82 TRADING RULES AND MARKET OBSERVATIONS

Extract from "Getting Started in Technical Analysis"
by Jack D Schwager


ENTERING TRADES

1. Differentiate between major trades and short-term trades.
   
2. If you believe a major trading opportunity exists, don’t be greedy in trying to get a slightly better entry price.
   
3. Entry into any major position should be planned and carefully thought out - never an intraday impulse.
   
4. Find a chart pattern that says the timing is right. Don’t initiate a trade without such a confirming pattern.
   
5. Place orders determined by daily analysis.
   
6. When looking for a major reversal in a trend, it is usually wiser to wait for some pattern that suggests that the timing is right rather than fading the trend at projected objectives and support/resistance points.
   
7. If you have an immediate instinctive impression when looking at a chart, go with that feeling.
   
8. Don’t let the fact that you missed the first major portion of a new trend keep you from trading with that trend.
   
9. Don’t fade recent price failure patterns when implementing trades, even if there are many other reasons for the trade.
   
10. Never fade the first gap of a price move! For example, if you are waiting to enter a trade on a correction, and the correction is then formed on a price gap, don’t enter the trade.
    
11. In most cases, use market orders rather than limit orders.
    
12. Never double up near the original trade entry point after having been ahead.



EXITING TRADES AND RISK CONTROL (MONEY MANAGEMENT)


13. Decide on a specific protective stop point at the time of trade entry.
    
14. Exit any trade if newly developing patterns or market action are contrary to trade - even if stop point has not been reached.
    
15. Always get out immediately once the original premise for a trade is violated.
    
16. If you are dramatically wrong the first day a trade is on, abandon the trade immediately - especially if the market gaps against you.
    
17. In the event of a major breakout counter to the position held, either liquidate your position immediately or use a very close stop. In the event of a gap breakout, always liquidate immediately.
    
18. If a given stock or futures market suddenly trades far in excess of its recent volatility in a direction opposite to the position held, liquidate your position immediately.
    
19. If selling into resistance or buying into support and the market consolidates instead of reversing, get out.
    
20. For analysts and market advisers: If your gut feeling is that a recent recommendation, hot line broadcast, trade, or written report of yours is wrong, reverse your opinion!
    
21. If you’re unable to watch markets for a period of time (e.g., when traveling), either liquidate all positions or be sure to have stop orders on all open positions.
    
22. Do not get complacent about an open position. Always know where you are getting out even if the point is far removed from the current price.
    
23. Fight the desire to immediately get back into the market following a stopped-out trade.



OTHER RISK-CONTROL (MONEY MANAGEMENT) RULES


24. When trading is going badly: (a) reduce position size; (b) use tight stop-loss points; (c) slow up in taking new trades.
    
25. When trading is going badly, reduce risk exposure by liquidating losing trades, not wining trades.
    
26. Be extremely careful not to change trading patterns after making a profit.
    
27. Treat small position with the same common sense as large positions.
    
28. Avoid holding very large positions into major reports or the release of important government statistics.
    
29. Futures traders: Apply the same money management principles to spreads as to outright positions.
    
30. Don’t buy options without planning at what outright price the trade is to be liquidated.
    


HOLDING AND EXITING WINNING TRADES


31. Do not take small, quick profits in major position trades. In particular, if you are dramatically right on a trade, never, never take profits on the first day.
    
    
32. Don't be too hasty to get out of a trade with a gap in your direction. Use the gap as initial stop; then bring in stop in trailing fashion.
    
    
33. Try to use trailing stops, supplemented by developing market action, instead of objectives as a means of getting out of profitable trades. Using objectives will
    often work against fully realizing the potential of major trends. Remember, you need the occasional big winners to offset losers.
    
    
34. The preceding rule notwithstanding, it is still useful to set an initial objective at the time of trade entry to allow the application of the following rule: If a very large portion of an objective is realized very quickly (e.g., 50-60% in one week or 75-80% in two or three weeks), take partial profits, with the idea of reinstating liquidated shares or contracts on a reaction. The idea is that it is okay to take a quick sizable profit. Although this rule may often result in missing the remainder of the move on the liquidated portion of the position, holding the entire position, in such a case, can frequently lead to nervous liquidation on the first sharp retracement.
    
    
35. If an objective is reached, but you still like the trade, stay with it using a trailing stop. This rule is important in order to be able to ride a major trend. Remember, patience is important not only in waiting for the right trades, but also in staying with trades that are working. The failure to adequately profit from correct trades is a key profit-limiting factor.
    
