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Rule Based Discretionary Trading
08 Apr, 2005
by Jim Harrison

Most “superstar” traders do not trade with mechanical systems; they trade with the most powerful force known to man: Vision.

Their experience has led them to an understanding, or “unlocking” of the Mystery of Market Behavior. They act proactively and intuitively. They use the most powerful computer with a unique operating system: Their brain and solid paradigms.

As a business consultant, it was often my responsibility to instill corporate paradigm shifts through Change Proficiency Maturity profiles and other means. A paradigm is like your “Mental operating system” much like Windows XP is to your Pentium 4.

A paradigm can be defined as:

  • One that serves as a pattern or model
  • A set of assumptions, concepts, values, and practices that constitutes a way of viewing reality, especially in an intellectual discipline

As with most of my business clients, most traders lack the ability to truly focus on learning the conventional wisdom and fundamentals of trading with:

  1. Education
  2. Patience
  3. Discipline
  4. Money Management

When first starting to trade the markets, we all need a way to create structure out of an inherently unstructured environment. Most will turn to one or more of the 1000’s of technical indicators to help make a decision. While these indicators are very powerful, it is my opinion that most traders will find a much better return on their time if they set up some basic guidelines while learning to trade intuitively.

This article will describe ways you can instill a “paradigm shift” in your trading business.

1. Education

Traders are a very stubborn bunch. Full of pride, their arrogance continues to feed the families of educated, patient and disciplined traders. Can you think of any other business or industry that prepares its participants for failure as does ours? Well, just as businesses grow and evolve, your trading business will most likely experience a very similar, predictable pattern, based on your education, tools and training

Many traders attempt to trade without a foundational education, or even worse yet they prove to the world over and over that what they thought they knew they are unable to exercise. That my friend is called ignorance. The zero-minus-sum nature of the markets attests to the fact that we need new “dumb money” losers virtually every day!

The cost of solid factual based education and powerful analytical tools are truly negligible and literally pennies on the dollar when compared to the daily losses of the uneducated, unequipped dumb money traders. Over the years I have watched numerous traders "pay the markets" for an "education" in which they derived absolutely ZERO benefit. Enroll in studies and courses that best fit your objectives and use forums like T2W, and the many fine traders who share their knowledge here to your benefit. Run, do not walk away from those who offer “instant success”. You know better by now.

2. Patience

Most traders get an uneasy feeling when watching the tick by tick action and a move happens that are not participating in. Learn to be patient, and know that the markets are in perpetual transmutation, or they are always moving. The challenge IS NOT to learn what all these indicators and potential patterns mean or to find out the dying question instilled in all humans as to cause and effect: WHY?

The biggest challenge most traders face is in limiting the Focus of your education to that which comes the most naturally to you. The one, or maybe two “set ups” that you seem to be able to identify with on an emotional level. That is the paradigm of patience, and we all started there. Some never escape this level, but all should learn. Yes, we “absorb” other information by attrition, but to focus on your starting operational procedures is paramount.

The first step to a Paradigm shift is to treat trading as a business. Write out the one or two set ups that you look for, and the appropriate actions you are to take when they present themselves in Real time. Be thorough and the more detailed the better. Once defined, your task is to simply be patient until they present themselves, focusing on nothing but your plan.

3. Discipline

Using patience, we now have taken the time and defined the exact set of circumstances that we seek in real time, and the accompanying appropriate actions that follow when these circumstances present themselves. As difficult and uneasy as it may seem, your written out and well defined trading plan should be the ONLY FOCAL POINT throughout the trading day, not the tick by tick action. You can quit staring aimlessly at indicators, trying to decipher hidden divergences. You now have very clear “rules of engagement” with clearly defined entry and exit strategies.

Combining patience and discipline, your Operating plan needs to be traded for a period of time. This means that we need to trade our plans exclusively for a set period of time to form the confidence to NOT KEEP LOOKING for the next “strategy”. This takes an enormous amount of discipline, and is probably the point at which most traders fail. Many traders make this business way too complicated because they lack discipline.

4. Money Management

Finally, the most important aspect to a paradigm change is money management. Consider you trading business as having only one inventory item: Your Trading Capital.

Do you want to offer it on sale for a discount each and every day? Mark it down unnecessarily? I do not think that most of us would willingly exchange a dollar for .75 cents. Why continue to trade without proper risk-to-reward ratios? One of the most important numbers to calculate is your closed trade risk reward ratio. Are you risking $1.00 to make .50 cents? Ouch! That will hurt over time. Yes the market will reward that type of trading in short spurts, but over time we must succumb to the forces of nature and the economic laws of diminishing returns among others. Eliminate that cycle with a disciplined money management program, and use stops that are reasonable and based on market structure, not monetary amounts. If the most “reasonable” stop is too far out of reach, or is too “wide” for your trading plan, then that is most likely a trade that needs to be passed on, regardless of the outcome.

In closing, I urge each and every one of you start the process of ridding your thoughts of the “balance sheet” mentality that simply fuels this zero minus sum industry known as trading, and put a little business structure in the forefront for a while. I like to measure my results, not in dollars, but in my ability to consistently trade my plan, which, over time, gets me the dollar amounts I desire.

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