A friend of mine recently asked me if I could give him a few rules for assessing a good technical trade.

I told him that there are very few rules, as I understand the term, involved in trading.

To me a rule is something that is always true.

Trading is about probabilities. The only thing that I have ever found to be always true is that nothing is always true. We have to trade in a world of probabilities, not certainties.

However there are some guidelines that may help with the probabilities:

1. Observe the size of oscillations for the timeframe you are going to trade.

2. Expect to capture no more than 80% of the average oscillation value in a trade.

3. Look at the spread (difference between bid and ask). You must make the spread before you make any profit at all.

4. If 80% of the oscillation is not at least twice the spread, you are better off in Las Vegas. It should be 3 to 5 times the spread to give you a decent chance of profit. The higher the better. I personally consider four times a general minimum.

5. Set a stop loss price and a target price that make sense and stick to them. This is where so very many traders go wrong. Small losses are a part of trading. If you let a trade go past your target price, at least move you stop to that price. Profits are too precious to sacrifice in the name of greed.

A few comments about number 5:

A trader can, and must from time to time, accept small losses. That is what stop losses are for. Use them and use them diligently. A bad trade seldom gets better with time.

Then there is the old saying, let your profits run. True, but do not let then reverse and vanish. When you have hit your target price, set it as a stop, profits are too precious to let slip away.

If you make three to four times your loss on each profit, you can be profitable with an average of 50% good trades.

Use a good momentum indicator and if the market you are trading reverses its direction for your time frame it is a good idea to get out of any long trade quickly. The secret to successful trading is as much avoiding losses as it is making profitable trades.

 

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