The full title of the book is “Trading Rules that Work: The 28 Essential Lessons Every Trader Must Master” by Jason Alan Jankovsky.
It is a difficult task to write a trading book that caters to traders in general because there are so many different ways that people have found to trade profitably. I would say that this book is more catered towards the traditional type of trader (e.g. trade with the trend, look at multiple time frames, let winners run and cut losers short), rather than other types of traders (e.g. HFT, statistical arbitrage, counter-trend specialists, specialists in pricing the bid-ask spread, etc.).
This book groups the 28 trading rules into 4 parts: (i) Getting in the game, (ii) Cutting losses, (iii) Letting profits run, and (iv) Trader maxims. The book is a relatively thin volume, and in some places, I felt that it could have gone into greater depth to expound on the rule. The rules given are not trading rules for a system per se, but more as general guidance rules for trading.
Some of the key takeaways that I have include:
- Looking for the loser
- Thinking about the levels at which players looking at different timeframes will participate
- Watching open interest as a clue to identify the end of trends.
Two points in the book that I did not really get are:
- Jankovsky wrote that markets by default have a downward bias because hedgers (i.e. those that produce) would be selling, and that will effectively overwhelm the small speculators. However wouldn’t there be similarly large buying hedgers that would be buying the commodity so that there is balance, rather than a one-sided market?
- Jankovsky explains that most traders operate on a timeframe of 72 hours or less, so most traders would have entered the market over a 72-hour time period. Then he highlighted that 50% retracements should be taken over a period of 72 daily bars. I did not get how the 72-hour period transitioned to a 72-day period.
All in all, the book touches on many of the important rules for trading, and is good for a quick read.
Identify Where is the Order Flow
- Your entire analysis must be to identify “where is the order flow?”.
- Your trade plan must answer the questions of “how do you know you are in wrong side of the order flow, and how to get out when you know that you are wrong”.
- About 80% – 90% of price action is simply the losers liquidating their losing trades.
Use Technical Analysis to Look for the Loser and His/Her Quitting Point
- The simplest way to effectively use technical analysis is to look at it from the loser’s point of view.
- Your best analysis is done by asking the question, “Where is the loser?” You need to anticipate potential net order flow when it is about time for the loser to quit.
- All of your technical analysis is best used to help uncover where the loser is and what he is most likely thinking in order to continually keep placing himself at risk.
- You really don’t need to answer the question, “Which price is coming next?” You need to answer the question “Where and when will the loser quit?”
Have a Sound Trading Plan
- Having a sound trading plan separates the net winner from the net loser. The trade plan should include
- How regularly will you re-evaluate your trading system?
- How many markets will you play at a time?
- What happens what you have a string of losses? e.g. take a break, lower size
- What is your trading goal for the year/quarter/month?
- How will you track your performance and what is your improvement target?
Think About the Psychology of Players At Any Point in Time
- Think about the psychology of the long and short players at any point in time, and ask yourself which is the most likely action they will take.
Trade in the Time Frame Most Compatible With You
- Trade in the time frame that is most compatible with your ‘natural time frame’, i.e. the amount of time required for you personally to reach a conclusion and then act on it.
Be Ready to Add to Your Winners When the Net Order Flow is Apparent
- You need to maximize the full potential of your winning trades.
- This helps during periods where a system is not doing well.
Watch Volume and Open Interest
- When there is a rise in volume on days when the market is moving in the intended direction, that is a good sign. When there is a rise in open interest, even better.
- If volume increases and open interest remains the same, it means that the same group of losers kept coming back to the market and cutting their losses.
- If volume increases and open interest increases, new winners and new losers are squaring off, and but the force in the intended direction is still greater.
- The market will continue in that direction until everybody quits, which is shown by a drop in open interest. That usually signals you are near a turn.
Use Multiple Time Frames
- Look at what traders in other time frames are seeing. If more than one time frame is thinking along the same lines, you have more confirmation that potential net order flow may develop along that direction. Conversely if several time frames appear to offer conflicting price pattern relationships, that trade has a lower potential.
- Traders from higher time frames are gradually drawn in as clock time passes. If traders playing the larger time frames are gradually drawn into trading the same side as you, that market will have a lot farther to go in your original direction.
