The only was that you can build a sustainable trading system is to develop principles that stand the test of time. A simple test for your principles is to ask this simple question, several days/months after the trade is done:
Would I take that trade again?
Regardless of the success of a specific trade, the set of rules that you have created for taking a trade shouldn’t change. Of course, early on in your path to become a Journeyman Trader, you will continue to tweak rules until they start to fit your style, the way you see the world, the way you think about protecting your capital, and the way you want to live. However, once you establish your a repeatable, repetitive, successful track, don’t keep changing on a whim or just because a few trades didn’t go well.
Here are some example of rules I use (after 4 years of practice!):
- Is the trade based on closing price?
- Are there 3 points of support/resistance?
- Is the support/resistance line flat?
- Is the trade in the direction of the 42-day Simple Moving Average (SMA)?
- Are the fundamentals moving in the same direction?
- Is there alignment with the Commitment of Traders (COT)?
I put limits to the risk I’m willing to take. The way I answer to each of the questions below determines if I get into a trade at all. I can break one of the rules above, but that should be rare and I would only risk a minimal amount of equity for such a trade.
With a decently sized account (i.e., $100,000 and up) I use the following risk management rules:
- Risk no more than 1% of equity for a single trade
- Have no more than 5% of closed equity at risk at one time, across all positions
- Have no more than 10% of cumulative risk during the span of a week
- (this rule is just a check up on overtrading — feeling good about only risking 0.3% of equity on a trade is still terrible if you trade 100 times in a week. In fact, this is a trap worth talking about in a separate post…
I also use a similar set of rules for exiting trades that I will discuss in the future.
In sum, the sustainability of your trading journey is predicated on your ability to stick to a tactical framework where the rules and parameters you set for yourself remain relatively consistent. Without consistency, you won’t be able to make adjustments that will bring you closer and closer to profitability. For example, if one day you work only with daily closing prices and the next you use 30-minute closing prices, your entire risk management structure, including your technical analysis is completely upside down. One timeframe is not better than the other (well, daily is better… but for the sake of this argument they aren’t), but risking 1% of equity on 30-minute bar is significantly more risky than on daily swings. If you decide to go with 30-minute bars, moving average, etc. stick to them and adjust all your rules around them. Tweak as you go, but don’t flip-flop from one to the other and especially don’t try to apply one timeframe on top of a different one expecting the same results!