TRADETHINK ARTICLES : Trade to Win – Four Cardinal Rules of Trading

FutureSource.com: Fast Break for Traders

February 1, 2008

Education Edition

Today's Featured Article

Trade to Win – Four Cardinal Rules of Trading

By Chris Morse

Trade to Win - Four Cardinal Rules of Trading

Trading commodities can be very exciting, challenging and potentially profitable. It is widely accepted in the trading community that rules based trading is an essential element to ones success. Using a quality trading system can be of great assistance to ones goal of consistency and discipline in searching the vast number of markets for trade opportunities. Quality trading systems will always employee the “Four Cardinal Rules of Trading”.

Rule I: Trade with the Trend

The trend is your friend! Commodities are unlike stocks in many ways. With stock trading one will try to buy low and sell high, or the stock trader investor is looking for value. Commodities are supply and demand driven and will buy strength and sell weakness. One of the simple ways to determine strength or weakness in a market is to first identify the direction of the trend. If the trend is up they look for a buy or long trade, if the trend is down look to go short the market. Trading systems will find the current trend direction. Then select the best potential trade for you by choosing which market to trade and even the best entry price for you to enter a position.

Rule II: Let Your Winners Run

If I had to choose one area of trading where most fail it would be in not letting their profits run. People want to take profits way to soon and miss out on the big trades. In order to have a fighting chance in this game we call trading you must have the wherewithal to stick to your guns. If a trade is moving in your direction why on earth would you want to pull it? Many traders are by nature trigger happy. Being trigger happy can be fun and exciting, but is seldom profitable.

The average individual/trader is controlled by fear and greed. On the greed end the trader will want to take those profits off the table too soon and run like a school girl. It is the trader that runs away who supply the professionals the ammunition to hunt them down and wipe them out again and again. A trading strategy that will keep you in a trending trade moving in your direction is essential for success.

Rule III: Cut Loses Short

For many taking a trading loss is psychologically and financially draining. In truth being able to take a loss or series of losses can be essential to being successful at trading the markets in the long run. The commodities markets typically only trend about a third of the time. This means that the markets are choppy and range bound the other two thirds of the time.

In trend trading to be successful 35% to 40% of the time is an exceptional feat. It is comparable to a professional baseball player having a .350 to .400 batting average!

In order to win one must be able to lose. The key to being a good loser is to know when to cut your loses. A systematic amount of risk can be placed on a trade when it is entered. You can use a hard dollar stop, percent of equity or a percentage of volatility to determine how much to risk on a trade and when to cut your loss. Knowing when you are going to take a loss before you enter the trade is key to your trading discipline. One must develop the ability to exit gracefully while under direst to be a success. An automated trading system like TradeThink sets protective stop loss levels for the trader.

Rule IV: Manage Risk

To be able to manage risk is paramount to success in trading. Risk or “trade risk” is managed primarily through hard dollar stops and trailing stops. You must not only be concerned with your initial downside risk on a trade. Managing profit on a winning trade is extremely important “let your profits run”.

The pinnacle of risk management is in sizing your trade “position sizing”. When you follow a disciplined set of trading rules that result in a positive expectancy trading system it is only prudent to compound your returns on the way up and reduce your trade size on the way down. This is position sizing. Positions can be sized based on a percentage of trading equity or individual trade risk. TradeThink provides all of its clients with a proprietary position sizing model “PPSM” for use with trading its systems. A position sizing model will do the risk calculations for how much to place on a particular trade. The benefit of position sizing or managing risk is to smooth your equity curve and make positive expectancy of returns exponential.

Summary

While the “Four Cardinal Rules of Trading” are not a certain guarantee of trading success. They are key ingredients to the road traveled by successful traders.


Disclosure: Commodity trading has large potential rewards, but also large potential risks. You must be aware of the risks and be willing to accept them in order to invest in the futures markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to buy/sell commodity interests. Users of the software are solely responsible for the operation of the software and trade postings to this website are either only as examples of how the software works or the results of operation of the software after the market closes provided to licensees of the software only to help validate their operation of the software. Trade Think does not manage any money or provide trade or investment recommendations.

