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Rules of the Trade - Nassar, David

Nassar, D. (2001). Rules of the trade : indispensable insights for online profits.
New York: McGraw-Hill.

As a trader, your job is to take money from others who will not only strenuously
resist your best efforts but will likely be better funded and more experienced and
will have the same motives you have, to take money from you. When your hard-earned
capital is at risk, emotions like fear, anxiety, stress, and apprehension can run
wild. The way you handle risk, emotions, and the inevitable losses you will incur
is as much about trading as the stocks you trade.

The stock market is a picture of human emotion and crowd mentality in action.
Short-term price fluctuations have little to do with the underlying value of the
stock. Rather, they are reflections of how market participants see the stock
through the twin lenses of fear and greed. Emotions and psychology are important
components in the market. Your ability to read and deal with emotional factors,
yours and those of other market participants, will determine your success or
failure in trading.

Trading success can be found only within your own personal psychology and the
passion you have for the market. Sure, education is critical. Sound understanding
of the market and tools of the trade are imperative, but without the right attitude
or willingness to form the right perspective and discipline, success will be
elusive if not impossible.

Begin by recognizing that many self-defeating mechanisms are present for the trader
that constantly work against you. Chief among these self-defeating mechanisms are
greed, hope, revenge, and fear.

I have come to is that successful trading is more a state of mind than a state of
mechanical or cognitive understanding of the market.

There is no one right way to trade. Only the trading style that meets your
personality, time horizons, risk tolerance, and personal goals married to the right
mindset will bring the results you desire. Incorporating the right rules and
discipline to that style will complement your trading.

Swing traders and momentum traders are forms of day traders who have a longer time
horizon and who believe technical analysis will reflect market reaction and trends
from both bullish and bear perspectives. Technicians also believe that the
psychology from both market crowds of professionals and amateurs is reflected in
the charts and indicators. While amateurs are reacting to the news the market
produces, professionals are generally fading their reactions.

I am often asked which approach—day trading or swing trading—works best for most
traders. I cannot answer that unequivocally for every trader, but I believe in a
multidimensional approach to trading when new. As a new trader, one discipline
should be learned at a time. In your written plan, one plan is written for day
trading and a second for swing trading. These plans are at the heart of the
discipline needed to succeed. As the student develops into a professional or
semiprofessional trader, one of the disciplines often emerges as the dominant
approach. But we like to see well-rounded traders who can take advantage of quick-
profit opportunities and still have the patience to work a trade over time.
RULES

The only separation between amateurs and professionals are the critical rules that
the market demands be followed. Obey them.

“Don’t break the rules or else.” The market is unforgiving of mistakes, and the
consequences are clear. The stock market has a natural self-cleansing mechanism
built into it by virtue of its capitalistic nature.

RULE: The market will lead the way. Follow the market. > Knowing where key levels
are in price and more importantly market psychology will more determine exit points
than any other factor. Paying attention to this will naturally guide you to letting
profits run while cutting losses quickly, hence allowing the market to lead you in
and out of trades.

RULE: Emotions should never be the beacon for trading. > If an emotion, such as
exuberance, is setting in due to a profitable situation, your tendency will be to
sell too soon. Conversely, when despair is setting in due to the wrong decision,
the tendency is to stay too long, hoping for a recovery. Marrying a position or
trade is the most common mistake traders make.

RULE: Stand behind your convictions. > Weak traders are easily influenced by news
and others, but strong traders have conviction. It is important to trust your
instincts and convictions. But having conviction in the course of action you have
chosen based on your own research and instincts will give you a much greater chance
for success than acting upon a whim or impulse.

RULE: Get a mentor. > When the opening bell rings, traders are on automatic pilot,
making fast decisions without the time and luxury of overthinking. Instincts must
kick in which are born from your efforts made prior to the opening bell. Mentors
can help in these efforts. Professional traders tend to be loners, much like
athletes who participate in individual sports, such as swimming, wrestling, golf,
or tennis. These types of individuals have no one to rely on but themselves once
the games have begun. The success of almost every great trader reflects the
influence of one or more people who took a personal interest in that person when he
or she first entered the trading arena. Everyone needs a sounding board—someone to
bounce ideas off, a trusted colleague to share plans with, someone to talk to when
things are going well, and most importantly, someone to be there when you are not.
Mentors are off the field, on the sidelines. They watch. They think. They offer
suggestions. They point out weaknesses and praise strengths. They cheer you up when
you are down and bring you down when you are too high. They try to keep you from
hurting yourself, and they push you to excel. They teach you what you do not know
and tell you when you think you know too much.

RULE: Create a written plan. > This is one of the toughest rules to convince
traders to follow. Time and again, they state they know exactly what and how they
are going to trade. These same traders constantly find themselves confused and
caught in losing trades.

