Trading: You Are The System

By Dave McLachlan

Many people when they first start investing buy and sell stocks based on reasons that are discretionary. By this I mean they either like the company or they have a good “feel” about it. Maybe their broker liked it and old them to buy. But I can assure you, this is the surest way to ruin when you are first starting out. I have seen many investors first hand who have lost their houses and nest eggs by this approach, and many more that have come too close for comfort.

Another Way: The Mechanical Approach

The traders who do the best in the market when first starting out have a back-tested approach, an approach that has shown them a high probability of success. It has exact rules for entry and exit, and also rules on how much to risk per trade. This is called a mechanical approach to trading, and not only does it help you become profitable, it also helps you sleep at night knowing your plan is tried and tested and works in the long run.

Here are some examples of a mechanical approach, used by actual traders:

Entry Signal: 50 day moving average crossing above 200 day moving average

Exit Signal: 50 day moving average crossing below 200 day moving average

Amount of Risk Per Trade: 2% of total equity

Or, here is another example:

Entry Signal: Dow Theory Entry on a weekly chart

Exit Signal: Dow Theory Exit on a weekly chart

Amount of Risk Per Trade: 2% of total equity

As you can see, these trading plans are simple. But the people who use them have made them work. They are able to stick to the rules and consistently make money.

The mechanical approach also has another benefit: because your risk is usually only 1-3% of your total portfolio, it will stop novice traders from betting the farm on one stock. This in turn stops them from going bankrupt like so many of their discretionary counter-parts.

Becoming The System

If you put a hundred traders in a room together and teach them exactly the same rules for trading, I can guarantee you that in 6 months they would all be trading in different ways – with their own personal touches. Why would people do this if the original system was proven to work? Because we are all individuals. We operate differently. We have our own little nuances and quirks, and over time these make their way into our investing.

What does this mean for you?

Basically, it means that you have to find a method that you can work with. If that method is doing Moving Average scans once a week, then do that. If it is trading A-B-C corrections intra-day, then do that.

If you find you can’t stick to the rules that you’ve created, then maybe they aren’t suited to your temperament. And that’s OK. It’s not the end of the world. Just go back to the drawing board and find some rules that you can be happy with. Because after all, what’s money if we can’t be happy?