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Anyone who wants to become a profitable stock trader only has to spend a few minutes online to encounter advice like "plan your trade, trade your plan" and "keep your losses to a minimum" but strategy goes much more deeply than this. These comments can be more of a distraction than actionable advice for some traders. Keeping some rules in mind can increase your odds of succeeding in the markets.
Key Takeaways
Treat trading like a business, not a hobby or a job. Set realistic expectations.
Keep on learning then learn some more.
Take advantage of technology.
Develop a factual methodology.
Protect your capital and don't risk what you can't afford to lose.
Trading as a business allows you to clearly identify all your expenses and losses. This helps you reduce uncertainty, risk, stress, and even taxes. Too often traders imagine that they're in the business of prediction. This point of view often generates unproductive effort. Traders who realize they're in the business of risk management begin to focus their efforts more productively.
Rule 3: Use Technology to Your Advantage
Trading is a competitive business so it's safe to assume that the person on the other side of a trade is taking full advantage of all available technology.
Charting platforms give traders infinite ways to view and analyze markets. Backtesting an idea using historical data prevents costly missteps. Getting market updates via your smartphone allows you to monitor trades anywhere. A high-speed internet connection can increase trading performance. Using technology to your advantage and keeping current with new products can be fun and rewarding.
Rule 4: Protect Your Trading Capital
Saving enough money to fund a trading account takes time and effort. It can be even more difficult if you have to do it twice.
Protecting your trading capital isn't synonymous with never experiencing a losing trade, however. All traders have losing trades. Protecting capital means not taking unnecessary risks and doing everything you can to preserve your trading business.
Rule 5: Become a Student of the Markets
Traders have to remain focused on learning more each day. It's important to remember that understanding the markets and their intricacies is an ongoing, lifelong process.
Hard research allows traders to understand the facts such as what the economic reports mean. Focus and observation allow traders to sharpen their instincts and learn the nuances. World politics, news events, economic trends and even the weather can all impact the markets. The more traders understand the past and current markets, the better prepared they are to face the future.
Read about Investopedia's 10 Rules of Investing by picking up a copy of our special issue print edition.
Rule 6: Risk Only What You Can Afford to Lose
Make sure the money in that trading account is expendable before you use real cash. A trader should otherwise keep saving until it is.
Money in a trading account shouldn't be allocated for college tuition or the mortgage. Traders must never allow themselves to think they're simply borrowing money from these other important obligations. Losing money is traumatic enough. It becomes even more so if it's capital that should have never been risked in the first place.
Rule 7: Develop a Methodology Based on Facts
Taking the time to develop a sound trading methodology is worth the effort. It may be tempting to believe in the "so easy it's like printing money" trading scams that are prevalent on the internet but facts should develop a trading plan, not emotions or hope.
Traders who aren't in a hurry to learn typically have an easier time sifting through all the information available. You would probably have to study at a college or university for at least a year or two before you qualify to apply for a position in a new field if you want to start a new career. Learning to trade demands the same amount of time and fact-driven research and study.
Rule 8: Always Use a Stop Loss
A stop loss is a predetermined amount of risk that a trader is willing to accept with each trade. The stop loss can be a dollar amount or a percentage. It limits the trader's exposure during a trade. Using a stop loss can take some of the stress out of trading because you know you only lose X amount on any given trade.2
Not having a stop loss is bad practice even if it leads to a winning trade. Exiting with a stop loss and a losing trade is still good trading if it falls within your trading plan's rules.
The idea is to exit all trades with a profit but this isn't realistic. Using a protective stop loss helps ensure that losses and risks are limited and that you've preserved enough capital to trade another day.
Rule 9: Know When to Stop Trading
An ineffective trading plan and an ineffective trader are two good reasons to stop trading.
An ineffective trading plan shows greater losses than anticipated in historical testing. That happens. Markets may have changed or volatility may have lessened. The trading plan simply isn't performing as expected for whatever reason. Stay unemotional and businesslike. It's time to reevaluate the plan and make a few changes or start a new one. It's not necessarily the end of the trading business.
An ineffective trader makes a trading plan but is unable to follow it. External stress, poor habits, and lack of physical activity can all contribute to this problem. A trader who's not in peak condition for trading should consider taking a break. The trader can return to business after any difficulties and challenges have been dealt with.
Rule 10: Keep Trading in Perspective
Stay focused on the big picture when you're trading. A losing trade is a part of trading. A winning trade is just one step to a profitable business. It's the cumulative profits that make a difference. Emotions have less effect on trading performance when a trader accepts wins and losses as part of the business.
Setting realistic goals is an essential part of keeping trading in perspective. Your business should earn a reasonable return in a reasonable amount of time. You're setting yourself up for failure if you expect to be a multi-millionaire by next Tuesday.
What Do I Do If My Trade Is in the Money and Profitable?
It can be easy to make money in a bull market. Knowing when to take profits takes practice. One way to take the emotion out of closing a profitable position is to use trailing stops.
How Much Should I Risk on Any Given Trade?
The answer to this question should already be part of your trading plan in the form of a stop loss. You can use a financial stop such as $500 or a technical stop price such as if the 50-day moving average is broken or new highs are made.
What Are the Key Elements of a Trading Plan?
The starting point is the impetus for the trade. Your trading plan should reflect it if your trade is based on fundamental factors. You should make trades based on your plan if your trading plan relies on technical analysis. The key is to adjust your position size to give yourself enough room to stay within your predetermined stop loss and not risk everything on a single position.
The Bottom Line
Most of these rules have one thing in common: attention to risk or minimizing the loss of capital. You're in the business of making money in the markets. Losses will inevitably occur. The trick is to keep the losses small enough to keep trading until you find more winning trades.
Experienced traders know when it's time to take a loss and they've incorporated that into their trading strategy. Traders also know when it's time to take profit so they may move their stop loss in the direction of the trade to lock in some profit or take profit at the current market price. There will always be another trade setup down the road either way.