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7 successful trading rules from a master

June 15, 2010 13:37 IST

No platitudes here, speculating is very dangerous business. It is not about winning or losing, it is about surviving the lows and the highs. If you don't survive, you can't win.

It's all about survival

The first requirement of survival is that you must have a premise to speculate upon. Rumours, tips, full moons and feelings are not a premise. A premise suggests there is an underlying truth to what you are taking action upon. A short-term trader's premise may be different from a long- term player's but they both need to have proven logic and tools.

Most investors and traders spend more time figuring out which laptop to buy than they do before plunking down tens of thousands of dollars on a snap decision, or one based upon totally fallacious reasoning.

There is some rhyme and reason to how, why and when markets move - not enough - but it is there. The problem is that there are more techniques that don't work, than there are techniques that do. I suggest you spend an immense and inordinate amount of time and effort learning these critical elements before entering the foray of financial frolics.

So, even if you have money management under control, have a valid system, approach or premise to act upon - you still need control of yourself.

Ultimately this is an emotional game - always has been, always will be

Anytime money is involved - your money - blood boils, sweaty hands prevail, and mental processes are short-circuited by illogical emotions. Just when most traders buy, they should have sold! Or, fear, a major emotion, scares them away from a great trade/investment. Or, their bet is way too big. The money management decision becomes an emotional one, not one of logic.

Greed prevails - proving you are more motivated by greed than fear and understanding the difference

The mere fact you are a speculator means you have less fear than a 'normal' person does. You are more motivated by making money. Other people are more motivated by not losing.

Greed is the trader's Achilles' heel. Greed will keep hopes alive, encourage you to hold on to losing trades and nail down winners too soon. Hope is your worst enemy because it causes you to dream of great profits, to enter an unreal world. Trust me, the world of speculating is very real, people lose all they have, marriages are broken up, families tossed asunder by either enormous gains or losses.

My approach to this is to not take any of it very seriously; the winnings may be fleeting, always pursued by the taxman, lawyers and nefarious investment schemes.

How you handle greed is different than I do, so I cannot give an absolute maxim here, but I can tell you this, you must get it in control or you will not survive.

Fear inhibits risk taking - just when you should take risk

Fear causes you to not do what you should do. You frighten yourself out of trades that are winners in deference to trades that lose or go nowhere. Succinctly stated, greed causes you to do what we should not do; fear causes us to not do what we should do.

Fear, psychologists say, causes you to freeze up. Traders act like a deer caught in the headlights of a car. They can see the car - a losing trade, coming at them - at 120 miles per hour - but they fail to take the action they should.

Worse yet, they take a pass on the winning trades. Why, I do not know. But I do know this: the more frightened I am of taking a trade the greater the probabilities are it will be a winning trade. Most investors scare themselves out of greatness.

Money management is the creation of wealth

Sure, you can make money as a trader or investor, have a good time, and get some great stories to tell. But, the extrapolation of profits will not come as much from your trading and investing skills as how you manage your money.

I'm probably best known for winning the Robbins World Cup Trading Championship, turning $10,000 into $1,100,000 in 12 months. That was real money, real trades, and real time performance. For years people have asked for my trades to figure out how I did it.

I gladly oblige them, they will learn little there - what created the gargantuan gain was not great trading ability nearly as much as the very aggressive form of money management I used. The approach was to buy more contracts when I had more equity in my account, cut back when I had less. That's what made the cool million smackers - not some great trading skill.

Ten years later my 16-year-old daughter won the same trading contest taking $10,000 to $110,000 (The second best performance in the 20- year history of the championship). Did she have any trading secret, any magical chart, line, and formula? No. She simply followed a decent system of trading, backed with a superior form of money management.

Big money does not make big bets; it wins big on small bets

You have probably read the stories of what I call the swashbuckler traders, like Jesse Livermore, John 'bet a millions' Gates, Niederhoffer, Frankie Joe and the like. They all ultimately made big bets and lost big time.

Smart money never bets big. Why should it? You can win big on small bets, see #5 above, but eventually if you bet big you will lose - and you will lose big.

It's like Russian roulette. You may well spin the chamber holding the bullet many times and never lose. But spin it often enough and there can be only one result: death. If you make big bets you are destined to be a big loser. Plunging is a loser's game; it can only set you up for failure.

I never bet big (I used to - been there and done that and trust me, it is no way to live). I bet a small per cent of my account, bankroll if you will. That way I have controlled loss. There can be no survival without damage control.

I believe the trade I'm in right now will be a loser

This is my most powerful belief and asset as a trader. Most would be wannabes are certain they will make a killing on their next trade. These folks have been to some 'Pump 'em up, plastic coat their lives' motivational meeting where they were told to think positive thoughts. They took lessons in affirming their future would be great. They believe their next trade will be a winner.

Not me! I believe at the bottom of my core it will be a loser. I ask you this question - who will have their stops in and take right action, me or the fellow pumped up on an irrational belief he's figured out the market? Who will plunge, the positive affirmer or me?

If you have not figured that one out - I'll tell you; I will succeed simply because I am under no delusion that I will win. Accordingly, my action will be that of an impeccable warrior. I will protect myself in all fashion, at all times - I will not become run away with hope and unreality.

(Excerpted from the book, Trading Rules from the Masters. Published by Vision Books.)

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