Trading Rules For Beginners And Active Traders
Step 3: Trading Rules For Entry: Know How And When To Enter A Position
We will keep our Trading Rules For Entry very simple and uncluttered.
For now we will only trade on breakouts which are really further confirmations of an upward trend.
Don’t worry, there are more than enough of these to go around.
Trading on reversals, though potentially extremely profitable, requires one to be nimble.
Many reversal signals on an established uptrend sometimes offer only a short and narrow window for gains as the equity often again reverses and continues on its upward march.
Some reversals on a powerful and established uptrend are effectively just Bear Traps. Similarly, some reversals on an established downward trend are essentially Bull Traps.
Again, we will stick to our Trading Rules and trade on Breakouts which are confirmed by above average volume. Enter half of your position. Enter the other half when the trend is confirmed.
Now this is very different from Dollar Cost Averaging where you put in a certain amount of money at set given intervals whether the equity is moving up or down with the idea that the same amount of money buys more as the equity gets cheaper and less as it gets more expensive.
Here we don’t have a preset time to initiate or add to a position. The stock’s chart pattern tells us when. We then enter on the trend or breakout continuation of that trend.
The best way to do this is to monitor multiple stocks that are building trend patterns and setting new highs that could result in a breakout. Set Alerts just above potential breakout points.
Once an alert goes off, check to see if there was above average volume.
If confirmed with above average volume, there is your breakout and your entry point!!!
For aggressive traders only, you can use options to initiate your positions. Use the same breakout points as your entry points. The more aggressive you are the more you will have to use leverage.
The use of Options is a leverage play. A small amount of money, compared to buying the actual stock, gives you a lot of control. It also increases your risk. 1 Option is equivalent to 100 shares of the stock.
Some words of caution when you just start to use Options
- Don’t go too far out in time duration but don’t set it too short.
If you are right, you can get out early with all you winnings. If you are wrong there is sufficient time for the stock to change course and get you back to a winning position.
3 months should be the shortest interval when you start. In fact, you should stick to 3 months until you get the hang and feel of it.
- Also, buy Deep In The Money Calls. In that way, more of the value of the call is its intrinsic value and would not “waste away” quickly with time.
The actual price would depend more purely on the price of the underlying stock and not just because of the high value built in for time and volatility. These values waste away and end at zero at expiration.
Only a very tiny amount of your portfolio should be used to play Options until you get the hang and feel of it.
Step 4: Exit Rules: Know When To Exit A Position
An integral part of your Trading Rules are your exit rules. These are just as important as your entry rules and must be established at the time you initiate your position. Listed below are some guidelines to follow.
- Do not get emotionally attached to any stock or position.
- Do not continue to hold them if they violate the parameters you set. Don’t hold them just ‘cause you like ‘em. Leave the emotion out. Period!
You want to get out when a stock losses its momentum and starts to move side ways or down.
- You also want to protect yourself in the event the stock moves against you. Sometimes they move against you right at the beginning of your position. Yes, you will have some of those. One way to do this to use Stop Losses.
Set your stops about 3% below support. As your position improves, set you Stop Loss higher. Some Brokerages have Trailing Stop Orders that could automatically do this for you.
- As soon as you initiate your position, enter your exit position with a Good Till Cancel order.
You are still not done yet! To enhance your Trading Rules, there are still a few things you want to do to improve your trading strategy. You want to implement a risk management plan.
Step 5: Risk Management
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