- Always compare multiple time frames to your trade hypothesis. If traders in the next few higher time frames are interested in the same side as you are, you need to let them have the clock time they need to execute.
Know Your Profit Objective
- The first objective is the area where you feel the market will have a pause, and a larger time frame trader must make a decision (e.g. at high / low of day).
- The second objective is usually a 3:1 reward:risk ratio.
Technical Analysis Is Not Predictive, Use It to Assess Order Flow
- For the most part, all technical analysis or mathematical models developed for systemized use have a success rate between 38% and 52% winning trades based on the predictive hypothesis used by the developer [my note: I read an article which wrote that traders at SAC capital have a win rate of ~50-55%, with the top trader at ~62%].
- The important bedrock understanding that you as a trader need to have about technical analysis is that it is not predictive. It cannot predict price action because everyone has the same technical analysis available to them, and it is mathematically impossible for everybody to be right in the first place.
- Technical analysis should be used to uncover historical information, which is used to deduce inequalities in the net order flow.
The Most Money Is Made Shorting
- Trading in a downtrend is the most secure and profitable way to increase your account balance. Contrary to uptrends, bear markets need very little to keep them going; hence the old trader’s phrase, “A bull has to eat every day but a bear only needs to eat once in a while”
- The highest performers have always been short-sellers working in downtrends or the sell-side of ranges.
- An uptrend is the most difficult to trade successfully. Most professional traders view bull markets as a short term situation to short sell. If you intend to be long a market for a developing uptrend, you must be prepared to consider a shorter-term trade.
How to Trade Ranges
- An established range will withstand at least 3 or 4 attempts to seek a new higher or lower equilibrium. Once a range is established, there is a very low risk of breakout in either direction for usually 2 solid attempts from the buy side or the sell side of the range.
- Buy the lower 5% of the established range and sell the upper 5% of the established range.
Play at Price Levels of Interest to Hedgers
- Know when hedgers are active, because they will execute to avoid risk only at price areas that are actually important. You want to either buy or sell with the hedger or against the hedger, you do not want to buy and sell from other speculators.
- When hedgers from the other side are active, the limits to the playing field are established and liquidating some or all of the position is advisable.
All [Commodities] Markets are Inherently Bearish
- There are hedgers, and there are speculators.
- The hedger always sells the market, he doesn’t have to buy the market.
- The hedger’s selling pressure is never met with a corresponding buy order, the market has more net sell orders as long as the hedger participates.
- The speculator who buys and sells is the “net force” on the market.
- Scale out when hedgers from the other side become active.
- In most cases, the higher the price goes in any market, the more the hedgers will exploit that from the sell side. A selling hedger needs a bull market to sell into; he only needs one bull market every few years to hedge several years out.
- The buying hedger will liquidate his buy hedge at any time because it is in his best interests for the price to decline.
Money Management Rules
- Don’t risk more than 1.5% of your capital on any one trade
- Roll protective stops to the break-even point
- Purchase options to lock profits and free up equity
- Add to the winner on pullbacks
- Scale out when hedgers from the other side become active
Withdraw Equity Regularly
- Most long-term successful traders don’t load up. Most successful traders are very careful about increasing their base trading size. Instead, when their account balances reaches a certain number, they simply withdraw their gains.
- Most do it as a measure of self-protection; they worked very hard for those gains and don’t want to risk giving it back.
Buy / Sell 50% Retracements
- 50% retracements are important because they balance the net inequality between the competing net order flows. At the 50% number, exactly half the bulls have a profit and half the bears have a profit.
- If the 50% retracement took place over a period of 72 hours (3 days), it means that most traders have already executed, because most market participants operate on a time frame of 72 hours or less. Everybody has gotten in and out at least once within a 72-hour period. The net result is usually a resumption of the previous trend.
- Look for the significant high or low price that is around 72 bars back in time (usually using daily). Enter at 50% retracement of that.
Recommended Readings (picked a few)
- The Inner Game of Trading (Abell, Koppell)
- The Disciplined Trader (Douglas)
- Trading in the Zone (Douglas)
- The Tao of Trading (Koppel)
- Viewpoints of a Commodity trader (Longstreet)
- Volume and Open Interest (Shaleen)
- Dancing with Lions (X, Trader)
- Methods of a Wall Street Master (Sperandeo)