    
36. One partial exception to the previous rule is that if you are heavily positioned and equity is surging straight up, consider taking scale-up profits. Corollary rule: When things look too good to be true - watch out! If everything is going right, it is probably a good time to begin taking scale-up (or scale-down) profits and using closing trailing stops on a portion of your positions.
    
    
37. If taking profits on a trade that is believed to still have long-term potential (but is presumably vulnerable to a near-term correction), have a game plan for reentering position. If the market doesn’t retrace sufficiently to allow for reentry, be cognizant of patterns that can be used for timing a reentry. Don’t let the fact that the reentry point would be worse than the exit point keep you from getting back into a trade in which the perception of both the long-term trend and current timing suggest reentering. Inability to enter at a worse price can often lead to missing major portions of large trends.
    
    
38. If trading larger positions, avoid the emotional trap of wanting to be 100% right. In other words, take only partial profits. Always try to keep at least a partial position for the duration of the move - until the market forms a convincing reversal pattern or reaches a meaningful stop-loss point.
    


MISCELLANEOUS PRINCIPLES AND RULES


39. Always pay more attention to market action and evolving patterns than to objectives and support/resistance areas. The latter can often cause you to reverse a correct market bias very prematurely.
    
    
40. When you feel action should be taken either entering or exiting a position - act, don’t procrastinate.
    
    
41. Never go counter to your own opinion of the long-term trend of the market. In other words, don’t try to dance between the raindrops.
    
    
42. Winning trades tend to be ahead right from the start.
    
    
43. Correct timing of entry and exit (e.g., timing entry on a reliable pattern, getting out immediately on the first sigh of trade failure) can often keep a loss small even if the trade is dead wrong.
    
    
44. Intraday decisions are almost always losers. Keep screen off intraday.
    
    
45. Be sure to check markets before the close on Friday. Often the situation is clearer at the end of the week. In such cases, a better entry or exit can usually be obtained on Friday near the close than on the following Monday opening. This rule is particularly important if you are holding a significant position.
    
    
46. Act on market dreams (that are recalled unambiguously). Such dreams are often right because they represent your subconscious market knowledge attempting to break through the barriers established by the conscious mind (e.g., “How can I buy here when I could have gone long $2,000 lower last week??.
    
    
47. You are never immune to bad trading habits - the best you can do is to keep them latent. As soon as you get lazy or sloppy, they will return.
    


MARKET PATTERNS


48. If the market set new historical highs and holds, the odds strongly favor a move very far beyond the old highs. Selling a market at new record highs is probably one of the amateur trader’s worst mistakes.
    
    
49. Narrow market consolidations near the upper end of broader trading ranges are bullish patterns. Similarly, narrow consolidations near the low end of trading ranges are bearish.
    
    
50. Play the breakout from an extended, narrow range with a stop against the other side of the range.
    
    
51. Breakouts from trading ranges that hold for one to two weeks, or longer, are among the most reliable technical indicators of impending trends.
    
    
52. A common and particularly useful form of the above rule is: flags or pennants forming right above or below prior extended and broad trading ranges tend to be fairly reliable continuation patterns.
    
    
53. Trade in the direction of wide gaps.
    
    
54. Gaps out of congestion patterns, particularly one-to-two month trading ranges, are often excellent signals. (This pattern works especially well in bear markets.)
    
    
55. If a “breakaway gap?is not filled during the first week, it should be viewed as a particularly reliable signal.
    
    
56. A breakout to new highs or lows followed within the next week or two by a gap (particularly a wide gap) back into the range is a particularly reliable form of a bull or bear trap.
    
    
57. If the market breaks out to a new high or low and then pulls back to form a flag or pennant in the pre breakout trading range, assume that a top or bottom is in place. A position can be taken using a protective stop beyond the flag or pennant consolidation.
    
    
58. A breakout from a trading range followed by a pullback deep into the range (e.g., three-quarters of the way back into the range or more) is yet another significant bull or bear trap formation.
    
    
59. If an apparent V bottom is followed by a nearby congestion pattern, it may represent a bottom pattern. However, if this consolidation is then broken on the downside and the V bottom is approached, the market action can be read as a sign of an impending move to new lows. In the latter case, short positions could be implemented using protective stops near the top of the consolidation. Analogous comments would apply to V tops followed by nearby consolidations.
    