Notice: Returns are hypothetical. Hypothetical or simulated performance returns have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since trades have not actually been executed, the results may have under or over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight, no representation is being made that any account will or is likely to achieve profits or losses similar to those shown.

TRADETHINK SHOWS YOU AUTOMATICALLY:

• when to enter the trade ... • where to enter the trade... • trend direction ... • when to exit the trade ... • where to exit the trade ...

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. INVESTMENTS IN FUTURES INVOLVES HIGH RISKS AND YOU CAN LOSE A LOT OF MONEY.

FUTURES TRADING HAS LARGE RISKS. YOU MUST BE AWARE OF THE RISKS AND BE WILLING TO ACCEPT THEM IN ORDER TO INVEST IN THE FUTURES MARKETS. DON'T TRADE WITH MONEY YOU CAN'T AFFORD TO LOSE. YOU SHOULD CAREFULLY CONSIDER WHETHER YOUR FINANCIAL CONDITION PERMITS YOU TO PARTICIPATE IN THE FUTURES INDUSTRY. IN SO DOING, YOU SHOULD BE AWARE THAT TRADING FUTURES AND OPTIONS ON FUTURES CAN QUICKLY LEAD TO LARGE LOSSES AS WELL AS GAINS. SUCH TRADING LOSSES CAN SHARPLY REDUCE THE VALUE OF YOUR ACCOUNT. THIS IS NEITHER A SOLICITATION NOR AN OFFER TO BUY OR SELL FUTURES INTERESTS.

USERS OF THE SOFTWARE ARE SOLELY RESPONSIBLE FOR THE OPERATION OF THE SOFTWARE. TRADE POSTINGS TO THIS WEBSITE ARE EITHER ONLY EXAMPLES OF HOW THE SOFTWARE WORKS OR THE RESULTS OF OPERATION OF THE SOFTWARE AFTER THE MARKET CLOSES. THIS IS PROVIDED TO LICENSEES OF THE SOFTWARE ONLY TO HELP VALIDATE THEIR OPERATION OF THE SOFTWARE. TRADE THINK DOES NOT MANAGE ANY MONEY OR PROVIDE TRADE OR INVESTMENT RECOMMENDATIONS. PROSPECTIVE TRADE THINK CUSTOMERS ARE ADVISED TO MAKE DECISIONS BASED UPON THEIR SPECIFIC CIRCUMSTANCES AND NOT MERELY ON THE INFORMATION CONTAINED ON THIS WEBSITE. THIS BRIEF RISK DISCLOSURE STATEMENT CANNOT DISCLOSE ALL THE RISKS AND OTHER FACTORS NECESSARY TO EVALUATE YOUR PARTICIPATION IN THE FUTURES INDUSTRY, WHICH SHOULD BE CONDUCTED INDEPENDENTLY BY YOU WITH THE EXPERTS OF YOUR CHOICE.

ALL TRADING INVOLVES HIGH RISK. THERE HAVE BEEN NO PROMISES, GUARANTEES OR WARRANTIES SUGGESTING THAT ANY TRADING BY TRADE THINK USERS WILL RESULT IN A PROFIT OR WILL NOT RESULT IN A LOSS.

ALL RETURNS PRESENTED ON THIS SITE ARE HYPOTHETICAL. HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.

ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

TRADE THINK AND ITS CURRENT EMPLOYEES HAVE HAD LITTLE OR NO RECENT EXPERIENCE IN TRADING ACTUAL ACCOUNTS FOR ITSELF OR FOR CUSTOMERS. BECAUSE THERE ARE NO ACTUAL TRADING RESULTS TO COMPARE TO THE HYPOTHETICAL PERFORMANCE RESULTS, CUSTOMERS SHOULD BE PARTICULARLY WARY OF PLACING UNDUE RELIANCE ON THESE HYPOTHETICAL PERFORMANCE RESULTS.