TRADING RULES

A collection of trading rules for stocks, ETFs, futures, commodities, currencies, cryptos, options trading and investing.

TABLE OF CONTENTS

  • Getting Started I
• Getting Started II
• Rules For Investors
• Cut Your Losses
• Taxes
• Be Independent
• Be Determined
• Learn to Wait
• Be Attentive
• Be Able to Change
• Keep it simple
• Mistakes 		• The Psychology of Trading
• About Technical Analysis
• Professional Traders
• The Dow Theory
• Bulls & Bears
• Market Dynamics
• About Gaps
• About Moving Averages
• Learning the Rules
• Reversals
• Dealing with profits
• Dealing with big losses
  1. GETTING STARTED I
  2. The secret of financial success is to spend what you have left after saving, instead of saving what you have left after spending.
  3. Invest your time before you invest your money. Test your strategy before you risk your money.
  4. Start small. When and if you decide to open an online brokerage account, try starting out with maybe 5-10% of your overall risk portfolio or cash. Keep your existing portfolio and cash where it is. Too many people open accounts with a large amount of money who tend to make larger mistakes. You will make mistakes in the beginning. Opening a smaller account will let you develop a strategy that is right for you without putting all your investment capital at risk.
  5. Watch out for transaction costs. Transaction costs are far more important in the overall performance of an investment strategy than typically understood. The reason is simple: Transaction costs are "certain" costs, whereas trading returns are uncertain. It is easy to control transaction costs, but it is difficult to enhance the success of your trading decisions.
  6. Avoid discretionary accounts and partnership trading accounts.
  7. Avoid margin. Margin can be beneficial, but it seriously increases risk. Particularly for new traders, a good rule to follow is to avoid holding stocks overnight that you cannot fully pay for with cash.
  8. Avoid using market orders. Use limit orders instead.
  9. Even if you are 99% smart and have 1% luck, that one percent can change all your fortune. Always have some spare cash handy!
  10. Keep a balance. Understand that there is a difference between a trade and a long-term hold. Your long-term holding should be just that, paid for in cash and held for the long term. It should be watched on a week or month timeframe. Trades are stocks you are in for a quick pop. You can end up holding some trades for a month, but that is generally because the stock is on a run. This is actually an ideal trade. It is a stock that we short or go long on that we catch on the start of a run and are able to hold for several weeks because the stock is still running.
  11. Plan your trade and trade your plan. In other words, develop a trading plan and adhere to it. A sound trading plan will give you needed confidence under pressure. Stick to your trading plan and avoid impulse trades. If you don't follow your plan, you have no plan.
  12. Avoid bottom fishing. Where a stock will fall is not known, unless you are looking at the stock technically and see support at a certain level and take a small position as a test. Have a very short stop-loss on this kind of trade.
  13. Do not attempt to day trade without real time quotes.
  14. GETTING STARTED II
  15. Buy your straw hats in winter. — Baruch
  16. The trend is your friend. Trade with the trend. Trade the active stocks and futures.
  17. Do not trade until the technicals and the fundamentals both agree.
  18. Do not buy because of dividends or P-E ratios.
  19. Do not buy a stock only because it is low priced.
  20. Do not sell a stock only because it is high priced.
  21. Never buy a stock because it has had a big decline from its previous high. — Jesse L. Livermore
  22. Never bet all your money at once. Remember that even the most reliable indicator can fail, so don't bet the ranch on it. Never underestimate the risk.
  23. If a stock doesn't act right don't touch it; because, being unable to tell precisely what is wrong, you cannot tell which way it is going.
  24. If a position does not feel right as soon as you put it on, do not be embarrassed to change your mind and get right out.
  25. If your judgment says you should liquidate a position, then do it immediately.
  26. Don't cast too wide a net. There isn't a "best" commodity or stock to trade. Narrow your scope to commodities or stocks you are comfortable with and you will have more time to focus on good trades.
  27. Trade in liquid markets. Markets are not continuous and it is dangerous to assume that positions can be liquidated at any time. For this reason, investors should stay away from illiquid markets, except if their investment horizons are very long term.
  28. If the market is letting you off the hook easily on a position for which there was a basis for fear (such as a fundamental development adverse to the position or a technical breakout in the opposite direction), there must be strong underlying forces in favor of the direction of the original position.
  29. For a lot of traders, it doesn't matter so much whether their first big trade is successful or not, but whether their first big profit is on the long side or short side. Those people tend to be perennial bulls or bears, and that is very bad.
  30. Sell short as often as you go long.
  31. Short rallies not selloffs. When markets drop, shorts finally turn a profit and get ready to cover.
  32. Always do your homework. Have a position (bullish, bearish, or neutral) before you take a position. Be disciplined and rational. Work hard. Make your own luck through hard work and perseverance.
  33. Trade with the TICK not against it. Don't be a hero. Go with the money flow.
  34. Beat the crowd in and out the door. You have to take their money before they take yours, period.
  35. Buy low, sell high.
  36. Execute your trade where price must move only a short distance to prove that you are wrong: Buy at support, sell at resistance.
  37. Don't chase momentum if you can't find the exit. Assume the market will reverse the minute you get in. If it's a long way to the door, you're in big trouble.
