I must admit, I am not smart enough to have devised these ridiculously simple
trading rules. A great trader gave them to me some 15 years ago. However, I will
tell you, they work. If you follow these rules, breaking them as infrequently as
possible, you will make money year in and year out, some years better than
others, some years worse - but you will make money. The rules are simple.
Adherence to the rules is difficult.
"Old Rules...but Very Good Rules"
If I've learned anything in my 17 years of trading, I've learned that the
simple methods work best. Those who need to rely upon complex stochastics,
linear weighted moving averages, smoothing techniques, fibonacci numbers etc.,
usually find that they have so many things rolling around in their heads that
they cannot make a rational decision. One technique says buy; another says sell.
Another says sit tight while another says add to the trade. It sounds like a
cliché, but simple methods work best.
- The first and most important rule is - in bull markets, one is supposed to
be long. This may sound obvious, but how many of us have sold the first rally
in every bull market, saying that the market has moved too far, too fast. I
have before, and I suspect I'll do it again at some point in the future. Thus,
we've not enjoyed the profits that should have accrued to us for our initial
bullish outlook, but have actually lost money while being short. In a bull
market, one can only be long or on the sidelines. Remember, not having a
position is a position.
- Buy that which is showing strength - sell that which is showing weakness.
The public continues to buy when prices have fallen. The professional buys
because prices have rallied. This difference may not sound logical, but buying
strength works. The rule of survival is not to "buy low, sell high", but to
"buy higher and sell higher". Furthermore, when comparing various stocks
within a group, buy only the strongest and sell the weakest.
- When putting on a trade, enter it as if it has the potential to be the
biggest trade of the year. Don't enter a trade until it has been well thought
out, a campaign has been devised for adding to the trade, and contingency
plans set for exiting the trade.
- On minor corrections against the major trend, add to trades. In bull
markets, add to the trade on minor corrections back into support levels. In
bear markets, add on corrections into resistance. Use the 33-50% corrections
level of the previous movement or the proper moving average as a first point
in which to add.
- Be patient. If a trade is missed, wait for a correction to occur before
putting the trade on.
- Be patient. Once a trade is put on, allow it time to develop and give it
time to create the profits you expected.
- Be patient. The old adage that "you never go broke taking a profit" is
maybe the most worthless piece of advice ever given. Taking small profits is
the surest way to ultimate loss I can think of, for small profits are never
allowed to develop into enormous profits. The real money in trading is made
from the one, two or three large trades that develop each year. You must
develop the ability to patiently stay with winning trades to allow them to
develop into that sort of trade.
- Be patient. Once a trade is put on, give it time to work; give it time to
insulate itself from random noise; give it time for others to see the merit of
what you saw earlier than they.
- Be impatient. As always, small loses and quick losses are the best losses.
It is not the loss of money that is important. Rather, it is the mental
capital that is used up when you sit with a losing trade that is important.
- Never, ever under any condition, add to a losing trade, or "average" into
a position. If you are buying, then each new buy price must be higher than the
previous buy price. If you are selling, then each new selling price must be
lower. This rule is to be adhered to without question.
- Do more of what is working for you, and less of what's not. Each day, look
at the various positions you are holding, and try to add to the trade that has
the most profit while subtracting from that trade that is either unprofitable
or is showing the smallest profit. This is the basis of the old adage, "let
your profits run."
- Don't trade until the technicals and the fundamentals both agree. This
rule makes pure technicians cringe. I don't care! I will not trade until I am
sure that the simple technical rules I follow, and my fundamental analyses,
are running in tandem. Then I can act with authority, and with certainty, and
patiently sit tight.
- When sharp losses in equity are experienced, take time off. Close all
trades and stop trading for several days. The mind can play games with itself
following sharp, quick losses. The urge "to get the money back" is extreme,
and should not be given in to.
- When trading well, trade somewhat larger. We all experience those
incredible periods of time when all of our trades are profitable. When that
happens, trade aggressively and trade larger. We must make our proverbial
"hay" when the sun does shine.
- When adding to a trade, add only 1/4 to 1/2 as much as currently held.
That is, if you are holding 400 shares of a stock, at the next point at which
to add, add no more than 100 or 200 shares. That moves the average price of
your holdings less than half of the distance moved, thus allowing you to sit
through 50% corrections without touching your average price.
- Think like a guerrilla warrior. We wish to fight on the side of the market
that is winning, not wasting our time and capital on futile efforts to gain
fame by buying the lows or selling the highs of some market movement. Our duty
is to earn profits by fighting alongside the winning forces. If neither side
is winning, then we don't need to fight at all.
- Markets form their tops in violence; markets form their lows in quiet
- The final 10% of the time of a bull run will usually encompass 50% or more
of the price movement. Thus, the first 50% of the price movement will take 90%
of the time and will require the most backing and filling and will be far more
difficult to trade than the last 50%.
There is no "genius" in these rules. They are common sense and nothing else,
but as Voltaire said, "Common sense is uncommon." Trading is a common-sense
business. When we trade contrary to common sense, we will lose. Perhaps not
always, but enormously and eventually. Trade simply. Avoid complex methodologies
concerning obscure technical systems and trade according to the major trends
Written by Richard Rhodes