The Importance of Trading Rules

As a trader, picking the right trades is only half the battle. Following rules is the other half of the equation. Here is a step-by-step breakdown of a trade that was initiated Thursday 7/10 and exited Friday End Of Day.

The security involved in the trade was an Oil Contract (CLQ4). For those not familiar with the futures market it’s OK, the rules remain the same and so does the technical analysis that initiates the trade.  The top 3 rules that were all on full display in this example are:

1. Always have a plan (A reason for entering, a profit price target and a stop loss target in case you’re wrong)
2. Be patient & don’t panic (This applies to both entering & exiting positions)
3. Only change the previous ‘plan’ if the risk/reward ratio will be improved in your favor.

You will see references to these rules throughout the post.

So let’s begin with the background into Oil by looking at the daily chart:

Oil Daily Chart

There will be other posts describing the reasons for entering a trade from daily chart patterns, but the primary reason for going Short Oil Thursday July 10th was because of a Technical Indicator known as TD Sequential which suggested that after the 9 day drop in the price, Oil might have a 1-4 day Dead Cat Bounce before heading lower once again. Perhaps this was NOT the best implementation of Rule#2 but it does create a good example for those looking to put more structure in their trading.

A decision is made to Short Oil around 9:45am ET with a limit order at $102.05 after seeing it bounce from an overnight low of $101.60. This is a swing trade looking for Oil to get down to the nice round number of $100, and immediately after the order fills, a stop loss is entered to exit at 103.17 and a profit entry is entered to execute a buy back at 100.15. It’s always a good idea to place your orders at values just outside round number targets. Looking at the chart it should be clear why the stop loss is around the $103.20. It was support a few days prior and the day before it was a breakdown point, it’s also just above a round value of $103 though in itself there is nothing special about $103. The target is a value just above $100 so the worst-case scenario is that the price of Oil goes up and there is a loss of $103.17 – 102.05 = 1.12 (or $1,120.00 per contract sold while expected profit is $1,900) Rule#1 is now fully implemented once orders to cover the position are entered.

Oil 60 Min chat 7-10

Immediately after entering the trade it starts to go the wrong way and within 4 hours there is an unrealized loss of $995.00 per contract on the position as the price moves up to $103. This is where Rune#2 is crucial: you had a plan and so this is NOT the time to ‘panic’, just let it develop and if it goes up 20 more cents you will cut your losses and fight another day. And just like a textbook prior support and breakdown point of $103 became resistance and price reversed back to the downside.

The next day the price of Oil begins to drop and starts to look like it might have been the correct decision after all. As the price falls bellow $101.50 (a nice round number which is also a new multi-week low) it’s time to follow Rule#3 and adjust the plan making sure this can’t be a losing trade. The profit target remains the same $100.15 but the Stop Loss has now been adjusted to $102.3 (just above a nice round number of $102 and a few cents below the entry to make sure we can at least buy a sandwich no matter what happens on this trade). As the price continued to fall and the day was almost over a new decision must be made whether the trade should be held over the weekend. Being so close to the target of $100, Holding Oil over the weekend with the futures market closed with all those tensions in the Middle East might not be the smartest move. The New Plan at around 4pm on Friday July 11 is to exit the trade. At the time the price has been rising from the day’s low of $100.42 and right around the price $100.65 a new Stop Loss of $100.70 and Profit tacking at $100.60 is set to buy back the Oil Contract(s). The exit happened at $100.70 for a gain on the trade of $1,350 minus $4 in commission per contract.

Oil 60 Min Chart 7-11

Not everyone trades futures due to the high risk of leverage, but the concerts presented here apply to other markets like Equity and Currency. This trade could have been a big loss and was looking like it right after the entry. It is thanks to our RULES we were fortunate to walk away with a profit. Don’t ever underestimate Rule#2 of being patient and composed, and do NOT adjust Rule#1 and change the original plan to prove you will be right if given some more time.

PS should you be upset you did not cash out 30 min earlier at the very bottom around $100.45 making an additional 20% or so profit. NO, it was never part of the PLAN.

Good luck in your trading!!!

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