by Markus Heitkoetter
People who want to profit from the market often ask experienced traders how they come up with their trading strategies. Newcomers are often overwhelmed by the amount of available data and are a bit mystified about how to navigate through it. But, even more often, they want to know how to develop a strategy that works consistently, and they expect to find “secrets” that brings them a stable profit. As I tell them, however, there is no crystal ball, no magical insight to be had on the market. Instead, I like to share with them three proven rules and habits that allow me to test my strategies and determine which to continue using.
My three rules are actually quite simple:
1. Learn to identify the direction of the market and follow it; that means that you buy when the market is going up and sell when the market is going down. 2. Always know when to exit a trade; specifically, remember to always place a stop loss and a profit target after entering a trade. 3. If you are using a trend-following strategy, find a trending market.
For the first rule, there are, of course, many ways to identify the direction of the market. You can use chart pattern recognition like Trend Lines, Head-and-Shoulder Formations, Flags, Pennants and so on. Other chart pattern techniques include candlestick formations like Hammers, Dojis, Dark Cloud Covers (quite an interesting name), Morning and Evening Stars and others. You can also use indicators like Moving Averages, Parabolics, MACD, Bollinger Bands and many others.
All these tools are designed to help you to identify the direction of the market, but none of them is “best.” They all serve slightly different purposes, and individual traders need to research them to know which is right for their own style and goals. However, once you feel confident that you’ve found a tool which gives you the direction of the market, you should simply follow it. Jesse Livermore said something more than 100 years ago which still applies today: “Successful traders always follow the line of least resistance. Follow the trend. The trend is your friend.”
The second rule is also straightforward: as soon as you are in a trade, place a stop loss order and a profit target. Make sure that your profit target is larger than your stop loss, because then you will make money even if you just achieve a 50% winning percentage. You should even be able to do better. Setting these markers and sticking to them is key to ensuring that you don’t let your emotions get in the way of your preparation. Know when to accept a reasonable profit and when to cut your losses. Otherwise, you’re simply gambling and depending on luck, not a system that you can evaluate and depend on.
Third and finally, watch multiple markets and look for one that is trending. Not every market will always be profitable. Besides, it is trends, not markets, that make money for traders. For example, if the e-minis are not moving, check the currencies, or the grains, or oil, or gold. These days we have more electronic markets and tools than ever, and you shouldn’t have a problem finding a trending market.
Following those three rules should allow you test, clarify, and revise almost any strategy you come across or develop on your own. The most important thing to remember about all three rules is that they help you determine whether a strategy is consistently profitable. As long as you are making more than you are losing, you have a successful strategy, and following these three rules will help you stay focused on that outcome.
There’s nothing magic about finding a successful strategy. Many people like to make it sound more complicated than it actually is, and some newcomers have trouble accepting that it can be so simple, but it is. The key to trading success is to keep it simple.
About the Author
Markus Heitkoetter is the author of the international bestseller “The Complete Guide To Day Trading” and a professional day trading coach. For more free information on day trading visit his website http://www.rockwelltrading.com.
