6 Basic Trading Principles

  • Kanan Arora
  • Jul 21, 2021
  • Financial Analytics
6 Basic Trading Principles title banner

Introduction 

 

Having technical or fundamental knowledge is required but most of the time is insufficient, a disciplined trader is a successful one. This blog aims to provide an overview of six eternal trading principles or rules that have been in a major part responsible for the success of a lot of traders and investors.

 

It is a commonly known statistic that 90 percent of people lose money in the stock market to the rest of the 10 percent. This blog aims to provide the principles that differentiate the winning 10 percent from the losing 90 percent.

 

(Top read: Option trading guide)


 

Trading Principles

 

  1. TRADE WITH CAPITAL THAT CAN BE AFFORD TO BE LOST: 

 

As is already established, trading is a very emotional job. Emotions come in because money comes in. The most important job of a trader is to manage emotions and therefore the first basic principle of trading is to start the process only after accumulating money that a trader is not attached to and would not seriously mind losing.

 

The best process could be to start the journey considering that the money is already lost. Considering oneself to be at zero and the initial trading capital as a tuition fee to the markets will most definitely make a trader less emotional while trading and more effective at trading.

 

(Read also: 7 Intraday Trading Strategies)

 

 

  1. FOLLOW OWN PROCESS

 

The next basic principle of trading is to develop one’s process and follow that process in a consistent manner. Since there is a lot of commotion around the markets all the time, it is enticing to take the easy way out by following the chatter. This however is the worst way of blowing up a trading account. 

 

It is essential for a trader to have a process in place that personifies his/ her way of thinking. 

 

For example: A person who is of a contrarian mindset will most definitely not benefit from a trade that goes along with the trend no matter how successful the trade may be otherwise. He would rather perform better in reversal trades such as the pull back trades from critical points, harmonic trades and trades that capitalize on overbought and oversold zones.

 

(Must read: What is fundamental analysis?)

 

 

  1. TAKE SELECTIVE TRADES:

 

One of the biggest issues that needs to be addressed better sooner than letter is the problem of overtrading. It is presented by a compulsive desire to trade, specially in situations involving deep emotions. Emotions play a huge role in trading, it is up to a successful trader to channel these emotions in a positive manner in his/ her journey. 

 

Overtrading is usually associated with fear of missing out (FOMO) when in green and revenge trading when in read and when trading with such deep emotion, a trader is almost certainly not able to follow his/ her process, all in an attempt to somehow outperform the markets by acting emotionally. 

 

Essentially overtrading is not necessarily a bad thing, people could overtrade and make a lot more money since they are putting in more effort, but this is never the case since in practice,overtrading refers to the trading that is not necessary and if avoided will be much more beneficial than actually trading. 

 

The lesser the number of times a trader touches the markets or actually places trading orders (in his/her own preferred time frame), the better he/ she will perform in the longer term. As thrilling as trading might sound, essentially the whole game is to capitalize in the longer term and that is where selective trades help one reach.

 

Selectivity is obtained from one’s process. There would be certain stocks or other instruments that at a certain point of time would provide you with the best possible setup in accordance with your process. That is the best time to trade.

 

(Suggested blog: Types of financial risks)

 

 

  1. HAVE A DECENT POSITION SIZE: 

 

Once a decent trading process is owned and good quality setups are learned to be identified. The first and foremost step in the execution part is to decide a position size based on a trader’s risk appetite. 

 

Usually, it is considered to be a good practice to risk not more than one to two percent of one’s capital in a single trade and not more than five percent on a single trading day. 

 

Since, actually trading is speculating and there will almost certainly be instances where one is terribly wrong, extremely emotional and just stuck in front of one’s terminal. 

In such instances, having a decent position size will not only avoid a lot of regret later on, but also will substantially reduce the otherwise vast amount of overflowing emotions. 

 

 

  1. ALWAYS PUT A STOP LOSS: 

 

Once a decent position size indicative of a trader’s risk appetite is established, it is important to determine a predefined stop loss and have an exact quantitative measure of the risk being taken in a particular trade. 

 

Risk management is one of the most important aspects of participating in the financial markets, if not the most important. A trader who is able to manage his/ her risk consistently will most definitely be successful in the longer term because he/she critically evaluates his/ her risk prior to the entry and thus, prepares his/ her mindset prior to the whole emotional experience of trading. 

 

A good practice could be to mentally accept the loss beforehand and only move only in a way as to reduce that loss. If done, this can prove to be splendid.

 

 

  1. RIDE WINNERS, CUT LOSERS: 

 

The most cliche principle might be to ride winners and cut losers. No matter how beautiful the process, it is impossible for any market participant to be right all the time. That is where riding the winners and cutting the losers comes in. 

 

The most acquired aspect of any great trader/ investor is that they are able to get out of their losing trades quickly and build up on their winning trades eventually. 

 

It is important to ride the winner so as to afford the losers because there always will be losers. 

 

“Winners are not afraid of losing. But losers are. Failure is part of the process of success. People who avoid failure also avoid success.” -Robert T. Kiyosaki

 

Once armed with an armory of proper trading system, selective trades, decent position sizing and a mandatory stop loss, a trader just needs to optimize his/ her execution technique so as to maximize the profits and minimize the losses and come out of his/ her trading journey in a profitable manner. 

 

After all, a trader or an investor is there in the markets, not to prove himself/ herself right, not to get high off trading, not to accept it as an escape, not to feed his/her ego but to make money and that is where a solid trading process with essential trading principles is viably able to take an enterprising trader.

 

(Must read: Introduction to investment banking)

 

 

Final Note

 

This blog provides a holistic list of trading principles that if incorporated as part of the trading or investing routine will provide success.

 

These are the same principles applied and mastered by the best traders and investors of all time. Between them and a trader struggling to make it there is only a wall separated by these principles.

 

The process for all the greatest traders and investors is similar to that of a struggling trader. The only thing separating the two is that the successful traders are able to follow their rigorous process along with an almost absolute level of commitment, courage and dedication. 

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