10 Rules for Successful Trading

Make a plan and stay disciplined

Busy businesswoman checking financial trading data on smartphone in commercial dock in city during sunset
•••

d3sign/Getty Images

Have you ever wanted to be a full-time day trader? Maybe you’re just interested in learning how to trade so you can make the most of your investments. Either way, successful trading is not easy. You need financial capital to get started, and a relatively strong stomach for risk. But with proper planning and discipline, you can make money. Consider these rules for becoming a successful trader.

The Financial Industry Regulatory Authority (FINRA) requires that anyone buying and selling the same security on the same day, four or more times in five business days, must maintain at least $25,000 in equity in their account. This applies to anyone whose day-trading activities are greater than 6% of their trading activity for that same five-day period.

Have a Plan

When it comes to trading, it may not be the best idea to just jump right in. It’s important to take some time to outline what you want to accomplish and establish a set of rules that will allow you to achieve good returns and manage risk.

Your plan should include rules on when to buy investments and when to sell. It should also outline how much cash you want on hand at all times

If you don’t have extra cash to trade, don’t get started until you do. It may also be wise to pay down debt and establish an emergency fund before getting started with trading.

It should include rules regarding the level of exposure you want for specific industries, sectors, and asset classes. And it should all be underpinned by a set of goals for the short and long term. Following this plan will allow you to make thoughtful, disciplined decisions and allow you to trade with confidence.

Test it Out

So you have an investing plan, but how do you know if it’s a sensible one? There are thankfully ways to test a trading strategy without putting money at risk. Any investor can use historical data to see how a strategy would have played out in real life.

Of course, this can require a lot of time and effort. In some cases, an investor may benefit by hiring a programmer to develop a backtesting system. Some online brokers offer platforms that allow for testing of strategies. For example, TD Ameritrade offers a practice system known as paperMoney on its thinkorswim platform. Traders receive $100,000 of fake money to test different investments and trades with. Fidelity has a similar product called Wealth-Lab Pro that lets you test it out before making a trade. 

Some of these platforms require minimum balances to use them and may come with additional fees.

Leverage Technology

Nearly every investor makes trades using online platforms these days. And as stated above, it can be hugely helpful in backtesting potential strategies. But the use of the internet and technology doesn’t stop there.

Smartphone apps allow you to make trades while you are on the go. Sophisticated charting software and websites allow you to analyze investments and market conditions. Bookkeeping software allows you to track cost basis to ensure proper tax accounting. The technological tools available are bountiful, so take advantage of them.

Don’t Risk All Your Capital

Let’s say you have the majority of your life’s expenses covered, and now have $50,000 in extra cash on hand that you are willing to invest.

That $50,000 is a nice sum, but it should never be invested all at once. In fact, a rule of thumb is to never risk more than 1% of your money on any given trade. That means that if you have $50,000 invested, you should never allow yourself to lose more than $500 on any single trade.

Another sensible guideline is that if you have $50,000 in a stock account, you should keep some of that money in cash. This way, there’s no chance of you being completely wiped out. You’ll also have money on hand to pounce on any good buying opportunities. 

Read, Read, Read

It’s now easier than ever to trade in an informed way. There’s no excuse to make trades that are not backed by a thorough analysis of the underlying investment, as well as the broader economic and geopolitical trends that might impact performance.

Essential reading for traders should include:

  • Financial documents, including balance sheets and annual reports
  • Reports from analysts
  • Economic indicators
  • Technical analysis
  • Historical pricing data
  • Independent white papers and reports on relevant trends
  • Daily financial news
  • Books on investing, secular trends, and world events

The more you educate yourself about investments in the markets, the smarter your trades will be. 

Don’t Rob Peter to Pay Paul

A smart investor will never invest money they can’t afford to lose. This means that you should have dedicated funds for important expenses, such as your mortgage payment or child’s college education. You should also have an emergency fund to cover at least several months’ worth of expenses in case you suddenly find yourself without income.

These funds should be kept separate from the money you use to trade. When investing, there is always the risk you could lose money, so the last thing you want to do is miss a house payment or go into debt because you used that money to trade stocks or bonds.

Stay Calm

Have you ever wondered how a robo advisor can make money for an investor? It’s because the advisor is designed to carry out a strategy and stick to it, regardless of the daily ups and downs of the market. A robo advisor has no feelings. It can’t get angry or upset when markets drop and can’t get pumped up when markets rise.

Investors play the long game. This means that they don’t worry too much when an investment loses value on any given day, and don’t get too excited when they make quick money.  

It can be difficult to look at the value of your portfolio and see that you’ve lost a lot of money in a short period of time. But that’s no reason to quickly sell an investment at a loss or make some other silly decision.

As legendary investor Warren Buffett once said, “If you’re going to do dumb things because a stock goes down, you shouldn’t own a stock at all.”

Be Realistic

Is it possible to get a 40% annual return on a single investment? Sure. Is it sensible to believe such a return is guaranteed year after year? Of course not.

Prudent traders should have an honest and even overly conservative outlook regarding the future performance of their portfolio. Every investor should know the old adage that past performance does not guarantee future results. Don’t bank on one investment making unreasonably good returns, and don’t fall into a pattern of wishful thinking.

Use a Stop-Loss Order

While there’s no need to panic just because an investment drops in value, it is important to install protections to avoid losing a massive portion of your savings.

One helpful thing you can do is install something called a “stop-loss order” that will automatically sell investments if they drop in value by a certain percentage in a certain amount of time. You can request a stop-loss order through your broker.

Let’s say that you purchase shares of Company XYZ ay $100 a piece, but don’t want to lose more than 10% of your investment in a given year. With a stop-loss order, you would sell the shares if they fell to $90 per share or less. This order prevents you from losing any additional money. Of course, this also means you won’t benefit if share prices go back up, so it’s important to put in stop-loss orders only to avoid sizable losses. You wouldn’t want to put a 5% stop-loss order on an investment that moves up and down by 10% each week, for example.

It’s possible to put in stop-loss orders for individual investments, but you may also put in a stop-loss order for your entire portfolio.

Know When to Quit

You may come to realize that you simply are not very good at buying and selling investments regularly. You may be consistently losing money, and you might not have the knowledge or patience to understand why.

On the flipside, you may have made enormous sums of money in the markets and have achieved all your financial goals.

Either way, it’s important to understand when it’s time to stop trading. Trading without success year after year may just mean you’re throwing good money after bad. And if you’re continuing to trade after reaching financial security, you may be doing nothing more than putting your nest egg at risk. One of the biggest parts of investing success is knowing when it’s time to step away from the trading platform.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. 

Article Sources

  1. TD Ameritrade. "thinkorswim," Accessed Oct. 18, 2019.

  2. CNBC. "Full Transcript: Billionaire Investor Warren Buffet Speaks With CNBC's Becky Quick on 'Squawk Box' Today," Accessed Oct. 18, 2019.