Every investor needs a trade entry system. The first fundamental step of trading is to choose the market in which you want to trade. But, within each market, there is a plethora of trading opportunities to chose from - I call this the universe of securities. So how do you choose from this vast universe? Simple. Predefine your trade entry rules.
Trade entry rules are a stringent set of conditions that you develop, document and then apply, to decide when you are going to enter a trade. It doesn’t matter what securities you’re trading, you just need a consistent method of trading entry.
Like sifting through a bucket of sand trying to find pieces of gold, the same approach is used to reduce your universe of securities to a shortlist of those that meet your criteria.
Developing your trade entry rules
As in all aspects of trading, there are many theories on buy-on-sell price points. I believe the best way to approach trade entries should be simple, direct and leave nothing to human judgment. This is contrary to the philosophy of many traders who buy stocks based on media reports, ‘expert’ opinion, rumours and/or gut feel. The good news is that by acting contrarily, you will do what most traders never do… make a profit.
Reinventing the wheel
You shouldn’t copycat someone else’s system, but that’s not to say you can’t take elements of a proven trading plan and stitch them together into something that will suit you and your personality.
The example of Richard Dennis and his Turtles illustrates proves an excellent illustration of the importance of following a trading plan. Dennis’s proteges were successful because they were under his direction at all times. Every trade was heavily scrutinised and made according to his strict rules. The students had to follow these rules or be dropped from the project. The fear of loss forced the traders to follow the system no matter what. In the real world, most people would not have the discipline to do this. And nor should they; it wasn’t designed for them.
Furthermore, the Turtles were trading with someone else’s money. When it’s your own money on the table, you need to be completely comfortable with the decisions you make, and you can’t do that unless your system suits your personality.
Dennis’s students went on to become successful traders in their own right because they learnt discipline from their mentor, not because they continued to trade his system out of the box. They adapted it to suit themselves. And that’s what you should do.
Think of it this way: how many people do you know who have stayed in a job or field of work just because it’s what they’re used to? They may not love it, but they persist just the same. Maybe you’re one of those people. But, while these people might be able to do that job with their eyes closed, they will never excel at it if they’re not passionate about it. Their heart needs to be in it. Trading is the same. If you’re not 100% behind your trading system, chances are you won’t be able to stick to it, and if you can’t stick to your system, you will never reap the benefits you are hoping for.
Put trading entry rules in perspective
Most traders believe the key to success is being able to pick the bottom of the market. This is why 99% of traders spend most of their time fidgeting with the entry; they are looking for that elusive secret, that one setup that will ensure ongoing success. But let me tell you from experience - that setup rule doesn’t exist. And, in actual fact, it’s not that important.
Spending countless hours optimising your trade entry rules, trying to find that ‘perfect’ indicator, can actually do more harm than good. Over optimisation based on historical data actually decreases the profitability of your trading system when trading in real-time. Typically, the more you optimise, the less robust your system tends to be.
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