  38. Do not hold stocks or mutual funds for long term, because prices fluctuate like the waves of the sea. No rally lasts forever.
  39. Rising interest rates tend to divert money from the stock market and depress stock prices.
  40. Try to avoid holding onto stocks you know nothing about. Hold on to stocks that you know something about fundamentally or that you have been watching technically for some time. Every trader or investor gets into stocks from time to time that they know nothing about. Keep tight stop losses on these than other trades.
  41. Daily money goals are useless in day trading. Whoever says that you can "consistently make X amount of dollars" a day, week, month, etc., in day trading is not telling the truth. In day trading everyone wins and loses. The amount you make or lose will depend on your discipline to limit your losses and apply what you learn. Your goal is to take from the market whatever is available on a particular day. Each trading day will be different.
  42. RULES FOR INVESTORS
  43. Diversify your portfolio. Don't put all your eggs into one basket.
  44. Divide your trading capital into ten equal risk segments.
  45. Diversify over a broad spectrum of totally different investments, including cash and bonds.
  46. Buying during a bear market can be dangerous. Buy when market indexes are in an uptrend.
  47. Never invest more than what you can afford to lose.
  48. Do not assume that big-name and well-respected firms are safe or trustworthy.
  49. Leaders of today may not be the leaders of tomorrow.
  50. Buy that which is showing strength, sell that which is showing weakness. The public continues to buy when prices have fallen. The professional buys because prices have rallied. This difference may not sound logical, but buying strength works. The rule of survival is not to "buy low, sell high," but to "buy high and sell higher." Furthermore, when comparing various stocks within a group, buy only the strongest and sell the weakest.
  51. Focus on hot stocks. These are stocks that have growing institutional ownership, stocks that show up day after day on the top gainers list. A lot of people will avoid these stocks because they are generally priced above $100. Buy fewer shares in a stock that has a good likelihood of a movement rather than trying to search out a stock that meets your price range just so you can buy 100 or 1000 shares.
  52. Always invest in funds that are the best performers NOW and dump the rest.
  53. Invest in companies with low price per earnings ratio (P/E) and high earnings per share (EPS).
  54. Invest in industry leaders. Buy the No. 1 company in an industry in earnings and sales growth, R.O.E., profit margins and product quality.
  55. Invest in companies that have consistent rather flashy returns. Check the company's stability and examine its five-year earning record.
  56. Check into companies buying back 5% to 10% of their stock and those with new management.
  57. Select stocks with increasing institutional sponsorship in recent quarters.
  58. Select companies that regularly outperformed their competitors in the last 3 to 5 years.
  59. Consider buying stocks with each of the last three years' earnings up 25%+, return on equity of 17%+ and recent earnings and sales accelerating. Recent quarterly earnings and sales should be up 25% or more.
  60. Pick companies with management ownership of stock.
  61. Pick companies with a new product or service.
  62. Find out if the market currently favors big-cap or small-cap stocks.
  63. Stocks under $1 and stocks with few outstanding shares can swing up and down violently, therefore they are risky investments.
  64. Avoid high priced penny stocks. When a penny stock runs +100% in one day, it can drop just as fast.
  65. The best time to buy a penny stock is when it is in a period of a narrow trading at low price and low volume.
  66. CUT YOUR LOSSES
  67. The most important thing in making money is not letting your losses get out of hand.
  68. Never place a lid on how much money you can make, but always have a floor on how much you can lose. Take big profits and small losses.
  69. Preserve your capital. Identify and commit to an exit point BEFORE every trade.
  70. Learn to take losses. Before taking a position, always know the amount you are willing to lose. Decide the price at which you will sell your position if a loss occurs. Set a limit; and if you reach that limit, GET OUT.
  71. If you are going to short as a new trader, you must be mechanical about covering your position if it starts to go in the wrong direction. There is no limit to the loss of a short position. You must be disciplined on the cover.
  72. Never permit speculative ventures to turn into investments.
  73. Cut every loss when it is 5-8% below your cost. Make no exceptions so you can always avoid huge, damaging losses.
  74. The elements of good trading are 1) cutting losses, 2) cutting losses, and 3) cutting losses. If you can follow these three rules, you may have a chance.
  75. If you aren't willing to cut your losses, you probably should not buy stocks. Would you drive your car without brakes?
  76. Do not sell in panic — it is probably the bottom. Sell BEFORE the panic stage.
  77. Investors are the big gamblers: They make a bet, stay with it, and if it goes wrong, they lose it all. — Jesse L. Livermore
  78. Have a 10-12% equity draw down rule in your account. Take your overall equity and if you lose 10-12%, exit out of all your trades. The thought behind this is that it is easier to try to make up 10-12% than 30-50%.
  79. Risk less than 5% (usually 1 to 2 percent) of your capital on a single trade. Ride winners; cut losses; trade small.
  80. Often the market has a paralyzing effect on traders. You must resist this force. It is crucial that you take ACTION and not freeze when the moment demands it. Sitting astonished, trembling, and hoping is the worst thing you can do.
  81. Ban wishful thinking in the markets.
  82. Isolate your trading from your desired profits. Do not hope for a move so much that your trade is based on HOPE. Although hope is a great virtue in other areas of life, it can be a great hindrance to a trader. When hoping that the market will turn around in their favor, speculators often violate basic trading rules.
