The Rules of Day Trading
Irby, I am currently employed as a consultant for a trader who has been having a rough time trading for a partnership. I worked this up for him, and I thought it might be of use to others. This is for a trader who is not currently successful. FWIW...
The Rules of Day Trading
(c)1998 by Tastes Like Chicken
Written by Mr. Mighty Chicken
edited by cOUSIN SHORTY
Produced by Whipping Boy Trading, Inc.
A trading plan is essential for success. It is utterly impossible to succeed at trading without a concrete plan. The following are suggestions, some general, some specific, which I believe will assist the partnership's trader in achieving the goals of the partnership.
GENERAL POINTS
Homework: The study of specific equities and their relationship to the overall market is essential. It is suggested that the trader work at least one hour outside of market hours on familiarization with stocks that could be traded the next day. This can be done on the Internet. Also suggested is "Nightly Business Report" on PBS. As time goes on, the trader will have greater understanding of the widely traded stocks, and will be able to better judge information for potential opportunities. In addition, the trader should spend time every day honing his craft; studying trading techniques, refining his ideas, etc. Weekends require at least 2-3 hours of study to setup for the following week. The trader should be prepared to spend a minimum of 12 hours a week outside market hours on this planning and study.
Schedule: A standard schedule is essential. The trader should arrive a the trading center 45 minutes before the market opens (or more) and plan on being there all day.
Before the market opens: The trader should have a list of potential trading stocks from his homework from the prior evening. He should look at these as to how they traded intraday the day before, and draw conclusions as to whether or not he will follow them when the market opens. Also, he should observe CNBC at the trading center for breaking news, and keep an eye on the Dow news wire for news. The trader should have his attention on the market, and on nothing else, be rested, and be ready to attack the market. If there is some outside influence that could take attention off the market, the trader should cease trading until the situation is addressed and handled, and he can trade without external influences that could have a detrimental effect.
SPECIFIC RULES
Taking heat: This is the term used for watching a trade go the wrong way. It is the number one reason why traders lose money. Losses are inevitable. Nobody makes money every day. The key to winning overall is to limit the losses and offset them by winning trades. The trader should never take more than a set limit of heat. In my personal experience, it is extremely difficult to set a number limit on how much heat, such as one-half a point, etc. An easier way to define the problem would be in terms of dollar value loss on the trade. For example, a dollar loss on 500 shares loses more than a dollar loss on 200 shares. Under ordinary circumstances, 3/8 should be a maximum amount of heat. The trade has gone the wrong way, and 3/8 is usually enough to prove it. The trader should never, under any circumstances, take more than 5/8 of a point heat on any trade. The trader should never take more than a $250.00 loss on a trade.
Rule #1: Under most circumstances, 3/8 point maximum heat. Under no circumstances more than 5/8 heat. Under no circumstances more than $250.00 heat.
Maximum Shares per Trade
This, in my experience, is the second most violated rule. Traders with little experience get wiped out in short order by trading large amounts of shares. Until the trader is making money consistently, i.e. 10 trading days in a row with no losing days, the number of shares should be limited to a maximum of 600. Most good, professional traders limit the share size to less than 1000. There are situations where more shares than 600 may be traded with relative safety, but the rule must be:
Rule #2: Maximum shares traded on one trade is 600. If the trader is taking a multiple position on one stock, the maximum is still 600. Stick to 300 shares except in cases where the trader's opinion is very strong. Trade over 600 shares in rare and exceptional occasions only.
Mistakes
Traders make mistakes. The most common mistake is to sell when one wants to buy, and vice versa. The computer can go down, the feed to the exchange can be interrupted. There are a lot of things that can go wrong. The trader must assume full responsibility for any mistake that occurs. Open positions should be exited immediately (almost always at a loss) when a mistake occurs.
Rule #3: Exit instantly upon the execution of any mistake. No exceptions.
Number of Trades Per Day
Trading too much in one day is the third reason why traders lose money consistently. There is absolutely no reason to trade more than 15 trades per day. The maximum number of trades should be limited to 15 per day.
Rule #4: Maximum 15 trades per day.
Trading Times
Trades are consistently more successful before 11:00 a.m. and after 2:00 p.m. Trades are consistently less successful between 11 and 2. There is only one exception; if a particular stock is "in play" (being traded heavily due to some factor such as a big news announcement), this rule can be broken with relative safety. But trying to "find a trade" between 11:00 and 2:00 is almost always a bad move, and should be avoided by the trader. It is safer to miss a few opportunities than to consistently lose money when the market is slow. Also, under most circumstances, initiating a trade after 3:45 is too dangerous, and should be avoided. Never initiate a trade before the market opens or after it closes.
