Rules to Trade Stocks
Rules to trade stocks are essential
for success. In
the October 1989 issue of Futures, Dennis Gartman
published 15 simple rules for trading. Dennis is a
successful trader having experienced the gamut of
trading from winning big to almost losing everything.
Currently, he publishes
The Gartman Letter, a daily publication for
experienced investors and institutions. For the most
part I have taken these rules as they were published
with some minor adjustments and additions of my own based on experience.
- In a bull market only be
long. In a bear market only be short.
Approximately 60% of a stock's move is
based on the overall move of the market. So go
with the trend when investing or trading. That is
is one of the primary pages on this site, so everyone begins with a the market
trend in mind.
- Buy what is showing the
most strength; sell what is showing the most
Basically, the idea is not to
buy low and sell high, but to buy high and sell higher.
We never know what is the low price, nor what is the
high price. By buying strength we greatly improve
our probability of success. Shorting on weakness
works the same way.
- Do not trade until the
fundamentals and the technicals agree.
For fundamentals I focus on Return on
Capital and Earnings Yield as defined by The Little Book That Beats the Market that is further discussed on the
to Beat the Market page. The
technical review focuses on the chart pattern and the
growing strength of volume.
- Do not enter a trade until
it has been thought out, including your target price
and your stop loss price.
Before entering a trade, I identify
the entry price, 1st and 2nd target prices, the stop loss, the
Risk-reward ratio, current volume as a percent of the 50
day average, the technical pattern, the market trend,
the sector, the Return on Capital, the Earnings Yield,
the capital to put at risk, why make the trade and the
risks that may be encountered while the trade is open.
This incorporates all the important aspects of a stock
before I make the trade decision.
- Only add to trades on
minor corrections to support or resistance levels
that go against the major trend.
Use the technical chart to identify
these support and resistance levels in different time
frames. Monitor volume expansion and contraction
during these pull backs. Generally, you should see
pull backs occurring on lower volume and then a pick up
in volume as the price rebounds off these levels,
indicating greater strength.
- Be Patient with good
positions. If you miss an entry trade, wait
until a correction occurs before entering.
Often the price will return to its
breakout point, so you do not have to chase the price.
Also, your technical charts show support and resistance
levels to help identify good entry points. Volume
expansion and contraction also provides a good
- Be patient with good
positions. Once a trade is entered, give it
time to develop.
Set your targets and stops and then it
perform. As the price moves up toward your first
target, move the stop up to the next clear support
level. When your first target is hit sell
according to your plan and the market (1/2 of your
position in a bull market, 3/4 of your position in a
flat market). This creates capital for
further investments and trades. Adjust your stops
up to new support levels. Review your 2nd target
and adjust if strength continues. The real money
is made by letting your best positions to continue to
perform. Taking small profits unnecessarily will
not create wealth and most likely will lead to ultimate
- Be impatient with losing
positions. Small losses are the best losses.
Use your stops to minimize losses.
You use up too much time, money and mental capital
sitting on a losing trade. Holding on to losing
positions cost measurable sums of actual capital, but it
cost immeasurable sums of mental capital. Of the
two types of capital, mental is the most important.
Besides there are always new opportunities to focus your
valuable time and capital.
Never add to a losing position, ever.
While it goes counter to an often
followed belief of traders and investors it is critical
to your ongoing trading success. Many
investment advisors recommend averaging down to get a
better average price on a stock. Adding to a losing
position or averaging down on a bad trade will take you
out of the trading business very quickly.
at what happens when you "average down" on a losing
stock. When you add to a stock that is declining, your
net worth declines as well. Also, if you increase your
short position in a stock that is rising you will
experience the same decline in net worth. Sure, it may
prove fortunate if the stock returns to its previous
levels, but in the mean time you have spent your
precious capital (financial and mental) waiting and
watching for it to turn around.
- Do more of what is working and do less of what
Each day look at your positions and
try to add to those that that exhibit the most strength
while subtracting or eliminating those that are showing
weakness. While "letting your profits run" is an
interesting concept, you really want to try to maximize
your profits with your strongest positions.
- When trading well, trade somewhat larger
positions. When trading poorly, take time off
for a few days, closing all positions.
Align the size of your positions with
your performance, making the most of when things are
going well and minimizing your losses when things are
going badly. When times are good even trades based
on bad analysis will work. When times are bad even
the best analyzed trades will go wrong. This is
the nature of the market. Embrace it.
- Act like a mercenary fighter who invests and
trades on the winning side.
Fight on the winning side and be
willing to change sides readily when the other side has
gained the upper hand. Invest and trade on the
winning side. If no side is winning then you do
not need to trade. The facts of the situation can
and do change, so you must be willing to change as well.
- When investing and trading in the markets, an
understanding of mass psychology is often more
important than an understanding of economics.
Markets are made up of all the insight
and ignorance of the people who participate. Mass
psychology often rules the day, week and month.
Markets can remain illogical longer than you can remain
solvent according to Dr. A. Gary Shilling. Look at
all the bubbles that have occurred. They each grew
to extremely high levels before economics finally took
- Keep your technical systems simple.
Complexity breeds confusion.
Simplicity breeds elegance. Decisions need to be
made with a clear understand of the factors.
Simplicity also makes errors stand out so they can be
- There is never one cockroach.
When you encounter a problem due to
management malfeasance then expect many more will
follow. Bad news begets bad news. Should you
encounter any hint of this kind of problem, then avoid
the stock and sell any you currently own.