  83. You must fear that your losses may develop into a much bigger loss, and hope that your profit may become a bigger profit. — Jesse L. Livermore
  84. If in doubt, Get out. Personal doubts indicate that something is wrong with your game plan. Get out of the market quickly if you don't know what to do, or if you can't sleep at night.
  85. Profits always take care of themselves but losses never do. — Jesse L. Livermore
  86. It is harder to get out of a trade than to get into one.
  87. Selling a loser is harder than selling a winner.
  88. Anticipate and plan rather than react; think of all the "what-ifs." Place your stop at a point that is difficult to reach (above resistance or below support). If this implies an uncomfortably large loss, trade smaller.
  89. In the real world, it is not too wise to have your stop where everyone else has their stop. That system is going to have above-average skids.
  90. Many traders place their stops slightly below the previous day's low.
  91. Do not only use a price stop. Use a time stop as well. If you think the market should break and it doesn't, get out even if you are not losing any money.
  92. In any month with net trading losses, reduce the risk exposure to make sure you never register a double-digit loss in a single month.
  93. Selling your winners and holding losers is like cutting flowers and watering your weeds. — Peter Lynch
  94. DON'T WORRY ABOUT TAXES
  95. Individual investors worry too much about taxes and commissions. Your key objective should be to first make a net profit. Excessive worrying about taxes usually leads to unsound investments in the hope of achieving a tax shelter. At other times in the past, investors lost a good profit by holding on too long, trying to get a long-term capital gain. Some investors, even erroneously, convince themselves they can't sell because of taxes — strong ego, weak judgment.
  96. BE INDEPENDENT
  97. Block out other opinion. One of the biggest pitfalls in trading is to rely too heavily on the guidance of other people. Don't be influenced in your trading by what someone says. Learn and follow all the rules. Think against the herd. It is important that you formulate your own personal view of the world and make investment decisions in tune with this view.
  98. Avoid, at all costs, discussing, listening, or otherwise exposing yourself to others' ideas or opinions about the market. This is a very difficult thing to do. It requires one to not read trade journals, news reports, advisory services, and brokerage house letters. It also requires you to keep your ears "shut" as much as possible (very often the best way to do this is to keep your mouth shut). — The Investor's Quotient by Jacob Bernstein.
  99. Market letters tend to lag behind the market since they generally respond to demand for news about recent activity. Although there are certainly important exceptions, letter writing is often a beginning job in the industry, and as such may be handled by inexperienced traders and non-traders. Good traders trade. Good writers write letters.
  100. Be careful who you listen to. A man cannot be convinced against his own convictions, but he can be talked into a state of uncertainty and indecision. The chart alone is your most reliable source of information.
  101. Learn how to use charts to spot exact buy points.
  102. Put your ear to the railroad tracks. Watch prices. Prices move first and fundamentals come second.
  103. Forget the news, remember the chart. You're not smart enough to know how news will affect price. The chart already knows the news is coming.
  104. Trade what you see, not what you think. Do not act according to your feelings; act according to the rules. Know the rules and act promptly. Do not hesitate.
  105. Do not trust in anyone. Be strong and independent. Be self-reliant. More money is lost listening to brokers than any other way. You are your best advisor. Most analysts and advisors who do not charge an hourly fee act as salespeople who want you to buy and hold.
  106. A stockbroker is someone who invests your money until it is all gone. — Woody Allen
  107. BE DETERMINED
  108. Buy a stock only if you are sure that it will go up. Do not make a trade if you are uncertain. A trader has to be confident that every trade he makes is going to be a winner. They are not all going to be winners, but you have to have confidence in your judgment.
  109. A man must believe in himself and his judgment if he expects to make a living at this game.
  110. Don't formulate new opinions during market hours. Formulate a basic trading plan before the market opens or before opening a trade, then look for a proper time to execute the decision that has been made.
  111. Indecision will destroy the trade right then and there!
  112. Be ready to execute your decision flawlessly, in an automated unemotional manner when the moment demands the response. Learn to control yourself and become the master of your emotions.
  113. LEARN TO WAIT
  114. You don't have to be in the market all the time. Don't trade until an opportunity presents itself. Wait for a trade you feel most confident about.
  115. Be patient. Avoid impulses. There is nothing wrong with doing nothing.
  116. If you don't know what's going on, don't do anything. Money cannot be made every day from the market.
  117. Don't trade too much or trade to play. This detracts from finding real winners.
  118. Avoid the open. They see YOU coming sucker!
  119. Don't chase a stock, let it come to you.
  120. If you missed a trade, don't worry, there is always another.
  121. Take a Trading Break. A trading break helps you take detached view of the markets, and tends to give a fresh look at yourself and the way you want to trade for the next several weeks.
  122. Do not overtrade. If you don't want to trade for whatever reason, don't do it. Maybe you have a stomach ache one day or you feel uneasy about the market, or maybe you just don't feel like it. The worst thing a trader can do is trade when he doesn't feel like it. Whatever the reason, you do not have to trade every day. If you force yourself to trade, you will lose, period!