A plan is composed of only two primary parts:


1. The blueprint. A blueprint is a preliminary action plan developed before
trading begins. This step is accomplished before beginning to trade if the trader
is new and inexperienced. If the trader is experienced, he or she should reevaluate
the plan every 13 weeks. An inexperienced trader should review the plan more
frequently. Either way, it is a “living written document” that evolves over time.
For example, I always revise my plan for the summer trading season since summertime
market conditions call for different strategies.
2. The journal. The journal is a day-to-day micro-adjustment of the blueprint.
A journal helps you avoid making the same mistake again. This is the document that
requires you to adhere to your plan. Emotional aspects of trading on a daily basis
are written in here. Questions such as:
- Did I follow my blueprint today?
- Did I maintain discipline?
- Did I do the research required?
- Did I recognize support and resistance levels through volume?
- Was my methodology correct?
- What was my strategy (earnings play, split, momentum, etc.)?
- Did I exit on fear or logic?
- Did I do the right thing, and do I feel good about my decision? Why or
why not?
- Would I make the same trade again in the same situation?
- Did I have objective confirming indicators when entering the trade?
- Was my discipline followed? Why or why not?

Writing stimulates thought. When you put your plan on paper, it somehow becomes
more real than it is when it is just in your mind. You can more easily share it
with a mentor or a fellow trader. Often a thought running through your head sounds
great, but when it is in black and white in front of you, it seems unrealistic or
improbable. And nothing is more expensive to a trader than trying to make something
happen that is unrealistic.

Think of your written trading plan as one way of measuring your success in terms
other than monetary. Emotions, accountability, responsibility, focus, and creative
thought all get brought into the dynamics of trading versus a one-dimensional
fixation on monetary gain. Writing down what these motivations and components are
for you while tracking your adherence to them each day, through your journal,
increases exponentially the likelihood that you will achieve your desired result.

RULE: Supply and demand determine prices. > Whether you trade derivatives such as
options and futures, commodities, currencies, equities, or bonds, this rule is a
law that must always be your beacon. As a trader, volatility and momentum swings as
the result of an imbalance in supply and demand of the floated shares is what your
focus must be. Supply and demand imbalances reflect all factors in the market at
any given moment. As an active trader, you are simply looking for supply and demand
imbalances on a short-term time horizon. In the end what every tool and software
program ever written has set out to reveal to its user is where the buyers (demand)
are exceeding sellers (supply) and where the sellers are exceeding buyers. Any
imbalance that exists will result in an associated price change in the instrument
being traded, and those that understand and remember this rule will remain at the
top of the financial food chain in the market.

RULE: Don’t wait for certainty. > As the public is also waiting for news
announcements and certainty, professionals are often exiting on the news—“selling
into strength” with good news and “buying weakness” on bad news—as the amateur
rushes in or out providing liquidity. Although this is just an example, it
illustrates the mindset of a professional who trades on market indications without
waiting for the certainty of rumors and news. Once enough indicators confirm
directional bias, professional speculators tend to act and trade ahead of the
impending price move, hence putting them several waves ahead of amateurs who wait
for news to break. Because of this, active traders must have conviction and
confidence while reading and reacting to these indications. An aggressive trader
acts on the volume and increased activity without waiting for news to be announced.
RULE: Let market indications lead you in and out of trades. > The indications that
lead you into trades, and the time frame over which these indications are revealed,
are important to correlate to the amount of time you remain in the trade. An exit
strategy is not contingent on a profit and loss scenario, but instead based on the
way the trade is acting defined by indications such as volume and price levels over
a given time frame.

RULE: Be multidimensional. > When having a multidimensional approach to the market,


traders subscribe to a mixed style that includes day trades and swing trades.

RULE: Open positions early in the week and offset ASAP or by the weekend when swing
trading. > I am not a fan of holding positions over the weekend. One reason for
this rule is that imbalances occur in the largest form after the close and before
the open because this is when most news is released in the market. The risk
associated with this trade automatically increases exponentially because of this,
and it becomes even more exacerbated over weekends.

RULE: Gaps tend to close. > The imbalance in supply and demand during nights and
weekends create gap openings, which are essentially blank spaces in liquidity where
little or no trading takes place. Market makers will gap it as low (high) as they
can! The concept behind this rule is that buyers will come to market and force
stock prices higher, while closing some or all of the price gap.

RULE: Amateurs control the open; professionals control the close. > Pay more
attention to the closing prices of stocks than the opening prices since amateurs
influence the open while professionals influence the close.

TECHNICAL ANALYSIS

Technicians form opinions based on a common belief system called technical


analysis, which is a way of looking at the market through chart formations and
mathematical formulas designed to find and uncover patterns that have a high
likelihood of either repeating or changing.

The theory stems from the belief that all factors in the market are built into the
psychological patterns in which market participants (professionals and
nonprofessionals) trade stock. Market events, such as earnings, R&D developments,
and sector rotation, cause people to react. These reactions are manifested in the
way people buy and sell securities to reflect their up-to-the-minute perception of
the market and stocks.

Charts allow the technician to read the psychological behavior of the market as a
whole, often referred to as market psychology or sentiment, as well as individual
views.

EVALUATING PERFORMANCE

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