10 Essential Trading Principles
We summarize 10 Essential Trading Principles at TraderLion. Each letter of “TraderLion” represents a key component of our trading strategy. We call this the TraderLion Philosophy.
The TraderLion Philosophy is based on each letter of TraderLion defining trading rules & principles that Ross has successfully developed and adapted over his trading career. Here are 10 Essential Trading Principles Every Trader Needs to Know.
Trade Plan: The first thing before a position is initiated is a clear plan must be in place detailing specific entry areas, their associated sell stops, and potential profit-taking zones.
Never trade without a plan. Never enter a trade without a clear understanding of exactly where your entry and exit areas are and why they are there.
There are endless factors to consider such as an individual trader’s personal objectives and goals, their personal progress at any given point, the state of the general market, and the many fundamental and technical factors relevant to each individual stock, its sector, industry group and its overall strength relative to the rest of its industry
Risk Management: Risk Management is the golden key to consistent success in the stock market. Yes, it is even more important than stock selection.
This is why Bernard Baruch, a stock trader and close friend of Livermore said that cutting losses short is crucial. He continued that if a speculator is right half of the time, he’s hitting a good average. Even being right three or four times out of ten should yield a person a fortune if he has the sense to cut his losses quickly on the ventures when he is wrong.
Annual & Quarterly Earnings: Look for companies with annual earnings that are positive and have been increasing year over year for at least three years. Also, look for companies with at least 25% quarter over quarter growth in earnings and sales for a minimum of three quarters. These are early indicators of companies that may be ready to explode in growth.
Direction of The General Market: Three-quarters of all stocks follow the direction or trend of the general market. William O’Neil would often say that getting this part of the equation correct is more than half the ballgame. At TraderLion, we have a very specific, quantifiable technique that we use to determine the direction of the general market.
Keep in mind however that the stock market is half science and half art. Hence, this only solves the first half of the equation. The other half involves qualitative factors that largely concern the overall health and breadth of the market’s leadership. Understanding how to correctly interpret the action of the market’s leadership is crucial, especially when the general market is in a correction or consolidation mode. Healthy rotation is always the key.
Emotional & Psychological Capital: This aspect of trading is not given anywhere near the attention it needs and deserves. Understanding how to properly manage one’s emotional and psychological capital is every bit as important, if not more so than the proper management of one’s financial capital.
Understanding how they factor into your trading process is also extremely important. Keep in mind, this goes well beyond simply understanding your psychology and emotions as they pertain to trading. How you handle your personal life plays a big role as well. For example, things like your health, the health of your loved ones, all of your relationships, and personal finances are just as important as your trading and must be kept in balance as best as possible. Trading in the Zone by Mark Douglas is one of Ross’ favorite books covering this topic.
Relative Strength: Buy the strongest stocks, in the strongest groups, with the strongest fundamental story and strongest growth characteristics. Period.
There are many ways to calculate relative strength, however, Ross personally finds Relative Strength (RS) rating and RS line to be extremely effective.
In general, the RS line for a stock should be in an uptrend and at a bare minimum, confirming new highs in price as a stock moves higher. When the general market is consolidating or correcting, the RS line will start to make new highs ahead of a stock’s price. This is a sign of power and strength that is often a clue that stock is getting ready to move higher.
Liquidity: The more money you manage, the more you will learn to love liquidity. There is nothing like being able to push a button and being able to fill your entire stock order instantly with the price of the stock moving very little. There comes a point, however, where extremely large-cap stocks can become quite sluggish and slow.
There are some super large-cap liquid stocks that are extremely powerful. But according to a 40-year study performed by William O’Neil + Co., it was identified that more than 95% of the companies which had fewer than 25 million shares in their capitalization did so when they had their greatest period of earnings improvement and stock market performance. That being said, if all else is equal when given the choice between two stocks, choose the stock with the lower amount of total shares outstanding in their capitalization.
Institutional Sponsorship: Extremely large banks, mutual funds, hedge funds, trust companies, and other large financial institutions of this nature account for over 70% of the market’s total volume. Some of these companies manage hundreds of billions of dollars. So when one of their portfolio managers decides to take a position in a stock, it can take weeks to months for them to accumulate a full position.
Adding to this, there are still all of the other fund managers out there with enormous portfolios to invest that also decide to take positions in the same stock which also requires the same amount of time given the amount of cash they are managing. It is often very difficult for large institutions to hide their tracks especially when they are all trying to pile into these same stocks. It is for this reason why heavy volume accumulation or distribution is so important and is frequently used as a sign of big institutional players entering or exiting a specific stock.
Optimal Entry: Always use stock charts to enter and exit a stock at its optimal point. This is the point where risk/reward is highly skewed in your favor. Limit your buying activity to stocks that have formed constructive bases.
Don’t buy a stock as it goes through a pivot point or trend line unless it is trading well above its average volume for the day. Don’t purchase a stock more than 3% past its pivot point. Some stocks may warrant a tighter buy limit of 1-2% from their pivot depending on their personality and the market environment
New Leadership: The United States is often on the leading edge when it comes to developing new products and services that change the way we live, work and communicate. These companies are the lifeblood of a healthy bull market and the key ingredient to a sustainable uptrend.
Every bull market or uptrend is led higher by at least two or three groups of well-established leadership and every new bull cycle should be led by a fresh batch of new leaders. Very rarely does the old leadership from a prior cycle come back to life and the ones that do, typically take a very long time.