Single Trade Rule: A cure for overtrading

The promise of nearly unlimited freedom of being a trader, both in the way you work and your overall lifestyle attracts people of poor discipline to trading.

Discipline is the ability to obey your own rules by sacrificing short term temptations in favor of long term goals.

If your technique and market knowledge is poor, you should still be a break-even trader. A losing trader usually has discipline problems or is engaged in self-destructive behavior such as chronic counter-trend trading, random entries, chasing unexpected moves, reversing and re-entering on every loss and so on.

If you have a modicum of discipline, you should be able to limit your losses and turn the corner using the two strikes principle.

If you are unable to stick to even that, I suggest you try the single trade rule. Any day, you will take exactly one trade, win or lose. The purpose of this system is to slow you down and remove the urgency and unrest when sitting out and reactive behavior on loss (or even wins) that causes so much destruction.

A few months of the single trade system should make you more cautious and more tolerant emotionally to loss. More importantly, this should protect your account from rapid evaporation.

Patience and Agility

One of the hardest things to come to grips with trading is that you need to hone two conflicting instincts. The first and foremost is patience. You should be able to wait patiently for a setup that you are confident is a high probability setup. However, when the setup does show up, you need to jump on it and act without hesitation.

Impatience and unrest when sitting out is an account killer and many new traders fall for this trap and blow their accounts. If you feel an urge to get back into the market right after the moment you are stopped out, you are afflicted by this trading ailment.

When traders see large bars such as b1,b11 or b20 they get anxious about missing out on a potentially huge move. They suspect a potentially large drop or huge rally that will net hundreds of ticks which they have been waiting for all their lives and are compelled to act. Subconsciously, they have made a choice that losing one more trade among the thousands of lost trades is a small risk compared to the huge gain they are going to have if they chase this big bar.

Unfortunately, huge rallies and dramatic crashes are rare. But when they do happen, it leaves a strong impression in our memories simply due to the intensity of such moments. Our instincts are tuned to prepare for such moments and we act accordingly.

To deal with impatience, develop a set of checkmarks that you need before entering a trade. Such a test needs to be simple enough that you can evaluate it in a moment and anticipate such a setup as it develops. If you have to process a lot of information at the second a bar closes, the urgency will force you into errors.

A simple three pronged test I use is the following: The trade should occur with support. For example, trade #1 today was at the low of the prior day and is a potential place of reversal. Trade #2 was the first touch of ema and at a trendline. Trendlines, ema and the high and the low of the prior day are very strong supports for your trade.

The second is a two or three legged move: Both trade #1 and #2 were two or possibly three legged move to support.

The last is a decent signal bar. While strong closes with a body at least half the bar make excellent signal bars, occasionally you can relax this constraint depending on experience. Note that the weaker the bar, the worse the pullback and the larger the required stop.

As the price action unwinds, you would keep track of these three variables and when the market sets up, you would already have made the decision before the bar closes. This ensures that your decision has been made with care and you are not forced to make a split-second decision.

At this point, you should act immediately and without hesitation. You should not be worried about taking a loss or panicking if the trade moves against you. Some amount of losing trades are normal and you should welcome them.

Once you enter, hold your ground and do not exit early. The only reason to adjust your targets are if the move is much weaker than you expect. For example, I expected a strong entry bar for trade #1, when it turned out to be weak and was followed by another weak bar, a breakeven exit is ok to take.

The key to confidence

Many traders are unsure whether to buy or sell. Typically, this presents itself as the trader reversing their position with every loss. When they encounter a market such as the few bars on today's open, they may find themselves getting into may trades and getting chopped up.

Such traders have very little confidence in their ability to judge the overall direction of the market. The ability to recognize if the market is trending or simply in a chop is the basis of being profitable. The market provides different options based on whether its trending.

Therefore the first skill a trader needs to work on is the ability to read market direction. This also includes the ability to know if there is no real direction. The simplest way to get there is to always draw a trendline. When the price moves well beyond your trendline, you should assume the trend has ended but until then, trade only in the trend direction.

Over time, trading in only one direction improves sense of direction. You may then consider adding obvious reversals such as the three push move and obvious TCL OS at b26. When you have confidence in your direction, you will be able to re-enter in the same direction (#3) even when your original entry failed (#2)

Do not be overconfident on initial success. A sense of direction is primary but not a complete set of skills. Entering correctly, estimating stop size, and an ensemble of many other skills make a complete trader. Also be wary of very strong and very weak trends that will test your ability to trade profitably.

Location: Trading a trendline

The primary precondition to trade trendline is an established trend. Two higher highs followed by two higher lows is a bull trend. After the open, we had the first higher high at b6 and the second higher high at b10. b11 was the second higher low. There are some optimizations that try to detect the trend earlier, but 2 HH/HL is a definitive bull trend that anyone can recognize.