Rule #5: Initiate trades only between 9:30 a.m. and 11:00 a.m., and between 2:00 p.m. and 3:45 p.m. The only exception is a "hot stock" and these are rare; perhaps one a week at most.
Maximum Positions at One Time
The trader should try and limit himself to one open position at a time. Two positions is acceptable, but three is not.
Rule #6: Maximum two open positions at any one time.
Holding Overnight
Holding overnight is usually done to try and avoid a loss. It is stupid. Holding overnight for an expected gain is too risky for the trader.
Rule #7: Never hold a position overnight.
Consecutive Losing trades
It can occur that the trader makes several bad trades in a row. After three, it becomes clear that the trader has done something to consistently lose money, and need s to re-evaluate his thinking processes. This should be done prior to the next trade. Negative emotions or other non-survival influences may have entered into the trader's regimen, the overall market may have gone the "wrong" direction, the trader may have broken several of these rules, etc. If the 4th trade is a then loser, the trader should stop and seriously evaluate whether or not to continue for the day. He would probably be wise to stop and wait till tomorrow.
Rule #8: If there are 3 losing trades in a row, the trader must stop and examine what is going wrong. He should start trading again only after understanding what really went wrong. If the next trade, (the 4th) is then a losing trade, the trader needs to stop until he fully understands what went wrong. It would be wise to stop for the day at that point.
Breaking the Rules
All rules are made to be broken. All rules can be safely broken under certain circumstances. But in my experience, breaking more than one rule is a grave mistake, and reduces the possibility of success to less than 25%. It should not be done.
Rule #9: Never under any circumstances break more than one rule on a trade.
Sophisticated Trading Techniques:
Boxing, simulated long and short positions, hedging with options, etc. have no place in the trader's regimen. These should be avoided. The simple trading plan should be adhered to.
Rule #10: No boxing, simulated long or short positions in two accounts, options hedging, or other "tricks" should be employed. Stick to the basics, and follow the plan.
Trading Regimen
Every trader has a regimen; a style or set of rules that he follows to choose trades. For example, most day traders use technical analysis as part of their personal regimen to form conclusions. The personal regimen would include the specifics of what indicators are used and why. These regimens are constantly being refined and polished, due to the fact that the market changes all the time, and what worked 6 months ago may not work now. The trader must have a personal regimen, a specific set of rules or guidelines that he follows. This must be in writing. These guidelines must be his own, in other words, he must not use another trader screaming, "Buy Hollywood Global Internet right now" as a buy signal, or some "hot tip", or some computer program, or anything else, to make his FINAL decisions. He must make his final decisions himself, and he can't do it without a personal regimen. No personal regimen means the trader is open to the vagaries of whomever or whatever is making the decisions around him. The trader himself must make the call, not something or someone else. This is a most important factor in success. If the trader makes a decision himself, he is in control. If he lets someone else make a decision, he is not in control from the start. Not being in control of a trade is a mistake, and violates Rule #3. The personal trading regimen helps the trader refine his skills and learn what works and what does not. He can change his regimen at any time, of course, but he must have something to change.
Rule #11: The trader must have a personal regimen in writing so he knows what personal rules he must follow.
SUMMARY OF RULES
Rule #1: Under most circumstances, 3/8 point maximum heat. Under no circumstances more than 5/8 heat. Under no circumstances more than $250.00 heat.
Rule #2: Maximum shares traded on one trade is 600. If the trader is taking a multiple position on one stock, the maximum is still 600. Stick to 300 shares except in cases where the trader's opinion is very strong. Trade over 600 shares in rare and exceptional occasions only.
Rule #3: Exit instantly upon the execution of any mistake. No exceptions.
Rule #4: Maximum 15 trades per day.
Rule #5: Initiate trades only between 9:30 a.m. and 11:00 a.m., and between 2:00 p.m. and 3:45 p.m. The only exception is a "hot stock" and these are rare; perhaps one a week at most.
Rule #6: Maximum two open positions at any one time.
Rule #7: Never hold a position overnight.
Rule #8: If there are 3 losing trades in a row, the trader must stop and examine what is going wrong. He should start trading again only after understanding what really went wrong. If the next trade, (the 4th) is then a losing trade, the trader needs to stop until he fully understands what went wrong. It would be wise to stop for the day at that point.
Rule #9: Never under any circumstances break more than one rule on a trade.
Rule #10: No boxing, simulated long or short positions in two accounts, options hedging, or other "tricks" should be employed. Stick to the basics, and follow the plan.
Rule #11: The trader must have a personal regimen in writing so he knows what personal rules he must follow.
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