    
60. V tops and V bottoms followed by multi month consolidations that form in close proximity to the reversal point tend to be major top or bottom formations.
    
    
61. Tight flag and pennant consolidations tend to be reliable continuation patterns and allow entry into an existing trend, with a reasonably close, yet meaningful, stop point.
    
    
62. If a tight flag or pennant consolidation leads to a breakout in the wrong direction (i.e., a reversal instead of a continuation), expect the move to continue in the direction of the breakout.
    
    
63. Curved consolidations tend to suggest an accelerated move in the direction of the curve.
    
    
64. The breaking of short-term curved consolidation (see Chapter 11) in the direction opposite of the curve pathway tends to be a good trend reversal signal.
    
    
65. Wide-ranging days (i.e., days with a range far exceeding the recent average range) with a close counter to the main trend usually tend to provide a reliable early signal of a trend change - particularly if they also trigger a reversal signal (e.g., filling of a runaway gap, complete penetration of prior consolidation).
    
    
66. Near-vertical, large price moves over a period of two to four days (coming off a relative high or low) tend to be extended in the following weeks.
    
    
67. Spikes are good short-term reversal signals. The extreme of the spike can be used as a stop point.
    
    
68. In spike situations, look at chart both ways - with and without spike. For example, if when a spike is removed a flag is evident, a penetration of that flag is a meaningful signal.
    
    
69. The filling-in of a runaway gap can be viewed as evidence of a possible trend reversal.
    
    
70. An island reversal followed shortly thereafter with a pullback into the most recent trading range or consolidation pattern represents a possible major top (or bottom) signal.
    
    
71. The ability of a stock or future to hold relatively firm when other related markets are under significant pressure can be viewed as a sign of intrinsic strength. Similarly, a market acting weak when related markets are strong can be viewed as a bearish sign.
    
    
72. If a market trades consistently higher for most of the daily trading session, anticipate a close in the same direction.
    
    
73. Two successive flags with little separation can be viewed as a probable continuation pattern.
    
    
74. View a curved bottom, followed by a shallower, same-direction curved consolidation near the top of this pattern, as a bullish formation (“cup-and-handle?. A similar pattern would apply to market tops.
    
    
75. Moderate sentiment in a market that is strongly trending may be a more reliable indicator of a probable continuation of the price move than a high or low sentiment reading is of a reversal. In other words, extreme sentiment readings can often occur in the absence of major tops and bottoms, but major tops and bottoms rarely occur in the absence of extreme sentiment readings (current or recent).
    
    
76. A failed signal is more reliable than the original signal. Go the other way, using the high (or low) before the failed signal as a stop. Some examples of such failure patterns are rule numbers 56, 57, 58, 62, 64 and 69.
    
    
77. The failure of a market to follow through on significant bullish or bearish news (e.g., an important earnings report or a major report) is often harbinger of an imminent trend reversal. Pay particular attention to such a development if you have existing position.
    


ANALYSIS AND REVIEW


78. Review charts every day.
    
    
79. Periodically review long-term charts.
    
    
80. Religiously maintain a trader’s diary.
    
    
81. Maintain a patterns chart book.
    
    
82. Review and update trading rules, trader’s diary, and patterns chart book on a regular basis.
    

THE PLANNING TRADING APPROACH

1. Define a trading philosophy
   
   
   
   1. Fundamental analysis
      
   2. Chart analysis
      
   3. Technical trading systems
      
   
   
2. Choose markets to be traded
   
   
   
   1. Suitability to trading approach
      
   2. Diversification
      
   3. Volatility
   
   
3. Specify risk control plan
   
   
   
   1. Maximum risk per trade
      
   2. Stop-loss strategy
      
   3. Diversification
      
   4. Reduced leverage for correlated markets
      
   5. Market volatility adjustments
      
   6. Adjusting leverage to equity changes
      
   7. Losing period adjustments
   
   
4. Establish a planning time routine
   
   
   
   1. Update trading systems and charts
      
   2. Plan new trades
      
   3. Update exit points for existing positions
   
   
   
5. Maintain a trader’s notebook
   
   
6. Maintain a trader’s diary
   
   
   
   1. Reasons for trade
      
   2. How the trade turned out
      
   3. Lessons
   
   
   
7. Analyze personal trading
   
   
   
   1. Analysis of segmented trades
      
   2. Equity chart