is distant). There is a lot of volatility in the markets. The only solution is to trade for the long term, but you should then adjust your position size to be able to place a stop loss further away. Whether you are dealing with the short or the long term, your risk should be the same. Capturing a large trend movement over the long term is therefore the same as capturing a small short-term movement (larger position size because the stop loss is closer).
If the market movement triggers your stop loss, it always costs you money. Either your trade is a losing one right from the start or it is a winner and you can then move your stop loss. If your stop loss is triggered on a winning trade, it is a sign of a loss of profit. Effectively, moving a stop loss on a winning trade is performed when the price has made a push in the direction of your trade. Between cutting after the thrust and exiting because of your stop loss, there's a huge differential! If you accumulate this on all your trades, it is often the difference between a winning and losing trader on the stock markets.
The adage of a winning trader is,in my opinion, "Cut your losses and take your profits". If we look at the studies conducted on Forex for example, 50% of trades (a majority of which were made by novice traders) are winners. Yet 90% of Forex traders are losers. You should understand the importance of good profit and loss management on a trade.
There are other commonly accepted trading rules that do not necessarily have to be followed to the letter. This is the case, for example, of the risk/reward ratio.
Trading rule no.1: Accept losses
It is obvious that if you never take your losses and you cut at the slightest small gain, you cannot win in the stock market. This is what most novice traders do. This behaviour can be found on all financial markets. Let's take an extreme case with a stock market crash. It is noted that the majority of traders didn’t ever cut their positions during the subprime crisis. Worse, they cut their positions when the stock market was at its lowest, weary of seeing prices go down. Explanations for such behaviour are easy to find.
Nobody wants to lose money on the stock market. When a trade loses, traders often focus on the hope that the trade will one day become a winner. They often tell themselves while they have not cut it, anything is possible. That's true, but in the majority of cases, not taking your losses leads you to lose even more.
Novice traders also see a loss as a personal failure. It means they were wrong, and to take the loss is to make the fact that they were wrong official but losing a trade doesn't necessarily mean you made a mistake. This is often very hard for novice traders to comprehend, but good analysis does not guarantee a trade’s success. In the end, it is always the market that has the last word, it is the market that makes your trade win or lose. A trader only tries to exploit the probabilities of a scenario. So you should not see loss as a personal failure, but simply as a stroke of bad luck (if of course your analysis was good in the beginning). Losing trades is inevitable for all traders, it's part of trading.
If you combine the desire not to lose money with the refusal of failure, this explains the behaviour of the majority of novice traders never cutting their losses. Ironically, this behaviour ends up leading them to the loss of all their invested capital.
For this reason, always use a stop loss. It is there to force you to take your losses. The sooner you take your losses on your losing trades, the sooner you make money on the stock market. You do not have to wait until your stop loss is triggered. If you no longer believe in your scenario, if you are only waiting for a miracle, then cut your trade as quickly as possible. It's these sort of details that make the difference.
Up to this point, the saying cut your losses and let your profits run, seems to be true. But what about the profits?
Trading rule no. 2: Take your profits
Letting your profits run implies not taking your profits too quickly on a winning trade. However, it is better not to let your profits run too much, this is the best way to lose them. The only important thing is that your winnings exceed your losses. If you accept taking losses without flinching, it is not necessary to let your profits run. When trading on the stock exchange or Forex, it is important to set price objectives. Once a goal is achieved, take your profits quickly. If you still see bullish/bearish potential in your trade’s direction, you can cut just a portion of your position and let your winnings run on the other portion. This way, you are sure to come out a winner from trading.
There is nothing worse, in terms of accounting and psychology, to have had a winning trade and to see it cut with a loss just because you were too greedy. Greediness is often the weakness of novice traders. They're looking to capture large movements, they're looking for the coup of the century. It's a mistake you shouldn't make. There are large trend movements, but it's difficult to capture them. Why?
With large trend movements, there are also large correction movements. These movements generally make you exit your trade by triggering your stop loss (even if it is distant). There is a lot of volatility in the markets. The only solution is to trade for the long term, but you should then adjust your position size to be able to place a stop loss further away. Whether you are dealing with the short or the long term, your risk should be the same. Capturing a large trend movement over the long term is therefore the same as capturing a small short-term movement (larger position size because the stop loss is closer).
If the market movement triggers your stop loss, it always costs you money. Either your trade is a losing one right from the start or it is a winner and you can then move your stop loss. If your stop loss is triggered on a winning trade, it is a sign of a loss of profit. Effectively, moving a stop loss on a winning trade is performed when the price has made a push in the direction of your trade. Between cutting after the thrust and exiting because of your stop loss, there's a huge differential! If you accumulate this on all your trades, it is often the difference between a winning and losing trader on the stock markets.
Conclusion
The adage of a winning trader is,in my opinion, "Cut your losses and take your profits". If we look at the studies conducted on Forex for example, 50% of trades (a majority of which were made by novice traders) are winners. Yet 90% of Forex traders are losers. You should understand the importance of good profit and loss management on a trade.
There are other commonly accepted trading rules that do not necessarily have to be followed to the letter. This is the case, for example, of the risk/reward ratio.