  123. BE ATTENTIVE
  124. Know what time it is.
  125. Examine both linear and log charts of any stock or index to get a better picture of what is really happening.
  126. Keep charts current.
  127. A General principle: When a clear-cut technical pattern of unquestionable significance has been completed on your charts, do not let some apparently contrary development that occurs shortly thereafter lead you to forget or neglect the previous plain signal.
  128. Always double-check an online order before you send it. If you want to sell, make sure that you selected SELL before you click OK. Buying more of something that you wanted to sell might cost you a lot.
  129. Pay attention to institutional buying and selling.
  130. Pay attention to what other markets are doing.
  131. Observe sentiment: How many days has the market been up or down in a row?
  132. Observe crowd mood, excessive fear and excessive greed. Watch for fatigue. Watch for excessive pain. The crowd is euphoric at the top and depressed at the bottom.
  133. Make sure that you don't get caught in a situation in which you can lose a great deal of money for reasons you don't understand.
  134. A good trade is profitable right from the start.
  135. Triple Witching: This happens four times a year. The third Friday of March, June, September and December. It occurs when the contracts for stock index futures, stock index options and stock options all expire on the same day. It is sometimes referred to as "Freaky Friday." The final trading hour for that Friday is the hour known as triple witching. In this final hour the markets are quite volatile as traders quickly offset their option/futures order before the closing bell. If you are a long-term investor then triple witching has minimal impact.
  136. BE ABLE TO CHANGE
  137. Lose your opinion, not your money. If the market doesn't do what you expect, then you must reconsider.
  138. Be objective. Be open-minded. Be willing to take in information that is difficult to accept emotionally. A good trader cannot be rigid. If you can find somebody who is really open to seeing anything, then you have found the raw ingredient of a good trader.
  139. Remember that the world is always changing. Be aware of change. Buy change. You should be willing to buy or sell anything. So many people say, "I could never buy that kind of stock," "I could never buy utilities," "I could never play commodities." You should be flexible and alert to investing in anything.
  140. KEEP IT SIMPLE
  141. Over analysis causes paralysis. Those who need to rely on complex stochastics, linear weighted moving averages, smoothing techniques, fibonacci numbers, etc..., usually find that they have so many things rolling around in their heads that they cannot make a rational decision. One technique says buy; another says sell. Another says sit tight while another says add to the trade. It sounds like a clichι, but simple methods work best.
  142. Do not watch or trade too many markets at once.
  143. Avoid information overload. Set aside a reasonable time for preparation and limit analysis to focus on key stocks and indices in detail. Reduce watch lists, news and charts until they conform to a healthy personal lifestyle.
  144. There is no "genius" in these rules. They are common sense and nothing else, but as Voltaire said, "Common sense is uncommon." Trading is a common-sense business. When we trade contrary to common sense, we lose. Perhaps not always, but enormously and eventually. Trade simply. Avoid complex methodologies concerning obscure technical systems and trade according to the major trends only.
  145. Put your eggs in one basket and WATCH THAT BASKET. — Mark Twain
  146. Trading rules are simple. Adherence to the rules is difficult.
  147. Nothing new ever occurs in the markets.
  148. Charting is a little like surfing. You don't have to know a lot about the physics of tides, resonance, and fluid dynamics in order to catch a good wave. You just have to be able to sense when it's happening and then have the drive to act at the right time. — Ed Seykota
  149. MISTAKES
  150. Be willing to admit mistakes fast. Follow your ideas, but be flexible enough to recognize when you have made a mistake.
  151. Do not blame others for your failures.
  152. Bull and bear markets are like summer and winter. They are natural cycles. Many people like to blame the President or the Fed for causing a bad market. Don't blame nor praise anybody, because prices rise and fall regardless of who is in charge. Focus on your own actions. It is possible to make a lot of money in both bull and bear markets. If you miss the opportunity, that's your fault.
  153. The principles of successful stock speculation are based on the supposition that people will continue in the future to make the mistakes that they have past. — Thomas F. Woodlock
  154. If a man didn't make mistakes he'd own the world in a month. But if he didn't profit by his mistakes he wouldn't own a blessed thing. — Jesse L. Livermore
  155. Write down your observations and think about them. Review your trades. Keep track of what you are doing right and what you are doing wrong. The trading experience is so intense that there is a natural tendency to want to avoid thinking about it once the day is over.
  156. Never make a mistake without asking yourself why. Learn from your trading mistakes.
  157. Keep a record of your trades on paper. Keep a trading journal.
  158. Most traders who fail have large egos and can't admit that they are wrong. Even those who are willing to admit that they are wrong early in their career can't admit it later on. Also, some traders fail because they are too worried about losing.
  159. Separate your ego from trading. Making money is most important. Learn to accept mistakes and limit losses — quickly.
  160. THE PSYCHOLOGY OF TRADING
  161. The enemy lies not in what surrounds us, but in fact, we surround it since it dwells within. — The Investor's Quotient by Jacob Bernstein.
  162. A positive mental state is necessary for successful trading. A trader's inner state of mind directly impacts his performance.
