The Basics of Trading:Part 2

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Mark Williams

20 Jan, 2005

in Getting Started and 2 more

In part 1 of this article, I looked at some of the basic elements of trading, including chart reading and money management. In this second part, I will consider some other essential issues, such as the need for discipline in trading and the importance of practice and planning.

The Importance of Discipline

I have previously mentioned why it is important that you DONíT move a stop-loss to increase risk, and I wanted to go through the ďwhat ifĒ scenario of letting a stop run.

Weíll take this example from Barclays from January 2003.

Chart

Here we have a nice double (or even†triple) bottom on support, and a clean bounce up. You take this long entry with a tight manual stop at 360.

This is what happens over the days to come...

Chart

Brilliant, straight into profit and looking good.

The following week isnít so promising though...

Chart

You hear yourself saying,

"Ok the price has gone through support, but itís ok, it closed above support so itíll be ok."

So you leave it for a bit, and this happens...

Chart

"Oh no the price has gone through support, ok itís too late to sell now, Iíll wait until price gets back up to the support line."

Chart

"Now price has made a nice rounded bottom so the next move is up, I can let it run for a while longer as itís bound to go through the resistance level."

and the next thing you know price does this...

Chart

"Time to sell out and†accept the loss."

Well itís good to know you cut the loss Ė some 35 points or 10% below where you should have done.

Itís very easily done this, and Iím sure most traders have done this at some point in their trading career. This is why discipline is such a large part of trading. Always remember to move a stop to protect profits NOT to increase risk.

Now, we will look at putting in practice all that we have learned...

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Thanks - very interesting, I use Proquote at work and was just wandering with regard to what you say about paper practice trading using historical data if you had any ideas on how to advance a chart on a day by day basis using this programme? It does not seem possible unless you know any better? Also I have started trading stocks (3-4 at a time) on the AIM that exhibit a high degree of short term momentum, (SBT etc) therefore support lines are steeply inclined and less consistant than in your barclays example, in such cases would you still recommend setting the stops just a few percent below the inclining resistance trendline?
Lastly and on an unrelated point what do you think of trading brand new issues?Tthe upside potential seems huge and obviously losses can be limited with stops, I saw one treble in value within 2 hours of market opening last week (forget the name now sorry). The lse website gives a list of forthcoming issues as does investors chroncle, but I cannot find anywhere that gives advance opinion on likely market reaction to the listing. Any ideas on this? Thanks

Feb 16, 2005

Member (3 posts)

Perfect for me!

Feb 07, 2005

Member (1 post)

Thanks to all of you for your kind comments. They are very much appreciated and it makes the whole thing worthwhile :cool:

I believe that part the 3rd and final part will be published this week (all being well).

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Hi Ale

Need to sort out the link on page 2 to Sierra - it sends you to the top of page 1.
Thanks for that, I completely missed that one :o

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Hi jimmy1jag

Instead of paper trading, however, I have just opened an account with Finspreads, where, for the first 8 weeks you have the option to join their (from memory) "Trading College". If you sign up to the trading college, you can trade at as little as 1p per point (for the first 8 weeks), instead of the standard minimum of 50p per point. The minimum you can put into the account at start up is £100. So £100 max. exposure and an opportunity to put the theory into practice for a low initial outlay. But trading for real money.
Excellent. The Finspreads trading college was designed for this very purpose and well worth doing.

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Hi tulaine

It's good to get confirmation of 'common sense' while I'm still gathering information and learning the ropes. Not sure I agree with the figures though. Setting a maximum risk at 2% of the bank and 1 open trade at a time means it could be ages before any significant profits are visible. Another advisor suggests 4% and 12 open trades, still risking less than half the bank at any moment. Of course exposure to risk is a personal thing, so no arguments can ever resolve such an issue. I may not be comfortable with 48% out, but I don't think 2% would satisfy.
I can understand your thinking, however before you think about going above 2% risk, then please please make sure that you can trade profitably below this level before moving above it.

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Jan 31, 2005

Member (1518 posts)

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