September 12, 2019
A Simple Trading Rule to Reduce Bad Decisions
Have you ever been in a situation where you close a trade too early and kick yourself afterwards?
The most common reason for this is not having a clear plan This causes your psychological biases and nerves to play a big factor in your decision-making process. This can lead to you closing the position at an inappropriate time, just because the price fluctuated a little bit.
Overcoming this with a simple trading rule
Here’s a quick tip that I would really recommend adding to your trading rules. It’s a simple one but it’s very effective:
When you make a decision to take any action in the market, you specify before taking the action exactly when you should make your next decision.
Overall, this means that we will never be doing something without having a plan of what we need to do next.
What would count as taking an action?
- Opening a trade
- Staying in a trade (following a specific decision whether to stay in or not)
- Increasing your position size on an open trade
- Decreasing your position size on an open trade.
Using this rule to start planning ahead
Let's go through an example of how this may look in real life.
You’re about to open a trade. Assess all the potential outcomes that could happen.
Based on these outcomes, where should your next decision points be? You will need a decision point if the price moves in your favour or against you.
If the price moves against you, in most cases this decision will be made by your stop loss. You’ve made your decision in advance. However, that’s not always the case.
When you’re assessing where to make your next decision, you need to decide what the most important factors are.
Choosing where to make your next decision
Depending on the context of the market, any one of these factors may be important than the others.
You may see a specific level as being an obstacle for the price and therefore will be an ideal place to make your decision about what to do with the trade.
There may be a specific price point that’s far enough from your entry that you want to make a decision, such as moving your stop loss to break-even.
You may want to make your decision at a specific time. For example, your next decision might be at the end of the next hour because that’s when a dominant time frame is likely to disrupt your trade setup.
Other Disruptive Factor
If there are other factors that may disrupt trades using your system, you may want to use these as your decision point. For example, if you’re trading based on fundamentals or some sort of news release is likely to disrupt your trade, this may be the factor you base your decisions on.
Why do we do this?
The reason we set this rule is to make sure our decisions are kept logical. Once we open a trade and we’re in the heat of the moment, we can sometimes use our ability to think logically.
It’s just like what Mike Tyson said…
When we have a trade open, our head can be all over the place.
Sometimes all we want to do is avoid taking a loss on our account and just bank any profit we can, rather than making the right decision for our long-term success.
The aim of the game here is to always keep the decision-making logical and remove as many emotional, rash decisions as possible.