Are you wondering why I’m comfortable sharing my trading rules with you?
Don’t other traders keep their trading strategy rules a carefully-guarded secret?
Well firstly, my rules change and adapt over time along with the market. So this is just what my current ‘set’ looks like. They will eventually stop working as market conditions change.
Therefore, you’ll need to understand the principles behind these rules, which you’ll learn in this course.
Secondly, in my experience, traders need to develop their own personal set of rules.
I could teach 100 traders these rules, and only one would follow them exactly without making changes (to fit the opportunities they see, their time zone, lifestyle, and unique psychology).
A ‘rules-based’ approach to day trading USD/JPY
For the past three years (since the COVID lockdown), I have day-traded USD/JPY using the methods in this course.
Here’s an example of a trade using this approach, buying USD/JPY on the breakout after a period of consolidation.
During this time, I generated a 3% a month return with 75% winning months.
Below are the (slightly simplified) rules I used to achieve this result.
Objectives
Building any trading strategy starts with objectives. You set the objectives and then build the trading system to achieve those objectives.
These objectives include your targeted return (how much you want to make), your maximum drawdown (how much you are willing to lose), and more.
Here are the objectives I use for this strategy:
| Objectives | |
|---|---|
Return targets | 3% a month |
Maximum drawdown target | 3% a month |
Number of trades | 20 a month |
Risk/reward target | One to three (1:3) |
Win rate target | 50% |
In this course, you will learn how to set objectives for your own trading system.
Position sizing
Next, I determine my position size. This is ‘how much’ I trade when I enter a position. In this course, I use a concept from Dr Van Tharp called risk (R) multiples to help me to determine my position size.
To do this, I work out how much I am willing to risk on a trade if it goes against me. This can be a percentage of your account, or a dollar amount (or both).
Here are my position-sizing rules.
| Position size | |
|---|---|
Position size rule #1 | I will risk 0.5% of my account per trade (this is my 1R) |
Position size rule #2 | 1R equals a position size of $1,000,000 USD/JPY |
Note: The position size changes for each trade, based on the placement of your stop-loss, and your trading account balance. But I have included it here for the sake of completeness.
Next, I need to determine my rules for entering a trade. This comes in two parts.
Set-ups
The first part is market analysis or research to define the trading opportunity I see in the market and the conditions I want to have in place before I enter.
In this example, I saw an opportunity to trade breakouts from periods of low volatility that expand into strong trends on USD/JPY.
Here are my rules designed to identify these opportunities. I’m using a 15-minute chart.
I define the rules based on market analysis and research ‘set-ups,’ as they are the conditions I need to ‘set up’ my entry.
| Set-up rules | |
|---|---|
Set-up rule #1 | Buy above the 200 period-EMA, sell below the 200-period EMA |
Set-up rule #2 | The Market Type indicator must be sideways |
Set-up rule #3 | Bollinger Band Relative Width below 80 |
Set-up rule #4 | Trade only between 7pm to 11pm (SGT) |
Set-up rule #5 | Don’t trade after news events |
Set-up rule #6 | Don’t trade if USD/JPY has already moved 0.6% in one direction that day |
Here is what the set-ups look like on the chart.
These rules act like filters to ensure I have conditions that provide me with an edge when I trade.
For day trading, these rules are kept uncomplicated due to the fast-moving nature of short-term markets.
Entries
Once I have the above conditions, I begin to stalk an entry point. Entries need to be simple, as I need to act fast.
Remember, I have already defined my trade size well in advance, so I am now just clicking the button to enter the trade.
Here are my entry rules:
| Entry rules | |
|---|---|
Entry rule #1 | Enter at the close of the candle on the breakout of the Bollinger Bands |
Here is what the entries look like on the chart.
I enter on the close of the candle after the price breaks out of the Bollinger Bands.
Stop-loss
Next, I need to place my stop-loss order. This protects me if the trade goes against me.
It is also one part of the equation of determining the risk/reward of each trade (along with the exit rules.)
| Stop-loss rules | |
|---|---|
Stop rule #1 | Place a stop-loss 10-pips from my entry |
Stop rule #2 | Move the stop-loss to breakeven once the first profit target is hit |
Here is what the stop-loss looks like on the chart.
I keep a tight stop-loss so that when I lose, I don’t lose much compared to what I could make on the trade.
During this course, you will learn more about how losing more often (having a lower win rate) can make you more profitable in the long run.
To summarise: you want very small losses when you lose, and very big winners when you win. This can sometimes mean you take several small losses in a row.
Exits
The final piece of the puzzle is when to exit the trade.
- To adapt to changes in market conditions
- To make the trade as profitable as possible
This requires having a few tools in my toolbox, or what I call a ‘complex exit strategy.’
This is because you can’t control the market conditions after you place the trade. You can only respond to them.
This is different from entries, where you can wait for the conditions you want to see before entering.
I break my trade into three equal parts.
I exit each part based on the following six rules.
| Exit rules | |
|---|---|
Exit rule #1 | Place a profit target at 30-pips on 1/3 of my trade |
Exit rule #2 | Place a profit target at 50-pips on 1/3 of my trade |
Exit rule #3 | Place a profit target at 80-pips on 1/3 of my trade |
Exit rule #4 | Exit if conditions become overbought or oversold and start to reverse |
Exit rule #5 | Place a trailing stop on the Supertrend indicator |
Exit rule #6 | Exit any open trades at the end of the day |
Here is what the exits look like on the chart.
Note: I use our Market Type indicator to measure if conditions are overbought or oversold, and I will wait for a reversal sign before taking a profit.
(You can get this indicator for TradingView here.)
Now you know what a ‘rules-based’ trading system looks like.
By completing this course, you will have your own set of rules for your trading.
This won’t be easy.
Trading is not a get-rich-quick scheme. It takes live trading to develop the nuanced understanding of the market needed to succeed.
This course will lay the groundwork, but it’s only the start (or the middle) of your trading journey.
I’ll see you in the first lesson, where I’ll talk about what I learned from studying for my Master’s Thesis, where I studied the habits of the world’s greatest traders.
Lesson #1 What it Takes to Win at Trading
Till next time,
Sources
Marketmates uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial guidelines to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
- Dr. Van K. Tharp – Trade Your Way to Financial Freedom. https://www.amazon.com/Trade-Your-Way-Financial-Freedom/
- Jack D. Schwager – Market Wizards: Interviews with Top Traders https://www.amazon.com/Market-Wizards-Interviews
