via John Mauldin, comes Dennis Gartman’s "Not-So-Simple" (But Really Utterly So) Rules of Trading
R U L E # 1
Never, ever, under any circumstance, should one add to a losing position … not EVER!Averaging down into a losing trade is the only thing that will assuredly take you out of the investment business. This is what took LTCM out. This is what took Barings Brothers out; this is what took Sumitomo Copper out, and this is what takes most losing investors out.
R U L E # 2
Never, ever, under any circumstance, should one add to a losing position … not EVER!We trust our point is made. If "location, location, location" are the first three rules of investing in real estate, then the first two rules of trading equities, debt, commodities, currencies, and so on are these: never add to a losing position.
R U L E # 3
Learn to trade like a mercenary guerrilla.The great Jesse Livermore once said that it is not our duty to trade upon the bullish side, nor the bearish side, but upon the winning side. This is brilliance of the first order. We must indeed learn to fight/invest on the winning side, and we must be willing to change sides immediately when one side has gained the upper hand.
R U L E # 4 DON’T HOLD ON TO LOSING POSITIONS
Capital is in two varieties: Mental and Real, and, of the two, the mental capital is the most important.Holding on to losing positions costs real capital as one’s account balance is depleted, but it can exhaust one’s mental capital even more seriously as one holds to the losing trade, becoming more and more fearful with each passing minute, day and week, avoiding potentially profitable trades while one nurtures the losing position.
R U L E # 5 GO WHERE THE STRENGTH IS
The objective of what we are after is not to buy low and to sell high, but to buy high and to sell higher, or to sell short low and to buy lower.We can never know what price is really "low," nor what price is really "high." We can, however, have a modest chance at knowing what the trend is and acting on that trend. We can buy higher and we can sell higher still if the trend is up. Conversely, we can sell short at low prices and we can cover at lower prices if the trend is still down. However, we’ve no idea how high high is, nor how low low is.
R U L E # 6
Sell markets that show the greatest weakness; buy markets that show the greatest strength.Metaphorically, when bearish we need to throw our rocks into the wettest paper sack for it will break the most readily, while in bull markets we need to ride the strongest wind for it shall carry us farther than others.
R U L E # 7
In a Bull Market we can only be long or neutral; in a bear market we can only be bearish or neutral.In a bull market we can be neutral, modestly long, or aggressively long–getting into the last position after a protracted bull run into which we’ve added to our winning position all along the way. Conversely, in a bear market we can be neutral, modestly short, or aggressively short, but never, ever can we–or should we–be the opposite way even so slightly.
R U L E # 8
"Markets can remain illogical far longer than you or I can remain solvent."The University of Chicago "boys" have argued for decades that the markets are rational, but we in the markets every day know otherwise. We must learn to accept that irrationality, deal with it, and move on.
R U L E # 9
Trading runs in cycles; some are good, some are bad, and there is nothing we can do about that other than accept it and act accordingly.Thus, when things are going well, trade often, trade large, and try to maximize the good fortune that is being bestowed upon you. However, when trading poorly, trade infrequently, trade very small, and continue to get steadily smaller until the winds have changed and the trading "gods" have chosen to smile upon you once again.
R U L E # 10
To trade/invest successfully, think like a fundamentalist; trade like a technician.It is obviously imperative that we understand the economic fundamentals that will drive a market higher or lower, but we must understand the technicals as well. When we do, then and only then can we, or should we, trade.
R U L E # 11
Keep your technical systems simple.The greatest traders/investors we’ve had the honor to know over the years continue to employ the simplest trading schemes. They draw simple trend lines, they see and act on simple technical signals, they react swiftly, and they attribute it to their knowledge gained over the years that complexity is the home of the young and untested.
R U L E # 12
In trading/investing, an understanding of mass psychology is often more important than an understanding of economics.Markets are, as we like to say, the sum total of the wisdom and stupidity of all who trade in them, and they are collectively given over to the most basic components of the collective psychology. The dot-com bubble was indeed a bubble, but it grew from a small group to a larger group to the largest group, collectively fed by mass mania, until it ended. The economists among us missed the bull-run entirely, but that proves only that markets can indeed remain irrational, and that economic fundamentals may eventually hold the day but in the interim, psychology holds the moment.
And finally the most important rule of all:
R U L E # 13
Do more of that which is working and do less of that which is not.This is a simple rule in writing; this is a difficult rule to act upon. However, it synthesizes all the modest wisdom we’ve accumulated over thirty years of watching and trading in markets. Adding to a winning trade while cutting back on losing trades is the one true rule that holds–and it holds in life as well as in trading/investing.
