3 simple rules of trading by Alen Hull

They look simple but following them is difficult for most of us and these are the rules which are frequently violated by most of the traders.

1 Buy a rising share - sell a falling share

2 Always use a stop loss that moves up with price activity

3 Never risk more than 2% of total capital on any individual trade

Buy a rising share - sell a falling share

This rule is often confused with 'buy low - sell high' which has 85% of share traders buying shares that are going down in price in the hope that they will immediately turn around and start going up. This mistake leads to the sad statistic that 85% of share traders lose money.

'Buy a rising share - sell a falling share' is all about buying into markets that are already rising, which is so painfully obvious that the majority of share traders, ie. 85% of them, don't do it. The reason for this is simple and psychological; human beings are counter-intuitive by nature. So in order to be successful we must be prepared to stop thinking like everybody else.

Always use a stop loss that moves up with price activity

An initial stop loss is a price level that defines the point at which we are ready to admit that the market is not behaving as we would expect and we are prepared to sell. In other words this is the point where we admit that the trade is a failure. All share traders have losing trades and the only fatal failure in the marketplace is the failure to execute one's stop losses. When the market moves in the direction we expect it to then the price at which we are prepared to sell should move with it, locking in profits. If our stop loss has moved beyond our entry price (the point at which we bought into the market) and we fail to sell if it is triggered, then we are being greedy; this will also prove fatal.

Never risk more than 2% of total capital on any individual trade

The game of coin toss is a fair game of chance where no participant should expect to win or lose over the long term. As global equity markets have risen by an average of 9% per annum for the past 100 years, all share traders should expect to profit by an average of 9% per annum. So why do only 15% of share traders make money? Answer…the ability to survive.If a participant wishes to remain in a game of coin toss for the long term then they would have to be able to sustain a string of up to 8 consecutive losses. This is because a string of 8 consecutive losses is likely to occur in a game where there are 2 equally possible outcomes. The same logic applies to the Stock market where the majority of share traders in the U.S. in the 1990s had an average life expectancy of only 8 trades. So in order to survive in the marketplace long enough to enjoy the average return of 9% per annum over the long term, it is essential that share traders can sustain an extended string of losses. By only risking 2% of total capital on any individual trade, a share trader can sustain up to 194 consecutive losses.