As trading is an enterprise to make a profit in an atmosphere of wide-ranging probabilities, a flexible approach is a must. Therefore, the following four rules are not supposed to be taken as sort of traffic rules that need strict adhering to. They are more like a checklist of do’s and don’ts – a bit like the routine a pilot goes through before pressing the ignition button. Nevertheless, a new trader would do himself a great favour by sticking to them as the traffic rules for a while.
- CAP rule
Count All Pennies involved in the total monetary value of the instrument to be traded beforehand. Especially the hidden ones that come up gift-wrapped in the form of Leverage, because Leverage is the real villain responsible for dispatching the trading capital on the road to hell more than often.
Let’s say, for example, that a nifty contract can be traded MIS for under 20,000 and as NRML for about 50,000. Now, this 20k leverage is the 25th part of approx. Rs. 500,000, the actual value of 75 shares of Nifty. The leverage thus is 25 times. So a trader with 100,000 trading capital can easily trade 3-4 contracts in one go, right?
What gets forgotten is that one Nifty contract will move with the full weight of 500K, not with that of 20K. That is, loss and profit will be calculated in terms of full value, not in terms of leverage.
One simple rule to follow to save yourself is to make sure you never lose more than 2% of your capital on a single trade. Next time you trade Nifty, pre-determine the stop loss and make sure that ‘risk’ in rupees is not greater than 2% of your capital on a single trade.
- One time Frame, no matter what.
For the new trader, mixing the timeframes while trading is not advisable. For example, it gets very unnerving for the trader if he/she initiates the trade on hourly or 30 minutes chart and then starts following the move on the 5-minute chart. Because invariably a trader gets tempted to milk every second candle, turning the whole trade into a headache. Worse, in case of a steep move against the trend on 5 min chart, a trader tends to liquidate the position out of panic. And when the next candle again moves in favour, he/she tries to hitch on the trade again impulsively. Either way, MM goes out of the window, resulting in either a fraction of targeted profit or a huge loss.
- Pre-determine Stop-losses and Targets
You must trade a system and must know the stop loss and Target before the trade is placed.
A trader must not initiate a trade willy-nilly. He/she must have precise information of Location of the instrument to be traded with respect to its previous locations on the left-hand side of the chart so that a logical SL can be placed. The second, Location of the target, the trader needs to anticipate on the right hand, blank side of the chart. The target could be fixed or riding the trailing stop loss is at trader’s discretion, and/or depends on his timeframe. MM works fine in both conditions.
- Reduce trading costs.
This is not a rule as such but a guideline, which the new trader should try to keep in mind.
As mentioned in part 1 of MM (linked back to mm1) for the new trader, brokering cost of trading has come down sharply due to the arrival of SAS in the market. However, taxes and other transaction costs are still the same for every trade. And they do add up, consequently affecting the profits. Not to mention, hopping in and out of the market not only is determinate to the effectiveness of MM but also to the health of a trader.
MM is a process that chiefly is there to underwrite the trader’s peace of mind by tipping the balance heavily toward profits. Every penny counts, remember.
As the new trader would eventually grow into an experienced one, he/she might find that above rules have enough room for flexibility and that many black & white outlines are but blurred grays. Elastic and bendable, though, but these rules are not supposed to be broken. For it does not matter if a trader is TA genius or comes in the market with 300k or 30000K. The unforgiving, ever-watching Probability math will catch up with the unruly. Large account size may just delay the inevitability.
A bit like the law of Karma, metaphorically speaking.