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Dennis Gartman: This is what I have learned about the world of investing over three decades. I try each day to stand by my rules. I fail miserably at times, for I break them often, and when I do I lose money and mental capital, until such time as I return to my rules and try my very best to hold strongly to them. The losses incurred are the inevitable tithe I must make to the markets to atone for my trading sins. I accept them, and I move on, but only after vowing that "I’ll never do that again."
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Source:
The Rules of Trading
John Mauldin
Safe Haven, January 21, 2006
http://www.safehaven.com/article-4471.htm
Thanks as always for a great blog.
R U L E # 11
Keep your technical systems simple.
Is there an indicator you could recommend that draws “simple trend lines?” There are so many technical catagories from moving averages to indicators and overlays I often look at a few and get confused.
Barry,
Great Post!!!
Aren’t theit times when adding to a losing trade makes sense??
For instance, recently with the metals becoming overextended, it seemed like a good idea to buy puts on some major Gold Miners specifically NEM… It was Late JAN and I wanted to buy some MAR 60 puts because NEM was running into long term resistence around 60, and was fundamentally trading at a very high dollar amount per oz. of Gold in the ground.. So, at 60 was the first buy.. However, there was one more push higher which in early FEB moved the stock to around 62 ish.. So at this point it was a losing trade…Though it seemed even more likely to begin a decline as it was even more overextended with Gold itself looking poised for a pullback….With the stock declining over the next 6 weeks to a low of 46 ish clearly it would have been a good trade to add to that losing position…
Obviously this isn’t the only example as these kind of scenarios happen everyday…
Would you say the rule is more a warning against progressively putting more of one’s eggs in a losing basket a la Barings LTCM? And maybe it could be solved by a rule to the effect of what I’ve heard from Larry Williams the Commodity Trader who says never bet too much on one position…
BIG PICTURE IS THE ISHT..
Peace..
Barry:
This piece is so wonderful. I’ve become a recent subscriber to and fan of Mauldin’s newsletter–a reference from my Dad. Since I’m on my sabbatical from work life, and I’m trying NOT to go out of mind, I’ve immersed myself in studying the market. I’m not sure how successful I’ve been, but it keeps me off the streets! I get my e-mail fix by posting periodically here and in RM. Your Apprenticed Investor series was one of the first on-line materials that I stumbled on (in RM). I’m going to post Mauldin’s link in JJC’s blog on RM. I keep an investing notebook of things that I run across that are worthy of archiving. This is definitely going in to keep your AI, The Zen of Trading, company in that notebook (I sound like a !@$^$# groupie!). The Zurich Axioms are in there too! I find it helpful to review my notebook (and it’s always enjoyable with a glass of great wine!) periodically and chastise myself for the bonehead stuff that I do, but also applaud the stuff that I do brilliantly. I should contrive a bonehead/brilliant ratio and track it over time. Perhaps I can be a bit disengenuous by not weighting the frequency of either by the the $’s!
R U L E # 1
Never, ever, under any circumstance, should one add to a losing position … not EVER!
A conundrum!
Each and every trading system I have tested has perfomed better, when I allowed adding to the losing position compared to adding only when the trade was profitable. Actually quite a few systems turned negative the moment I added to a winning trade.
Of course it is correct that adding to a losing trade is the first step to disaster and I have lost a few arms and a leg already clinging to hope, while the right thing to do was just cover and reverse.
Let’s look at an example and maybe some here can tell me, how they would trade it: Say the contract you trade made a nice move higher and is now in a 15 tick consolidation for the last 3 hours forming a nice and friendly bullish flag. So you “expect” the trend to continue higher and are looking for a long signal.
Prices tested the lower range, bounced, suddenly jump, you get a signal from your system and take the long as it happens just 2 ticks below resistance.
The Stop goes 3 ticks below support which means a 16 tick Stop on this trade. A bit wide, but imho there is no other logical place to put the stop.
Well this trade might work, prices might overcome resistance, having consolidated for 3h and decide to go up further. And assume that eventually prices will do exactly that…but not this time. Resistance holds and it’s down again to support, for just another bounce. You, being not the dumb newbee, have placed your stop a few ticks below support and are not stopped out, even if support was broken by 2 ticks and you see yourself 15 ticks down. On 3 contracts, your regular trading size, that can be expensive, and just waiting for one hour before the breakout really happens will cost you a lot of mental energy.
So why don’t you trade it differently:
Why no Scale In,
Why not enter the initial trade with 1 contract long, add another one at the middle of the range and add the last one 1 or 2 ticks above support. The first trade has a 16 tick stop, the second one in the middle of the range a 10 tick stop and the last one a 5 tick stop.
That means the Stop on the whole trade remains always 3 ticks below support, you make sure you get a bit of the cake, if the breakout happens right away, and if not, this technique actually saves you 17 ticks if stopped compared to the first example where you enter with the full position right away.
