Ten (Trading) Rules I Never Break

As with anything in life, we have rules. We stop at red lights. We do not touch the red “live” wire. We never put our hands in boiling water. We do not leave the baby unattended in the bath.

Rules are meant for our safety. Rules prevent bad things from happening. Rules keep things organized and orderly.

We have rules for trading too but unlike most other rules, we tend to forget them, break them or ignore them when we trade. The fact about trading rules is that if you do not break them, you will find your losses actually getting less. The risk factors are also lowered significantly and your confidence stays untested.

If it is so obvious that trading rules are good for you, why then do people not have rules when they trade or why do they not adhere to them as they are trading?

The answer is a word that most people do not like while others do not even consider … Discipline.

Traders also have a tendency to want to prove to themselves that they are better than they actually are. These traders would like to believe that they have the skill to manage their trades without the need for stifling and restrictive rules. If nothing goes wrong, then it is all fine and dandy. However, when things do go awry (and they often do in this business), they will lack the discipline to do the right thing no matter how skillful they are.

The reason such traders do not feel the need to have rules is simply a matter of Pride. For such traders, having rules is a sign of weakness. Their pride will precede common sense and when something does go wrong, it is that same pride that will keep them from admitting that they have made a mistake. They will then defend that pride by blaming and finding excuses for their misfortune. For their lack of discipline, proud traders will never accept accountability for their losses.

Discipline and Pride … somehow, the two words do not jell well in the same sentence.

It is the humble trader who knows that things can go wrong, that mistakes can happen, that nothing should be taken for granted and that a set of rules will readily keep him safe.

I keep a set of ten simple rules when I trade to keep me disciplined so that my psychology is never tested and my confidence is kept high:

1) I Trade Only When There Is Something To Trade.

This is not the easiest thing to do. Experienced traders will tell you that the most difficult thing in trading is knowing when not to trade. Too often, we look for trades, we find an excuse to want to trade and we jump into trades without fully considering the consequences.

This rule keeps me from doing all that. I trade only because there is a trade to be made because the market is telling me so. If I have to consider my analyses for more than a minute, it simply means that there is no trade yet. If there were a trade to be made, it would be crystal clear.

2) I Never Trade Without R.S.T. (Reason, Strategy and Targets).

I keep a simple guideline about having a reason to trade and they fall into five categories:

  1. Interest Rates (Monetary Policy)
  2. Earnings
  3. Seasons
  4. Cycles (Sector Rotation)
  5. News (Macroeconomics)

If I do not have one of these reasons to take a positional trade, then I really do not have a reason to trade. Interest Rates give me a reason to take a long-term position like an investment. Earnings give me a quarterly reason to hold an equity position for up to three months. Seasons also give me a quarterly reason to hold anything other than equities. Cyclical trades can last between a week to a month or two. News can be a good reason to get a quick profit within a week.

Once you have your reason, you need to strategize that trade in the event that something goes wrong. You will need to have a fix, a hedge or some sort of protection because in this business, things can go very wrong very quickly.

Lastly, I never take the trade without first planning my trading budget, timeframe (duration), price target and stop-loss.

3) I Never Trade Something I Did Not Research Myself.

A common practice among sloth traders is to get a tip from someone else and jump into the trade, hoping for the best. They know little about the trade and definitely have no plan for it. Whether the tip loses or becomes profitable, they will surely not know what to do with it and when to do it.

Researching is a basic part of what good traders do before taking a position. If someone had a tip, I would research that tip thoroughly, have a plan to trade it and have a total understanding of what is about to happen.

Not researching a trade is akin to going on a road trip without first mapping the journey. You are bound to get lost at the first wrong turn.

4) I Never Buy The High

A general reaction to securities on the way up is that if you do not catch it soon, you will miss the ride. The problem with that thinking is that the security has already left you behind. If you do get a position, you will find that you are almost always going to suffer a dip thereafter.

Never buying the high allows me to contemplate my choices, of which there are always three: buy, sell/short or hold/do nothing.

