FX Trading Rules to Live By

10/09/2013 9:00 am EST

Focus: FOREX

When profitable traders share their lessons, it often pays to listen, notes Tyler Yell of DailyFX.com, as he shares some rules that have guided his trading over the years.

When a new trader approaches any market they understandably look for those who have over time proven themselves successful. This often comes by building a library and reading through the trading greats. However, like most things in life, the true value of the lesson often lacks the ability to be put into practice until the pain of avoiding that lesson comes front and center so that you take notice of the lesson's value.

While this is not an exhaustive list of the wise sayings from traders over the years, it does give you a gathering of collective wisdom that has benefited my trading. Naturally, when approaching a new book or line of thought with regards to trading, I'm really only interested in seeing if it will heighten my ability to manage the risk inherent of every trade or to better approach trading as a whole to make me sharper. Sadly, as mentioned earlier, the rules or guidelines often don't carry the weight they deserve until a loss is taken which illuminates the wisdom that lay under the rock of wisdom.

Trading Rules That Have Guided Me

“If you are going to place a stop, put it at a logical, not convenient place.”
-Martin Pring, Investor Psychology Explained

Determine Stop Location & Then Trade Size

chart
(Created from FXCM Marketscope 2.0)
Click to Enlarge

Many traders are rightly concerned with the risk to reward about their trade. However, it can be a mistake to have a fixed position size in mind and then force a stop based on what is convenient so you don't lose too much. As you can imagine, the market will likely remain bound by prior price action as opposed to your stops so it is best to think about your trade size like a pro and set your stop level first and then adjust your trade size.

“Everyday I assume every position I have is wrong.” and “At the end of the day, the most important thing is how good you are at risk control.”
-Paul Tudor Jones

Many traders look to Paul Tudor Jones as a hero of trading and money managers. Paul Tudor Jones busted onto the scene by shorting stock indices through the Black Monday of 1987 to reportedly net north of $100 million as the US30 dropped 22% However, his attention to keeping risk under control is what has kept him atop the game as his ability to limit downside. As my years in the business increase, I become much more attuned to how pros have approached the psychology of risk management than to which indicator they've fallen for because risk management will lead itself to longevity.

NEXT PAGE: More Words of Wisdom

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Never average losses.” and “Markets are never wrong—opinions often are.”
-Jesse Livermore

Jesse Livermore is a headline trader who roughly called, and more importantly profited, through the 1907 and 1929 stock market crash and was rumored to have made the modern day equivalent of $1.2 billion in today's dollar. The main lesson from the prior two quotes is that it's best not to try and outsmart the market. Traders often try and outsmart the market by trading against a trend or adding to a losing position when the market and their account equity are proving them wrong. I prefer to wait for price action to show early signals that are confirming my idea before I risk my own capital.

Wait for Price Action to Confirm Your Opinion

chart
(Created from FXCM Marketscope 2.0)
Click to Enlarge

“Don't try to buy at the bottom or sell at the top. This can't be done—except by liars.”
-Bernard Baruch, Baruch: My Own Story

This valuable piece of advice has kept me level headed when I see a top forming in the market. By all accounts, it may very well be a top forming but I'd rather wait until a lower low and lower high are in place before looking to sell the move. Another way this piece of advice has been put is that the first 1/8 of a move is often the most expensive part because everyone wants in on the ground floor, however, by the time the move has been confirmed many traders have depleted their capital.

“Equal distribution of risk. Trade in two or three different commodities, if possible. Avoid tying up all your capital in any one [trade]”
-W.D. Gann

Limiting your trade ideas to one trade can easily amplify your risk. We often recommend that if you have a strong argument for one currency's strength or weakness that you consider a currency basket. The benefit of a currency basket is that if you want to sell the US dollar, you can do so by limiting the purchase of one specific counter currency and spread out your risk by buying other currencies in a smaller lot size against the US dollar.

Closing Thoughts
The value in the prior statements has come from years of trading and recognizing how markets work to give you an edge. Your success lies less and less in the indicator you use and more and more in your ability to control risk and consistently exploit an edge that you've identified. I hope these sayings help you as they've helped me over the years.

By Tyler Yell, Trading Instructor, DailyFX.com

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