The seven rules of trading

I post this today as a reminder to anyone who is caught short in the big NLST short-squeeze.

Sometimes I’m asked why I don’t make more money. I have two responses to this: first, I am not actually a very talented trader; second, I trade for a living, so my goal is to make a certain income while taking as little risk as possible. Those who focus on making as much money as possible while ignoring risk will invariably lose almost everything, no matter how talented they are, just as Livermore and Niederhoffer did.

1. Hope is not a strategy.
2. Plan your entry and exit before you make a trade.
3. If you are unsure of what to do, get out.
4. Only trade when you have an edge.
5. Track all your trades. If a strategy loses money, abandon it.
6. Do not focus only on potential gains but also on potential losses. Trade only when the risk/reward ratio is favorable.
7. Don’t let a very good profit disappear or turn into a loss because you want an even bigger profit.

22 thoughts on “The seven rules of trading

  1. Yeah I’m getting tired of my same excuse “at least I’m learning” because that’s getting old. I sat in my chair and watched this thing breaking out trying to hope it back down, that’s pittiful trading.
    I should have the talent by now to cover that short and play it long, which is not to far fetched considering the price action it was showing me. I was smart enough to cover at my break even price so maybe I am learning but I’m still pissed at myself.

  2. It’s hard to accept this type of trading because these opportunities are few and far between. It’s one thing to have a trade go against you and take a loss but it’s another to let a perfect trade turn from 20% profit to break even. I should have my ass beat for this, no excuse.

  3. I thought I knew that I had to cut losses and abandon trades if they do not behave as planned. I thought I knew that my hope wouldn’t move a price to my advantage.
    I read it many times, so I THOUGHT I knew it.

    Until I lost $4k a few days back for not following those rules I supposedly knew so well. Now is deep under my skin and fear is stronger than any hope, it takes pain to learn… 😐

  4. One thing I question in the daytrading world is the ‘day’ part. One doesn’t have to get in and out of every position within a day.

    If you’re caught in what you believe is a short squeeze, be patient, period. While I wasn’t watching last week, a stock I shorted, GAP, shot up and was a big short squeeze. I was in at 11.22. It got as high as 12.70 while I waited. It’s back down to 11.17 as week speak and I might get out now. But, part of me is waiting because I think it still might be squeezed.

    Do I wish I had stop/lossed? Sure. But, did I also feel this stock would come back to earth? Yes. So, I waited. And currently, it’s not a loss.

    So, just my two cents on waiting. It’s sometimes a viable alternative to loss.

  5. Hawk, that is a risky way to trade. While it may work most of the time, all it takes is the one time to cause major pain.

    Now GAP isn’t like NLST in that it has a significantly higher float, unlikely to have a major gap higher even on a takeover, etc. It is also unlikely that you will not be locked out of shorting GAP as shares are plentiful. With many low float momo’s if you let it get away from you and have the thought that you will just add to your short at a higher price …. you might not be able to. And with the mandatory forced buy ins that many brokers are implementing these days, the broker may close your position handing you a loss.

    Plus when you have a very large position, many 1,000s of shares, you can be in a hurt of pain in no time.

    Shorting has it’s own set of risks.

    Trade well,
    MM

  6. Well put, MM.

    And I think we agree on all points considered. I’m simply making the point that patience can be a virtue in trading. Obviously not always, but sometimes. (Plus, I now have GAP out of my life as a profit, and I’m pleased.)

  7. Hawk,, what you just said in no way makes any sense to me. I should note that I’m very frustrated and I don’t want to take it out on you but I am going to tell you what I think.
    What you are doing is setting yourself up for a game stopping loss one day, while I’m not Michael when it comes to trading he has taught me to cut losses quickly or your out of the game. Shorts are nothing to play around with, they can ruin you in one bad swoop, I play with small positions so it doesn’t hurt as bad but Michael plays with large posisions and it can get ugly very quickly.
    I will tell you that if you continue with that style it will hurt one day, you will become a statistic, one of the 95% that looses money.

  8. Hawk: I have to agree with Preston and MM. Unless your strategy is hard-core fundamental investing or shorting, you need a stop. The same thinking that led you to a profit would have led you to a 100% loss if you’d shorted it earlier (and it definitely looked over-extended awhile ago).

    I should also add that if you keep a position longer than you should then you cannot use the money to trade something else that may potentially be better.

  9. DDRX a great example of why holding onto a losing position can be a very bad idea. I could have made a great fundamental and technical case to short it at many points during its run-up from $0.50 to $26.

  10. The way I see it as I have been burned so many times, it doesn’t matter if you are long or if you are short. $&% happens. Accepting a loss is the hardest lesson to learn (one that I am still struggling with even after 5+ years of trading).

    I have seen major gap ups as well as gap downs. I have seen unrelenting moves that go on day after day.

    Once we are in a trade there is only one thing we can “try” to control and that is our exit price.

    If I could have only really learned this so long ago !!!!!

  11. Another thing to think about here is the general market. Last year the strategy of averaging up on shorts worked perfectly. I was new to trading then and when I finally got the hang of it things turned. I kept averaging up on shorts in March and April and the market hasn’t looked back since. Even though I still think it’s going down in the longterm a few of my shorts got close to 500% up before I started getting out. Good thing I had small positions or it would have been a disaster. I’ve learnt that strategies morph very quickly. The Pump and Dump strategies that worked for me in May and June don’t work anymore. I think that’s what makes the stock market interesting and at the same time so damn difficult.

  12. I don’t disagree with anything written here. But, I do stand by my position that there are times to be patient. Obviously you wouldn’t want to be patient on a short squeeze which includes your life savings, but I’m careful with my amounts.

    Using an example different than the one I used above, I successfully shorted EONC at 3.95 recently and got out in the 3.7’s. I should have been more patient. Look where it is now.

  13. Patiently waiting for a setup …. yes.

    Patiently waiting for a stock to turn around from a loser to a winner …. that’s extremely risky.

    This is a great topic and is not directed at you per say.

  14. Reaper, yes that was me. GOTS chat room was a good one, although I have my own style, it was still a great place to hang out. Since then I have shifted even more of my trading over to options. Once and a while I like to play the NLST type of stocks.

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