  163. The market exists to give me profits.
  164. Trading is fun, not a frustrating experience.
  165. I don't trade for recognition, I don't have to prove anything, others' opinion is not of interest for me.
  166. Money is not the subject of my focus; stock movement is.
  167. Trading is a game, I know I can win.
  168. When you feel strongly enough about a trade (either getting in or getting out) to dream about it, the message should be heeded. A dream is the means by which our subconscious penetrates the barriers we sometimes erect in accepting the true analysis of a market.
  169. Most investors make their trading decisions as they are updating their charts or doing technical work. Typically a trader's mind will be so cluttered with information and data on all markets when he or she is updating work that they will interfere with effective and rational decision making. Make decisions after all technical and/or fundamental work has been updated. You will be more objective after all market studies are complete. — The Investor's Quotient by Jacob Bernstein.
  170. One of the best ways to increase profits is to do goal setting and visualizations in order to align the conscious and subconscious with making profits.
  171. Exercise 10-20 minutes in the morning.
  172. Have a clear reason why you want to trade.
  173. Explain yourself what you are going to do with the profits.
  174. Think of trading capital as of tool rather than money.
  175. Feel that you are in total control.
  176. Reward yourself for following the rules even if a loss occurs.
  177. One of the major problems people have is conflict. People have different parts of themselves, each of which has a positive intention. For example, someone might have a part to make money, a part to protect him from failure, a part to make him feel good about himself, a part which looks after the welfare of the family, etc... Now, once you establish these parts, you usually allow them to operate subconsciously. What happens is the parts continually adopt new behaviors to carry out their intentions. Sometimes, those new behaviors can produce major conflicts... Conduct a formal negotiation between the parts so that each part is satisfied. If possible, you also want to integrate the parts so that they join together.
  178. Everybody gets what they want out of the market. Some people seem to like to lose, so they win by losing money.
  179. People's trading performance probably reflects their priorities more than they would like to admit.
  180. The best time to get into the market is when it looks its worst. The worst time is when it looks its best.
  181. Don't get caught up in the 'herd' mentality, always BE A CONTRARIAN! Don't follow the crowd. Buy when they are selling and sell when they are buying.
  182. Buy the rumor; sell the fact.
  183. I want to buy stocks that no one else knows about, and I want to sell them after everyone discovers them. — John Markese
  184. Another way to forecast market moves: Try to figure out how the stock market can hurt the most traders.
  185. When the market gets good news and goes down, it means the market is very weak; when it gets bad news and goes up, it means the market is healthy.
  186. Be flexible and disciplined at all times.
  187. Trade with small shares first. Small shares let you get over the emotional pressing of the button. Many times, when day traders move from paper trading to real day trading, they hesitate and miss trades. Day trading small shares in the beginning alleviates the emotional part of day trading to some extent. Once the emotional feeling of loss or fear of loss is gone as day traders becomes more confident in their trading abilities, they are taking the steps to becoming a profitable day trader.
  188. ABOUT TECHNICAL ANALYSIS
  189. Many short-term players view trading as a form of gambling. Without planning or discipline, they throw money at the market. The occasional big score reinforces this easy money attitude but sets them up for ultimate failure. Without defensive rules, insiders easily feed off these losers and send them off to other hobbies. Technical Analysis teaches traders to execute positions based on numbers, time and volume. This discipline forces traders to distance themselves from reckless gambling behavior. Through detached execution and solid risk management, short-term trading finally "works." Markets echo similar patterns over and over again. The science of trend allows you to build systematic rules to play these repeating formations and avoid the chase.
  190. No two chart patterns are ever precisely alike; no two market trends develop in quite the same way. History repeats itself in the stock market, but never exactly. Nevertheless, the investor who familiarizes himself with the historical pattern, with the normal market action, and refuses to be tempted into a commitment in the belief that "this time will be different," will be far and away ahead of the fellow who looks for the exception rather than the rule.
  191. Stocks — most of them, at least — do not change their habits and their technical characteristics much from one bull and bear cycle to the next. An issue which, like General Motors, produces a straightline bull trend on an arithmetic chart in one primary upswing is likely to repeat that performance in the next.
  192. If something is closely observed the odds are it is going to be altered in the process. For example, if corn is in a tight consolidation and then breaks out the day the Wall Street Journal carries a story about a potential shortage of corn, the odds of the price move being sustained are much smaller. If everybody believes there is no reason for corn to break out, and it suddenly does, the chances that there is an important underlying cause are much greater. The less observed, the better the trade. The more a price pattern is observed by speculators, the more prone you are to have false signals. The more a market is the product of nonspeculative activity, the greater the significance of technical breakouts.
  193. Technical analysis of market action is not an exact science and never will be.
  194. PROFESSIONAL TRADERS
  195. Adopt the key characteristics of successful traders: discipline, patience to wait for the right trade and stick with a winner, adequate capitalization, a strong desire to win, and a noble goal.
  196. Winners know they are responsible for their results; losers think they are not.
  197. Pro traders quickly get into a position where they are playing with the market's money.
  198. The advantage of day trading: Sparrows take just a little piece at a time and fly away. They keep on flying back and forth, taking small bits of bread. They may have to make a hundred stabs at a piece of bread to get what a pigeon gets at one time, but that is why a pigeon is a pigeon. You will never be able to shoot a sparrow, it is just too fast.