Since the security is at a high, I obviously will not go long on it. I can choose to do nothing or if I am already in a position, I can choose to hold my position. I can also choose to sell what I have for a profit and even consider a possible short position if I do not have anything to sell for a profit (provided the short trade was researched first). Whatever my choice, I will not be buying it.

5) I Never Sell/Short The Low.

Tanking securities generate one of two extreme emotions in a trader – panic or greed. Panic tends to send the price down faster and more irrationally than greed sends the price up. To short an already tanking security is to court unnecessary risk. The security may have already arrived at the bottom where it is likely to consolidate or even bounce as a result of short covering or a short squeeze. To sell (cut loss) in panic at this level would be foolhardy as a bounce could save you some grief.

Of course, due diligence and research needs to be done in order to make a sound decision. Never selling/shorting the low allows me to pick from those three choices again — buy, sell/short or hold/do nothing.

Since the security is at a low, I obviously will not go short on it. I can choose to do nothing or if I am already in a position, I can choose to hold my position. I can also choose to short cover what I have for a profit and even consider a possible long position if I do not have anything to cover for a profit (provided the long trade was researched first). Whatever my choice, I will not be selling it.

But would I buy it? It depends on Rule #6.

6) I Buy On Supports

By using volumes and timing my entries to leverage on seasons and cycles, the lowest risk entry for a long trade is always when the security comes off a significant support level.

Other methods widely used by professionals include MACD, Candlestick Analysis and Breakout Patterns. But one constant remains – the lowest risk entry is when the price breaks out of those patterns as it comes off a significant support level.

Occasionally, the trend breaks down rather than bounces. For this see Rule #7.

7) I Sell/Short On Resistance

If I am looking to short something, I would rather short it at a high where there is a significant resistance to spoil the uptrend. I would also consider a short if a security breaks below a significant support level.

Remember that significant support levels used to be the recent significant resistance levels that are broken to the upside.

If such levels cannot support the security, it is rather common to see the price fall precipitously as it breaks below that support level.

8) I Never Trade In No Man’s Land

When a security is neither at a high near a resistance nor at a low near a support, that security is deemed to be in “No Man’s Land”.

Taking a position in No Man’s Land gives the trader a 50% chance of making or losing. I have been considered a high risk-taker but even a 50-50 chance is too much of a risk for me.

I would rather wait for the security to get up to the resistance again or fall further to the support before I consider my options. Remember rules #6 and #7.

9) I Always Wait For My Setup.

The setup is a familiar pattern that the security regularly performs that prompts me into action. Such patterns tend to repeat themselves thus making entries rather reliable.

One very common setup is the scalping opportunity at the opening hour of the U.S. Market. Certain stocks tend to take a direction in the opening 15 to 20 minutes and promptly reverse into the direction of the market trend. The initial direction is often from profit taking as the previous session could have closed higher. It could also work the other way as traders cover their shorts from the previous day’s drop.

When a security presents such an opening, regular traders of the security will identify an opportunity to make a scalp as the reversal falls into place and all the technical indications look ever so familiar. This is a setup.

All good traders have setups of their own. They will wait patiently for the security to set itself up and if it never happens, they do not trade. However, when it presents itself without any doubt, the trader knows that this is the lowest possible risk trade that he will ever take.

I have various setups for the various securities I trade. Each trading timeframe also comes with its own setup. There have been times in the past when I did not have the patience to wait for my setup. The results were always disappointing. Today, this is still one of my most testing disciplines but I have gotten better at it.

Good habits come from good practice.

10) I Never Break Any Of These Rules.

Now that should go without saying!

Feel free to download this poster and stick it up on the wall where you trade as a visual reminder to stay disciplined to your craft. Take it as my goodwill gift to you so that you may strive to be a mindful trader.

Happy Hunting!!


This article was featured in the National Best-Selling Book, “Winning Psychology Of Defensive Traders” 

Copyright © Pattern Trader™ by Conrad Alvin Lim. All Rights Reserved 






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