How to Build Stock Trading Rules - dummies

How to Build Stock Trading Rules

To plan and manage your trades, you need trading rules. A trading rule is the specific action you take when certain conditions are met. At the most basic, a trading rule instructs you to buy or sell a stock when an indicator meets a preset criterion. Most indicators have a buy/sell trading rule already embedded in them.

But technical trading is a mindset that goes beyond using indicators. Trading rules improve your trading performance by refining the buy/sell signals you get from indicators. Trading rules tend to be more complex and contain more conditions than raw indicators, such as “buy after the first 45 minutes if x and y also occur” or “sell half the position when z occurs.”

At each step you have to decide which indicators or combinations of indicators to follow, and your exact specifications for them. Here’s what your indicators and rules need to do:

  1. Determine the current trend.

  2. Establish the rules for opening a position.

  3. Manage the money at risk by scaling up or down.

  4. Establish the rules for closing a position — set stops and targets.

    The paramount rule in technical trading is to control losses.

  5. Establish a reentry rule after being stopped or after the target is hit.

Good trading isn’t about the securities you trade or about indicators. It’s about planning the trade in full ahead of time and following the plan. Strictly speaking, managing the trade isn’t exclusive to technical analysis. But all successful technical traders manage their trades.

If you want to increase your stake or preserve capital, it’s when you sell that counts. You sell for one of three reasons — you met a profit target, you met a loss limit, or you chose to increase or decrease the risk of the trade.