  199. Most people think that winning in the markets has something to do with finding the secret formula. However, winners have more to do with attitude than approach.
  200. How to spot potential winning traders: Winning traders have usually been winning at whatever field they are in for years. Two traits that winning traders have: 1) They love to trade. 2) They love to win.
  201. Top traders believe... 1) Money is NOT important. 2) It is OK to lose in the markets. 3) Trading is a game. 4) Mental rehersal is important for success. 5) They've won the game before they start.
  202. By definition, there can only be a relatively small group of superior traders, since trading is a zero-sum game. One's loss is another's profit.
  203. THE DOW THEORY
  204. THE AVERAGES DISCOUNT EVERYTHING. They reflect the combined market activities of thousands of investors, including those possessed of the greatest foresight and the best information on trends and events.
  205. The Dow Theory pays no attention to any extreme highs or lows which may be registered during a day but takes into account only the closing figures. Only closing prices are used.
  206. The price of stocks swings in trends:
    1. Primary Trends — These are extensive up and down movements which usually last for a year or more and result in general appreciation or depreciation in value of more than 20%. A bear market is primary down trend. A bull market is a primary up trend.
    2. Secondary Trends or Intermediate Trends — These are important reactions that interrupt the progress of the prices in the primary direction. Normally, they last for three weeks to many months, and rarely longer. Normally, they retrace from one-third to two-thirds of the gain/loss.
    3. Minor Trends — These are brief (usually less than 6 days and rarely as long as 3 weeks) fluctuations which in themselves make up the intermediate trend.
  207. The major (primary) trends in stock prices are like the tides. We can compare a bull market to an incoming of flood tide which carries the water farther and farther up the beach until finally it reaches high-water market and begins to turn. Then follows the receding or ebb tide, comparable to a bear market. But all the time, during ebb and flow of the tide, the waves are rolling in, breaking on the beach and then receding. While the tide is rising, each successive wave pushes a little farther up onto the shore and, as it recedes, does not carry the water quite so far back as did its predecessor. During the tidal ebb, each advancing wave falls a little short of the mark set by the one before it, and each receding wave uncovers a little more of the beach. These waves are the intermediate trends — primary or secondary depending on weather their movement is with or against the direction of the tide. Meanwhile, the surface of the water is constantly agitated by wavelets, ripples and "catspaws" moving with or against or across the trend of the waves — these are analogous to the market's minor trends, its unimportant day-to-day fluctuations. The tide, the waves, and the ripple represent, respectively the primary or major, the secondary or intermediate, and the minor trends of the market.
  208. Volume goes with the trend. In a bull market, volume increases when prices rise and dwindles as prices decline; in bear markets, the opposite is true. Therefore, large volume shows up at the end of bull markets and light volume characterizes the end of a bear market.
  209. An advance in prices through the upper limits of an established line is a bullish signal, and a break down through its lower limits is a bearish signal. A line in Dow Theory is a sideways movement (often no more than 5% divergence) in one or both of the Averages.
  210. Two averages must confirm. No valid signal of a change in trend can be produced by the action of one average alone.
  211. A trend should be assumed to continue in effect until such time as its reversal has been definitely signaled. A reversal in trend can occur any time after that trend has been confirmed.
  212. BULL MARKET & BEAR MARKET
  213. The first phase of a bull market is the accumulation phase. This is when prices are depressed and financial reports do not look good. However, farsighted investors use this period of depressed prices to take advantage and buy shares.
  214. The second phase of the bull market is characterized by increased activity, rising prices, and better financial reports. This is the period where the large gains are made. Wall Street is the hot topic. And tales of large amounts of money being made are bandied about. At this point, the market becomes vulnerable to a reversal.
  215. The first phase of a bear market is the distribution phase. This is where farsighted investors see the uninformed investors scrambling to buy shares. The farsighted investors begin to sell shares. Oversupply leads to weakening prices and profits are harder to come by.
  216. The second phase of the bear market is characterized by near panic selling. Prices accelerate to the downside and more and more people begin to liquidate their holdings.
  217. The third phase of the bear market is characterized by further weakening and erosion of prices. Lesser quality issues erase the gains of the previous bull market. The news is full of bad market news.
  218. MARKET DYNAMICS
  219. Market prices are determined by the interaction of groups of investors trading on very different time scales. The actual impact of fundamental factors depends on the market dynamics. Typically, market observers take a far too simplistic view of the interaction between market dynamics and fundamental events. Only sophisticated quantitative models, that are similar to weather forecasting models, can systematically analyze market conditions and generate forecasts of consistent quality.
  220. The stock market moves in its own manner. Stocks themselves move not because financial circumstances of the company dictate its direction. Otherwise, it would be too easy. Traders would simply buy what has strong fundamentals and sell what has weak fundamentals. Obviously this is not the case. Instead, interests of players in the stock and their emotions move the price. This philosophy can be confirmed by strong moves in stocks with questionable fundamentals. It can also be confirmed by a stock with great news that declines in price following the release.
