Why I break this trading rule all the time

 

Our trading rules are there to give us discipline, so we have trackable results and can properly see what works and what doesn’t.

In trading strategies that I’ve shared with people, I feel compelled to follow my rules to the letter. I know how frustrating it is when system creators tell me (always after the event) that they bent their own rules to skip losing trades, and make extra on the winners.

It feels a bit dishonest.

So, in those situations, I never fiddle with my trades (even if I’m having to gnaw off my own fingers to stop myself!)

But in my own trading, I’m forever bending my own rules.

Here’s why I do it, and why I firmly believe it’s a very good idea to break the rules … (sometimes) …

Here’s the scenario …

My trade is showing a healthy profit. I’m 80% of the way to my profit target, but it’s stalling. In fact, it’s been stuck for a while and there’s a clear area of resistance building up here, with the price struggling to move through to my target.

All well-trained traders know that now is the moment to show their steel. We need to have discipline and wait for our profit target to be reached.

If we don’t do that, we’ll be throwing our carefully planned risk-reward profiles to the lions.

Right?

Well, as with so many things … it’s just not that simple.

Let’s think about our risk-reward profile at the beginning of that trade … let’s say I had a stop distance of 200 and profit distance of 200, so my risk:reward was 1:1.

But by the time I’m 10 points away from my profit target, I’m actually risking 390 points to make that final 10 points. My profile risk:reward is now 39:1.

That’s certainly not a position I’d chose to take in the market.

As our trades move towards their profit targets, our risk-reward ratio gets worse. As they move towards our stop level, our risk-reward ratio gets better.

It can be tough to get our heads around. But, in fact, the most painful time in any trade’s life is the last few points to our profit target. Here, we have just a couple of points to gain, and might have hundreds to lose!

It can help to think a bit about what our profit target is there for.

Why do we place it?

This is a level you set at the beginning of this trade, with the knowledge you had then.

You have more knowledge of price behaviour at these levels now.

The automated target is a great tool which allows us to step away from our charts – but if you happen to be in front of your charts at a crucial moment, you don’t need to rely on this.

The profit target is your tool to help you manage your trades. It should be working for us, not making us slaves to it!

You are in charge and you can take your profits off the table at the time you see fit.

Many of us traders are so good at following the rules, that we don’t take our money off the table when we want it.

Only you can know what the profits on that trade actually mean to you; and only you know what the downside risk means to you.

But won’t taking early profits damage our performance?

Traders often bang on about the importance of trading with a good risk-reward profile.

In fact, I myself bang on about this a lot!

But – as we’ve seen, risk reward isn’t a stationary thing. It’s dynamic. So, rather than fixating on our risk-reward on a single trade, we should be worrying about our average risk-reward. And how this balances with our expectancy[link].

The only way to do this is to monitor your performance and measure these levels.

The Trader’s Bulletin trading journal will do this for you – you just put your trade details in, and it’ll calculate the RRR, success rate and expectancy.

If the market has stalled ahead of your profit target, there’s no way you can know if it’ll pull back, or whether it’ll forge on to your target. But this is unlikely to be a good bet to be taking.

Taking precautions

The problem with breaking our trading rules is that it can lead us into three dangerous territories:

1. Where we aren’t able to properly judge our trading results, because we aren’t clear what rules we’ve followed.

If you’re breaking your rules, make sure you record this in your trading journal. Without monitoring the effects of your meddling, you won’t be able to judge if your calls are better than leaving things alone. Ideally, you’ll also record what ‘would have happened’ if you hadn’t made the adjustment.

2. Emotional trading

This is where our trading decisions are made on fear or greed, rather than a rational look at the markets. Try making yourself ‘rules’ for when you’re allowed to break your rules, like … market-changing data has been released, or … consolidation pattern for more than 6 candlesticks … within 5 pips of target.

3. Where we think we know what the markets will do.

Avoiding this trap is one of the reasons that rules-based trading is so powerful. When we start thinking we know better, we get ourselves into all kinds of trouble.

Closing early should be based on a rational look at risk vs reward, not on what you think will happen.

If you’re bending the rules, make sure you know why you’re doing it, track your results carefully, and – most importantly – enjoy having those profits in your pocket, rather than open and vulnerable on your account!

 

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