Rules Shmules: The Importance of a Clearly Defined Trading System
Series: Mental Roadblocks of Day Trading
I put a lot of emphasis on a trader’s system in my tutorials. It must be one of the most used words in this blog. I use it as a general term because each trader has his own system with its own specific sets of rules. But the common denominator is that each system does have some invariable rules, regardless of the system itself. Because the market by nature (and the trader by nature for that fact) is a contradictory creature, you succeed only with the statistical average of a system. With that being said, let’s look at some cornerstones of trading YOUR system.
1. Define your system. In day trading, there are a plethora of systems out there. And, regardless of the claims of many, there is no perfect one. The fact is - if a system is correct even 30% of the time, a skilled day trader can make money. What this should tell you is that your system is not particularly important but how well and consistently it is executed. The important thing, before one should ever day trade seriously, is to define what system you will be using and the rules of that system. The second most important thing is to resolve to live by the rules of that system, indefinitely.
If I were to walk into your office right now and ask you how you call your trades, ideally you would have a definite answer. In six months, that answer should be about the same. Don’t get me wrong, I am not saying you cannot change or improve your system but the core methods you use to trade should be slow to change and only in small degrees at a time. The only consistency you have in the market is how you (via your system) react to it. It is tempting to “dabble” with other systems because the grass is always greener on the other side (or shall I say the ticker is always greener on the other trade…? Shameless, I know). This kind of experimentation should be seen as just that. Think long and hard before changing the way you trade and battle-test any changes with small capital (or even theoretical) trading for at least 30 trades (of course journaling your results for analysis).
Note: An exception to this rule is if you trade different markets. A system that works with small cap companies is not necessarily going to work on futures.
2. Change the outlook, not the system. I cannot tell you how many times, when I was learning to trade, I would have a bad day in the market and decide that the problem was my system. If only I had a better system, a more accurate system, a more apparent system. A crystal ball would have done the trick. It is a lot easier to think that a better or different system will improve your trading than to accept the fact that any system will have losing trades and that your job is to follow the system to a tee and manage your losses with precision. Using the methods above for incorporating system changes will also keep you from making spontaneous (and likely emotional) decisions about your system.
3. Don’t cherry pick your trades. In trading, the only way a system works is if, statistically, there is no control group. Every trade that the system calls must be traded. Otherwise you are relying more on an outside source (usually your own opinion) than the rules you trade by. Trading is not for the maverick despite how it can feel at times!