  221. As soon as you have money in the market, emotionalism is in the driver's seat and rationale and objectivity are merely passangers... "Soybeans were sharply higher. There was a drought in the Illinois Soybean Belt. And unless it ended soon, there would be a severe shortage of beans... Suddenly a few drops of water slid down a window. "Look," someone shouted, "rain!" More than 500 pairs of eyes shifted to the big windows... Then came a steady trickle which turned into a steady downpour. It was raining in downtown Chicago. Sell. Buy. Buy. Sell. The shouts cascaded from the traders' lips with a roar that matched the thunder outside. And the price of soybeans began to slowly move down. Then the price of soybeans broke like some tropic fever. It was pouring in Chicago all right, but no one grows soybeans in Chicago. In the heart of the Soybean Belt, some 300 miles south of Chicago the sky was blue, sunny and very dry. But even if it wasn't raining on the soybean fields it was in the HEADS OF THE TRADERS, AND THAT IS ALL THAT COUNTS." To the market nothing matters unless the market reacts to it. THE GAME IS PLAYED WITH THE MIND AND THE EMOTIONS.
  222. The only reality of the market has to do with the price/volume action of a specific stock. All other factors are either hints or distortions. A seasoned trader distinguishes himself from a naive follower by his ability to see the true reality through all the curtains provided by those with less than adequate knowledge or misguided intentions.
  223. Big volume kills moves. Climax blow-offs take both buyers and sellers out of the market and lead to sideways action.
  224. ABOUT GAPS
  225. Prices can move most rapidly and easily, either up or down, through a range where little or no stock changed hands in the past, where, in other words, previous owners have no "vested interest."
  226. A gap represents a price range at which (at the time it occurred) no shares changed hands.
  227. To carry interest for the chart technician, a gap must be wider than the usual changes in price which occur under normal or prevailing trading conditions.
  228. Gaps can act as horizontal support and resistance zones.
  229. Gaps may be divided into four classes:
    1. Common or Area Gap - Usually occurs within a price congestion pattern.
    2. Brekout Gap - Occurs when prices break out or break down. It signals the start of a move. It suggests that the buying demand or selling pressure that produced the gap is stronger than would be indicated by a gapless breakout.
    3. Continuation or Runaway Gap - Also called "Measuring Gap" because it often occurs halfway in rallies and downtrends. It signals the continuation of the move. This kind of gap is not closed for a considerable length of time. Any gap which shows up in a fast advance or decline AFTER prices have moved well away from an Area Formation may be a Runaway Gap.
    4. Exhaustion Gap - USUALLY comes at the end of a move. This kind of gap does not signal the end of an uptrend; it simply means STOP. These gaps are quickly closed (usually within 2-5 days).
  230. Exhaustion gaps get filled. Breakaway and continuation gaps don't. Trade in the direction of gap support whenever you can.
  231. A gap against the underlying trend tells you market direction has changed in a single bar. Don't wait for further confirmation when the market gaps and doesn't fill before that day's close. Missed your first chance to get out? Wait for the next test of the gap, and exit into that price level.
  232. ABOUT MOVING AVERAGES
  233. Moving Averages averages call attention to the current movement in relation to the past.
  234. The average itself can act as an area of Support and Resistance. The more times a Moving Average is touched, the greater the significance of a violation. A penetration of a Moving Average is a signal that a change in trend may be taking place. Confirmations of trend changes should be confirmed from alternative sources. Generally, the longer the timeframe of the Moving Average, the greater the significance of a crossover.
  235. Most commonly used moving average lengths are 10, 20, 30, 50, 100, 200.
  236. Bulls live above the 200 day, bears live below. Sellers eat up rallies below this key moving average line and buyers come to the rescue above it.
  237. Different prices may be used to calculate the averages: 1) A The most common is the close price. 2) The average of Open, High, Low, and Close. 3) The average of High, Low, and Close. 4) The average of High and Low.
  238. The basic BUY/SELL SIGNALS based on Moving Averages:
    • IF price crosses above the Moving Average, this is a BUY signal.
    • Long positions are maintained as long as price remains above the Moving Average.
    • IF price falls to the Moving Average but does not cross it and then moves back up, this is a BUY signal.
    • In a downtrend, short positions are held as long as price remains below the Moving Average.
    • IF price moves up to the Moving Average Line but does not cross it and then drops down again, this is a SELL signal.
    • IF price moves above a declining Moving Average Line, this is a SELL signal.
  239. IF price drops sharply below the Moving Average, a rebound toward the Moving Average Line may occur resulting in a whipsaw action.
  240. Don't buy up into a major moving average or sell down into one.
  241. Ribbon is a nice indicator of market indecision. It's like a topographic view of a stock. The ribbon is a set of simple moving averages which are not far from each other. Usually, the following moving averages are used: 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200. When ribbon tightens, which is a result of twists, the market arrives to a key decision point which means that it could either jump or fall a significant amount.
  242. LEARNING THE RULES
  243. A trader's career has three time periods: 1) Learning the rules and seeing how they play in the market. 2) Applying the rules with discrimination. 3) Knowing the exceptions. If you make it past the first revolution, you'll make money in the markets, if you make it past the second, you can impart your knowledge to others, and if you make it past the third, you'll retire a wealthy person.
  244. Although it may not be a reassuring thought — when you start, you ought to be as bad a trader as you are ever going to be, (because it is less expensive at that time). You shouldn't be too surprised if you really screw up.