Just this Scale-In is made into a losing position and it therefore violates Rule #1 and #2 or does it really, if the Stop remains the same.
As I said I already got my marks from violating Rule #1, so even if this Scale-In looks good, I’m always second guessing myself before I apply it. On the other hand, applying it makes for a very relaxed trading, so somehow it seems to be a technique my sub-contious mind likes. And one of the reasons is, that you no longer try to catch a top or bottom, try to pinpoint the exact entry, but work your position until being fully committed.
So if some traders reading this rather long comment could tell me how they do it, I would really appreciate it.
There is a difference between scaling in, and “Doubling down”
If you are looking to establish a position for lets say a 6 month holding period, and you are willing to allow a draw down of 6%, then deciding to scale in before hand is fine — let’s say you scale into that trade at $64, 63.40, and 62.90 over 2 weeks — thats ok.
Compare that with 1st buy at $64, adding at $52, and then again at $39 over 3 months.
In the first, you take advatage of short term volatility to obtain an advantageous entry.
In the second, you are ignoring what the market is telling you and merely throwing good money after bad.
Oh come on, GT! Dennis Gartman does not trade Ticks. I doubt Dennis has even looked at a Tick chart. You are scalping. Nothing wrong with that if you are good at it. Looking at the 1, 5, 15 or 30 minute data- depending on your rules – as a validation of the current micro trend might support allowing the position to breathe, ie, setting your stops, but averaging down even with Tick data is a no-no IMO. The biggest thing you need to worry about is not about investing on penny pullbacks but money management.
You are trading at a level where any little bit of extraneous information is going to upset your trade. That might even include the lunch break the MM might take. I’ve done what you are doing and it is possible to make money if you know what you are doing but………it is a b8tch and most people will simply trade themselves into losing money. ie, Real wealth is not created by scalping.
I’ve traded on all levels of analysis: Tick, levels of intraday, daily, weekly. I’ve never heard of anyone consistently making anything more than a quick scalp on what you are doing. That is usually pennies or dimes. That is not what Dennis is talking about.
This is a prime example of why NOT to average down.
http://finance.yahoo.com/q/ta?s=CMGI&t=my&l=off&z=l&q=l&p=&a=&c=
B, you used CMGI as example, in Janury I used JDSU as example (http://globetrader.blogspot.com/2006/01/stop-theories.html). It doesn’t matter. I’m not talking pennies and dimes either.
You might play in a league to be able to trade currency futures on a daily chart, I don’t have the resources (or the stomach) yet.
100 ticks daily Range in the euro is 1,250$, my “small” 16 tick stop on 3 contracts is already 600$. That might sound nothing to you, for me that’s still a roundtrip from Germany to Cape Town or Sydney (if I get a last minute ticket).
And you might replace my numbers with anything you like, so it reaches your threshold. The question still stands.
Let’s look at a different example: AAPL weekly
59.71 is the 50% retracement level. AAPL bounced already from 62.50 one upto 73 and is now down to 63.19.
Let’s assume you have a trading system and it tells you to go long somewhere between here and 59.71. Your Stop will be 58.00 or 55.00 what ever your system tells you.
So what do you do? Enter your full position now, scale-in or wait until it touches 59.71 or 60.00, even if it might never do so, and you will miss the retest of 86.10, because you waited for something which never happened?
I would like to add a rule if I may:
Never let a profitable trade turn into an unprofitable trade. Always set a stop at the break-even point.
Rule #7: In a Bull Market we can only be long or neutral; in a bear market we can only be bearish or neutral.
Every bull or bear market offers numerous opportunities to go the other way. Why ignore them?
When you’re yellin’ you should be sellin’. When you’re cryin’ you should be buyin’.
The worse you feel about a system’s trade, the better the trade. If you hate that trade, so do a lot of other people.
If you don’t know what your edge is, you don’t have one.
If you bet like a mouse, you get cheese.
If you lose all your chips, you can’t play.
—
a. cut losses. b. ride winners. c. keep bets small. d. follow the rules without question. e. know when to break the rules
The elements of good trading are 1) cutting losses 2) cutting losses and 3) cutting losses.
Be sensitive to the subtle differences between intuition and “into wishing.”
Volatility matters when you feel it. All the charts, ratios, and advanced math in the world mean nothing when you break down, vomit or cry due to the volatility in your portfolio. I call this the vomitility threshold.. Understanding your threshold is important, for it is at this point that you lose all confidence and throw in the towel.
Surrender to the reality that volatility exists or volatility will introduce you to the reality that surrender exists.
Ed Seykota
When in doubt, get out!
Vic Sperandeo
It takes courage to be a pig.
