If you want to be a successful trader, you need to have a set of written rules! Your personal trading rules will evolve as you progress through your trading life. The number of rules that each trader uses can vary from a couple to several dozen. Too many rules can lead to inaction! I believe there are three main steps you should take when creating your trading rules:
1. When entering into a transaction
Whether you use technical or fundamental analysis to trade, you must have certain criteria for entering a trade.
Overly strict requirements like aligning all the stars before entering a trade may not be practical, but if you don’t have the basic guidelines, you might as well bet on red and black in the casino!
2. When to exit the trade
Getting into a trade can be a lot easier than getting out of it, so whenever you enter a trade, you should have an exit strategy. Your strategy should cover when to exit both a winning and a losing trade.
When you’re in a losing trade, it’s easy to believe that the trade will flip and that you’ve made no loss until you exit the trade.
While with advanced strategies it is not always necessary to immediately exit the trade (you can convert one strategy to another), you should still have trigger points to indicate when to act.
If you are in a profitable trade, you may decide that there is a lot more profit in the trade, but if you do not make a profit, it is not a profit.
3. When to review and change your rules
As your trading career progresses, circumstances will change and you must decide when your rules will be reviewed and under what conditions they need to be changed.
An example of a change in circumstances would be several years of a bull market ending in a big drop followed by a bear market.
Although your strategies should be designed to generate profits regardless of which direction the market will move, fundamental changes in the global economy may require some adaptation of your current rules.