  245. When you enter the stock market, you are going into a competitive field in which your evaluations and opinions will be matched against some of the sharpest and toughest minds in the business. You are in a highly specialized industry in which there are many different sectors, all of which are under intense study by men whose economic survival depends upon their best judgment. You will certainly be exposed to advice, suggestions, offers of help from all sides. Unless you are able to develop some market philosophy of your own, you will not be able to tell the good from the bad, the sound from the unsound.
  246. Your level of understanding determines your long-term investment performance.
  247. Weapons change, but strategy remains strategy, on the New Exchange as on the battlefield. — Jesse L. Livermore
  248. REVERSALS
  249. Bottom Fishing: Percentage growth potential peaks at the very beginning of a new uptrend. As a result, being right at a bottom can produce the highest profit of any trade.
  250. When one sector is doing substantially better than the other, a divergence is taking place. This demonstrates that one sector is much stronger than the other; and if it continues, without the other sector catching up, a major reversal in the market will take place.
  251. When a large number of individual issues, after an extensive advance, make well-defined Reversal Patterns of plainly Bearish import, break down out of them, and then succeed only in pulling back no farther than their lower boundaries or "Resistance Lines" at a time when the Averages are going on up to new highs, the whole market is in dangerous condition and a Major Downturn is imminent.
  252. This is a possible sign that a bull market has ended: Popular, big name, leader stocks which have been going up for a long time now stagger and cannot go back up above their previous highs; yet weak, small, no-good stocks which were not advancing during the bull market now jump up for seemingly no reason.
  253. Bottoms take longer to form than tops. Markets form their tops in violence; markets form their lows in quiet conditions. The final 10% of the time of a bull run will usually encompass 50% or more of the price movement. Thus, the first 50% of the price movement will take 90% of the time and will require the most backing and filling and will be far more difficult to trade than the last 50%.
  254. Price has memory. What did price do the last time it hit a certain level? Chances are it will do it again.
  255. Trends never turn on a dime. Reversals build slowly. The first sharp dip always finds buyers and the first sharp rise always finds sellers.
  256. When time is up, markets must reverse.
  257. Big movements take time to develop.
  258. Sell the second high, buy the second low. After sharp pullbacks, the first test of any high or low always runs into resistance. Look for the break on the third or fourth try.
  259. Buy the first pullback from a new high. Sell the first pullback from a new low. There's always a crowd that missed the first boat.
  260. The trend is your friend in the last hour. As volume cranks up at 3:00PM, don't expect anyone to change the channel.
  261. Trends test the point of last support or resistance.
  262. Three trendlines drawn from the original Reversal point from which the Corrective Decline started, each at a flatter angle than its predecessor, are known as FAN LINES. And the rule is that when the third Fan Line is broken upside, the low of the Intermediate Correction has been seen.
  263. DEALING WITH PROFITS
  264. Never let a profit turn into a loss.
  265. Don't get complacent with profits. The toughest thing to do is hold on to them. Patiently stay with winning trades to allow them to grow.
  266. Add to trades on minor corrections against the major trend.
  267. When adding to a trade, add only 1/4 to 1/2 as much as currently held. That is, if you are holding 400 shares of a stock, at the next point at which to add, add no more than 100 or 200 shares. That moves the average price of your holdings less than half of the distance moved, thus allowing you to sit through 50% corrections without touching your average price.
  268. Don't increase your position size until you have doubled or tripled your capital. Most people make the mistake of increasing their bets as soon as they start making money. That is a quick way to get wiped out.
  269. Have selling rules on when to sell and take profit on the way up.
  270. Look for reasonable profits.
  271. Take windfall profits when you get them.
  272. When your stock doubles, sell half thereby recovering your initial investment.
  273. Reward yourself when you were right. Withdraw a portion of your profits.
  274. Do not talk about what you are doing in the markets.
  275. Guard yourself against pride. Stay humble. Be sober. Always question yourself and your ability. Don't ever feel that you are very good. The second you do, you are dead. To be successful, you have to be frightened. The greatest traders are the ones who are most afraid of the markets.
  276. Accept the fact that nobody can be always right, and the weaknesses to which a trader is prone are almost numberless. Improve yourself continuously.
  277. Decrease your trading after a series of successes.
  278. Got a lot? Give a little. Give to charity. It is better to give than to receive.
  279. DEALING WITH BIG LOSSES
  280. When sharp losses in equity are experienced, take time off. Close all trades and stop trading for several days. The mind can play games with itself following sharp, quick losses. The urge "to get the money back" is extreme, and should not be given in to.
  281. Moderate your emotions. Don't try too hard, and don't be arrogant. When you get arrogant, you forsake risk control. Whenever you try to get all your losses back at once, you are most often doomed to fail. That is true in everything -- investments, trading, gambling. After a devastating loss, always play very small.
  282. Don't Reverse Your Position. When your position is at a loss and you decide to get out, don't make a 180-degree turn. If you reverse your position outright you might get whipsawed losing as the market goes down, then losing more as the market goes up.
  283. Losing is part of the process of making money. Any particular loss doesn't make you a loser.
  284. Every losing trade is an opportunity to learn.

Compiled by Zsolt N. Perry (zsnp@juno.com)
Last Update: September 1, 2023