Stan Druckenmiller
The bigger the base, the bigger the bounce. The bigger the top, the bigger the drop.
Stan Weinstein
The worse the fill, the better the trade.
Technical analysis is like the thermometer. Fundamentalists who say they’re not going to pay attention to charts are like a doctor who says he’s not going to take the patient’s temperature.
Don’t get caught in a situation where you can lose a great deal of money for reasons you don’t understand.
Bruce Kovner
The tyro knows nothing, and everybody, including himself, knows it. But the next, or second, grade thinks he knows a great deal and makes others feel that way too. He’s the experienced sucker, who has studied – not the market itself but a few remarks about the market made by a still higher grade of suckers…It is naturally the semisucker who is always quoting the famous trading aphorisms and the various rules of the game. He knows all the don’ts that ever fell from the oracular lips of the old stagers-excepting the principal one, which is: don’t be a sucker!
Jesse Livermore
Rule No. 11 – Keep Your Technical Systems Simple.
A number of years ago, my technical systems consisted of a wide array of indicators – sentiment surveys, ARMS, McCllean Oscillator, NYSE Highs & Lows, moving averages, Bollinger Bands, VIX/ VXN etc. etc.
None of these indicators worked and worse, they induced mental bias on market direction. It took me many years to “unlearn” these indicators.
Finally I discovered the KISS system and it worked. KISS = Keep It Simple Stupid
Indicators Limit Real Intelligence.
GT,
There is no perfect answer or we’d both be rich beyond any measure. JDSU is another nasty. There are many. Remember Altavista? The Yahoo or Google of yore. At least GOOG and YHOO are very profitable. What a joke. In fact, I believe CMGI bought the Altavista assets didn’t they?
I will tell you that AAPL is under significant distribution. I realize that is simply an example. But, I see AAPL retracing to $38ish. It won’t happen over night but I believe it will happen. I will also say that so far, support has become resistance and AAPL does not have the mojo on its side to make a sustained move up right now IMO. Their fundamental picture is likely deteriorating as well. No channel checks but I’m quite confident from other macro measurements I see. If we are entering a bearish equity environment, there is absolutely no support below. This stock will crater. And $38ish is also th 61% retracement level from the bull market beginning. If we hold there depends on too many variables beyond our clairvoyance. IMO the number one rule of buying stocks is buying when the mojo is in your favor. The tone of the market has changed. Nearly every economic variable, technical variable, intermarket variable and breadth variable is telling me to not invest in anything from here unless you are adept at moving very quickly. I suspect you know a little of that.
Every trader has his own methods but I believe in doing one or two things very well and focusing on that. I think day traders that bounce from hot stock to hot stock are living on borrowed time. Frankly, I think that is gambling and it draws an impulsive personality versus analytical trading methods using quantitative, technical and macro economic analysis. That is simply my opinion. So, that means limiting my investments to three choices. I prefer scaling. Risk management is the biggest hindrance to success as a successful investor. But I try to scale on the micro level over a period of days into full leverage if the situation is giving me that feedback. That’s an approach that I believe most S&P pit traders use and most successful speculators use. Winning moves begets more leverage and more winning moves and more leverage until you are tapped with a cushion at your maximum exposure. Or, at least that is my experience.
Everyone has their own angle.
Back in the mid nineties I recall a gentleman by the name of Glen Ring who wrote commentaries on the grain markets. I was trading soybean at the time and received his newsletters. He listed 5 trading rules to abide by. Number four stated “You should never break your trading rules”, and rule number five stated “Know when to break your trading rules”…..good advice!
The markets are constantly changing, and I need to change with it, or I lose money. Even my trading rules change.
About seven years ago I was daytrading the 30 year bond. I developed a system that I thought was invincible. For two months I could not lose, making as much as 3k per day. Eventually, the market changed, but i didn’t……and gave it all back, and then some.
Now, I’m very nimble within my trading rules. I’m not a fundamentalist, i’m a technician with a simple approach.
I trade using few indicators and I trade primarily ETF’s.
links for 2006-03-14
The Big Picture: Dennis Gartman’s Rules of Trading Dennis Gartman’s Rules of Trading (tags: TradingRules)…
Thirteen Rules of Trading
Thirteen Rules of Trading
Wondering if Dennis Gartman can be a relative of mine. How do I contact him?
Wondering if Dennis Gartman can be a relative of mine. How do I contact him?
Try the phone book
whats happening with Cummins Inc.
I heard you were shorting it on Nov 22. I looked into it closer and felt you were not right (strong upwards earnings revisions).
I went long on it at $106 and it is now at $125. I am adding to it.
what is your position now?
Thanks,
Richard in Canada
mr gartman….would u rsvp to a question????