At this point, you can take a long trade and trade it until the trend breaks (by the strong move down from b14 to b21.)

If the trend break is caused by a reversal such as the three push W and TCL OS to b13, then you should consider taking trades in the new direction. If there was no clear reversal, the trend has simply terminated and you should not take any more trades until a breakout and new trend is established.

Once you see a reversal you can simply wait for a signal bar to form after poking the trendline. A conservative trader may choose to wait for two LL and two LH (b15,17,21,24) and then take every signal bar that pokes the trendline. Once the signal bar triggers, the trendline shifts a bit to give a shallower trendline.

If you do nothing else but trade the trendline with discipline, you should find a better than 50% success rate. Note that the steeper the trendline, the better your chances of success. If the trendline is too shallow, your chances of stop-out are high even though the market may ultimately go your way.

Trendline Discipline

The single most requirement for successful trading is discipline: the ability to stick to your own rules. Most people are impulsive and are easily pushed emotionally one way or another. Take stock of your own history. Do you rush to the office kitchen when someone announces free cookies or buy things on impulse? Check out the hot girl while at work well knowing that its detrimental to your career? If so, you are likely to be a poor trader.

Good trading requires you to be convinced that your rules matter and following them has long term benefits far outweighing the short-term emotional pleasures of breaking them. Once you realize this, then it becomes a matter of training yourself to stick to your rules.

Consistent profit comes from consistent behavior.

Once your profitability is consistent, you can work on improving it. Even a consistent loss is better than whipsawing between profit and loss since an introspective trader can figure out what is making them lose and apply corrections.

One of the simplest rules of trading that you can practice discipline on is trendline discipline. The idea is that you always trade with support behind your trade and even when other supports such as the ema are far away, a trendline is usually easy to draw. The best trades will take off from trendlines  or will pullback to trendlines. The only exception to this rule is a W such as b16 opening wedge or b55 WP.

Even if you don't follow any other rule, trading only after a trendline is tested (preferably poked through, not just tagged) is likely to improve your results.

Bar

Tick scalpers cause prices to pop up and down a few ticks and their net impact on the direction of the market is neutral. Generally speaking, tick traders will exit their positions when the market moves in their favor a few ticks. Other tick traders expect this and will fade such moves causing any move to pullback just a bit. These two groups of traders are tick chasers and tick faders respectively.

When the market activity is dominated by the above kinds of traders, bars tend to have small bodies and have tails on both ends (dojis). When many successive bars are dojis, any trend trading is likely to be lower probability. Occasionally, the move out of this area is strong enough to result in a trend in either direction.

When traders take positions and stand their ground and tick traders are unable to create tails at the ends of the bars, the likelihood of a strong entry bar and a sustained move are higher. Therefore bars like b12 and b9 are likely to be winning setups, i.e., respect stops and go at least as far as the signal bar before.

A strong close therefore is a very good indicator of a good with-trend setup given the market is at a good location and has a tradable pattern.

Note the exceptions to this rule: 

• A large overlap (b22,23) is likely to invite faders. You should treat the OL like a TR and take a BP or fBO of the overlap
• Inside bars, especially large inside bars are also overlaps and their breakout is likely to fail or at least require a large stop. Small inside bars (smaller than your stop) are usually OK. Inside bars that setup a fade of a much larger overlap are often OK (b9, b24)
• When the market enters a channel (b37-66), all signal bars are likely to be poor but the move can be protracted.

Pattern

One of the most interesting problems in day trading is early determination of a trend. An early determination is a decision before there are obvious HH and HL or LL and LH. One simple way to address this is to state that any sustained move from the open is a trend (b1-4) and any sustained move against such an opening trend (b5-8) is a possibly a first reversal (1Rev). Any move that is not sustained is simply a 1PB. The balance between a 1Rev and a deep 1PB is subtle. In the absence of a 3 push move and reversal, I generally err on the side of a 1PB (with some notable exceptions).

Once you have a trend, even if its simply an early determination, you can look for with-trend trades.

Among the with-trend setups, I'm most liberal about the first pullback (#1, #4). If the pullback is deep (#1) or has a strong signal bar (#4), I will often take it since it can lead to gains far larger than the risk. A first pullback made of a one leg or poor bar is not a higher probability trade, but when it does succeed, the gains can be large. Sometimes, a failed deep 1PB in the old direction is a 1PB in the new direction (#2,#3). Usually, I prefer to skip the reversal itself (b14) and take the 1PB after it (#4).

A first move against the current trend (#5,6) is likely to require you to exit on the entry bar, regardless of how good the signal bar may be.

Multi-leg pullbacks such as b54 have the highest probability of a strong entry bar and least adverse excursion after entry. When a multi-leg move is basically a micro-channel (#9), chances of a failed first attempt to break the channel are high.