Why rules in trading are meant to be obeyed...
Today's counter culture states that "Rules are meant to be broken." In trading, this couldn't be farther from the truth, especially as it relates to money management.
In some short term swing trading systems where the average time in trade ranges from one to five days, such as in OptionPlayers.com, strict stop loss and profit rules are maintained.
When a directional trade in entered, the profit target is 20%; the target loss is -10%. An experienced trader will tell you that the hardest thing to do is to take a loss. The second hardest thing to do is to take a planned profit. It is tough to overcome the emotion of being in a trade and thinking, "just 1 cent more" or "this is crazy, it's going to turn around." Guess what - Murphy is hiding behind every corner.
So what are the consequences of not obeying the rules?
This week at 15:15 on Wednesday, I (along with a few students) bought AAPL Nov10 $160 calls for $1.72 each based on a presumed bounce on an intraday ascending support line combined with the theory that AAPL would rally into close.
As the above TC2000 chart shows, AAPL intially behaved in the first 15 minutes, but broke the trend line between 15:30 and 15:45. I knew at that point I was wrongWhen the bid of my AAPL options hit $1.55, I immediately sold them at market and was filled at $1.54 for an 10.46% loss.
Losing money is painful. Period. But overcoming a a 10% loss means that I only need to gain 11% on the remaining capital to recover the loss.
One student held. She was happy because her AAPL options were down only 7%.
We all know what happened on Thursday - AAPL gapped down and closed red. The same option that I had sold for $1.54 was now worth $0.50 at the end of the day, a loss of 70.9%. To make up a 70.9% loss, you need to increase the remaining capital by 343.6%.
(Courtesy of TomsOptionTools)
Making mistakes is painful when we know we disobeyed the rules. But learn from them - set rules for yourself. Obey them! Live another day.