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Essential Rules for Successful
Futures Trading

If you have even the most limited experience as a trader then you know that the system or method you use is only part of the overall formula for success. The fact is that lasting success as a trader depends on a combination of three primary ingredients. The essential elements for profitable trading are:

1. An Effective System
By this I mean a trading system or methodology which has a demonstrated history of success through all types of markets and which contains definitive, objective, operational rules.

2. Risk Management
I define this element of profitable trading as a method which takes you out of losing trades and keeps you in winning trades for as long as possible. Ordinarily this task is part of the trading system, however, traders often override their trading systems and, therefore, need a failsafe procedure.

3. Discipline
Under this element I include self control, persistence, positive attitude, and more. Last, but certainly not at all least:

4. Trader Psychology
By this I mean self-knowledge, and the ability to resist one's emotions even in the face of losses. I feel that if you can master or even come close to mastering all four, then you will achieve consistent success as a trader. Moreover, you will avoid the boom or bust syndrome which afflicts so many traders.

Whether you're a newcomer to futures trading or an old hand at this risky business, you are most likely one of the many individuals who would like to improve, who is motivated to improve, but who doesn't know how to begin the arduous task of changing your behaviors.

Here are some suggestions as to how you may embark on the road to lasting profits:

Examine your trading results by looking at your statements and attempting to determine why you made the trades you did. This will let you know at once whether your trades were at all systematic or if they were based on a whim, on emotion, on tips, rumors, fear, or greed.

If you're like most traders then you'll find that a relatively small percentage of your trades were the result of a system and that most of your trades were prompted by other factors, most of which were totally unrelated to any definitive system, method, or indicator. This will alert you to the first problem area in your trading. It will let you know, without a doubt, that you are not basing your decisions on a consistent approach.

What to do? Begin looking for a system which has simple, unambiguous rules of application. In finding a system consider the following aspects of paramount importance:

A. Simplicity
The rules must be simple to understand, simple to follow, and not subject to interpretation.

B. Historical accuracy
should be 55% or more. While it is entirely possible to profit using systems that have less than 40% accuracy, it makes things more difficult. So shoot for a higher percentage.

C. Longevity
Use a system that has been tested in various markets - bull, bear, sideways, choppy, etc. At least several hundred trades should be included in the test. The fewer the trades, the less likely the results are to be representative of reality.

d. Draw down

Find a system that has shown reasonable draw down. By this I mean no more than 35% from its equity peak. If you decide to select a system that has had more draw down, but which you like due to its accuracy and total net profits, then do not begin trading such a system until it has experienced a period of draw down.

e. Consecutive Losers
Most traders cannot accept more than 6 losers in a row. Many profitable systems have shown over 15 consecutive losers. Before you trade any system, know the historical facts. A high number of consecutive losers will cause you to abandon your discipline and the result will be a loss.

f. Study the worst case scenario
not the best case. System promoters naturally portray their systems at their best. In reality many systems deteriorate. Hence, you are far better off looking at a system in its worst light as opposed to its best light.

g. Make certain
that the profits of a system were not generated by one or two or three large trades. Such a system will be very difficult to trade. It will cause you to lose your discipline.

h. Risk management
is an important issue. Many a good trading system has been undone by faulty risk management.

i. Study the worst case scenario, not the best case.
System promoters naturally portray their systems at their best. In reality many systems deteriorate. Hence, you are far better off looking at a system in its worst light as opposed to its best light.

You can master the psychological end of trading by learning about yourself, or by using simple, time tested, mechanical techniques to overcome the problems. Purists would argue that such an approach is shallow and not conducive to long term change. I disagree. There are numerous mechanical techniques which can be used to overcome problems of trader discipline. Whether the application of these mechanical methods results in permanent changes is irrelevant. If mechanical methods work then use them.

What do I mean when I talk about "mechanical methods"?

Here are some examples:

a. If too many of your losses are the result of your not using stop losses, don't waste your time trying to figure out why you don't use stops, just have someone enter your stops for you. In fact, there are many traders who cannot follow their own systems. To overcome this limitation simply turn your system over to someone who will implement all of the trades for you.

b. How about a method for dealing with over-trading? The answer is simple. Most over-trading comes from either too much contact with the market or from attempting to trade too many systems. A mechanical way of dealing with this problem is to eliminate the source or sources of information that stimulate you to make too many trades.

c. Other problems can be solved by making a verbal contract with your broker. Consider the trader who enters stop losses but who changes them repeatedly as the market approaches the stop. In such cases the broker and client can agree that once a stop is entered it will not be changed unless the system so dictates.

Go to part 2:
The Ultimate Factor Underlying Successful Trading

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Revision date: 03/22/11