The discipline to follow rules is the mark of a top trader

This article focuses on the discipline involved in using a technical approach to trading the stockmarket, but the rules shown below could easily be modified and in some cases equally applied to any approach and any type of trading.

What sets many of the world’s great traders apart from the crowd is their ability to have a single-minded approach to making money which at its most basic means being disciplined. These guys have shown it is possible to make money in many different markets including stocks, indices, foreign exchange and commodities. What is more they are able to adapt to different background conditions, and for CFD traders this aspect is crucial.

The search for the frustrating holy grail

Many technical traders are constantly searching for the holy grail of systems, and there are clearly some approaches that work better than others, though very few approaches work all the time in all markets.

What is more important is to have a basic set of rules which cover the emotional aspect of the trading process. One might start with three basic rules of trading: going with the trend, limiting risk by using stops, and careful money management. Not following these simple rules alone condemns many intelligent people to the trading dustbin.

There are of course many times though when things start to go wrong, and during these moments it is human nature to question the underlying methodology or trading system, or tweak the entry/exit points to try and try to ‘fix’ the problem, or even to abandon the existing system and start again.

Many traders become so frightened of losing again that they will then miss out on some of the best trades that occur purely as a result of the law of averages. They may begin to choose the trades that feel good to them, rather than treating every trade as a production line of potential winners.

On that basis, it is useful to look at a simple list of additional rules which will help you sleep at night as a CFD trader and take away some of the emotional damage that can be caused by stressful conditions in the markets.

Rule 1: Don’t make your system too complicated

Modern trading software often has hundreds of built-in technical analysis indicators, plus any combination of custom strategies and expert analyses which can be baffling in their complexity. One technique that you favour might indicate a buy signal, whereas another says sell, and a third indicator might not be conclusive or suggest perhaps adding to positions.

The key is to find a simple methodology that generally works bearing in mind that no one indicator works all the time. Try and keep it simple and stick to a strategy that you feel comfortable with.

Don’t use a trend based approach when a share or index is in a trading range (which for many stocks is the majority of the time. Likewise, it is suicidal to use oscillators in trending markets – not only do they give poor signals, but you may miss the main thrust of a brand new move.

If in doubt, find the strongest stocks in the market by measuring the slope of their performance or how they are faring against the benchmark index. Then simply look to go with the trend, and vice versa when shorting stocks.

Rule 2: Always buy strength and sell weakness

As a shorter term trader you don’t have to act like Warren Buffet with the luxury of being able to wait ten years before value shows itself for your stock. If you are using margin, which is normally the case for CFD trading, you want results.

The point to bear in mind based on going with the trend is that the public continues to buy when prices have fallen, whereas the professional buys because prices have rallied.

This difference may not appear logical, but buying strength works if you are trading. The rule of survival is not to "buy low, sell high", but to "buy high and sell higher". If you are comparing various stocks within a group, buy only the strongest and sell the weakest.

This works on the downside, too – don’t be frightened to sell and sell again until there is a trend change. Regular CFD traders know that stocks that are bid for are almost invariably already strong before any announcement. Those that issue profit warnings are usually already in a downtrend.

Rule 3: Every trade should be the same

You just never know when you might hit the jackpot in this business, but you should take the view that every trade should have the potential to be the biggest trade of the year. It might be, it might not be, but if you are following a disciplined strategy the whole point is to take every signal. Don’t be disheartened if your favourite trade doesn’t do what you hoped – there are plenty more every day to choose from.

Rule 4: Patience is a virtue

This may be the greatest trait of a successful trader. Once you have the set up to enter a trade, allow it time to develop and give it time to create the profits you expected. Taking small profits is the surest way to ultimate loss, as these are never allowed to develop into enormous profits.

The real money in trading is made from the one, two or three big trades that occur every so often. If the thought of losing a profit is toying with you, you might want to take some money off the table and let the rest of the position run using a trend indicator. Alternatively, simply set a realistic target that is much higher than your allowed stop loss. If your trading system is valid, you should make decent long term gains.

Rule 5: Take your losses

Small and quick losses are the best losses, however annoying they may be. It is not the money that is important, but the mental capital that is used up when you are preoccupied by a losing trade that is obscuring other opportunities.

You should expect occasional drawdowns as part of any valid trading system, but you must take them and move on. Many of the best trading systems have around a 40% success rate of winners, but the winners tend to achieve much higher returns than the losing trades.

Rule 6: Forget the urge to ‘get your money back’

If you do have a series of sharp losses, which happens to every trader at some stage, take some time off. Close all your trades and stop trading for several days, or go on holiday. The mind can play games with itself following losses and the urge "to get the money back" is extreme, and should be dismissed.

If you can master these simple rules, you are already far ahead of the majority of traders. By the law of averages, and given that this is essentially a ‘zero sum’ game, you have every opportunity to make steady profits and of course enjoy trading – it’s not supposed to be a stressful business, but humans have a tendency to make it one. You just need discipline.

About the Author:

Mike Estrey is the Head of Research for Blue Index, the Day Trading specialists in Contracts for Difference. Foreign Exchange Trading also forms part of their extensive services.