Day Trading Rules Book

Introduction

Statistics show that virtually all successful stock traders have one characteristic in common: discipline.

In stock market terms, discipline is a trader’s ability to establish, follow, and stick to a set of predetermined rules governing methods and timing of his trades, even in situations of stress and emotional turmoil.

By creating their own “Trading Rule Book” – and adhering to it – traders can establish in advance actions and behaviors that will help them navigate the ups and downs of the market with more confidence and without letting emotions get in the way. This is why traders of all kinds should follow a rulebook and why successful traders do.

For day traders, following a rulebook is even more important. They operate in the most dynamic and fast-changing environment and it is easier for them than anyone else to fall into the trap of decisions dictated by stress and emotions – such as extreme greed and extreme fear. Furthermore, day traders’ rulebooks can often also contain rules related to timing and maximum loss-per-day which are not always essential for swing traders and longer-term investors.

In this article, we’ll present you with the three key concepts that will guide you and help you create your very own Day Trading Rules Book.

Create Your Own Day Trading Rules Book Now

Whether you are a new day trader or a more experienced one, having a set of trading rules can be crucial to your success and, in most cases, it can make all the difference.

Some of the rules contained in successful traders’ rule books are dictated by pure common sense (i.e. do not risk your entire account on one single trade) while others originate from each trader’s experience, research, and learning. However, all such rules are effectively an integral part of a trader’s strategy. Without rules, there would be no strategy.

If you want to experience the difference that a good day trading rules book can make to your trading, you can start creating your own based on these 5 key concepts:

1. 1. Rules on Capital

      Set rules on the maximum amount of your own money you are able and willing to allocate to trading.

      Day trading is an activity full of potential benefits and satisfactions. But it requires capital and – we ought to remember – trading does present some risks.
      The first thing you will have to decide as a trader is how much money you will allocate to your trading account. Unless you are going to be trading for a company – either as an employee or as a prop trader – you are going to have to decide what amount of your own money you are willing to risk.
      Once you have decided what your budget will be, you must make sure you stick to it unless your financial situation changes.

   2. Rules on Risk

      The second vital concept you must consider when setting your trading rules is risk and it includes three different components: “Risk Tolerance”, “Risk Management”, and “Risk/Reward Ratio”.

      Risk Tolerance rules

      Set rules on how much of your trading capital you are going to risk on each trade.
      Your balance is bound to change continually – sometimes very rapidly  – but your risk-per-trade (RPT) should always reflect that. It is for this reason that it is advisable to set your maximum RPT in percentage terms rather than as an amount of money. For example, “I will risk no more than 2% of the account balance on each trade” is a much better rule than “I will risk no more than $100 on each trade”. A hundred dollars lost on a trade from a thousand-dollar account would seem and feel very different from the same loss on a $100K account, don’t you think?

      Not having (and not following) rules on risk tolerance could lead you to put too much money at risk and potentially lose too much on one single trade, or – on the other hand – not taking a large enough exposure and missing out on some potential higher gains.It is up to you to set your RPTat the level you think it’s best. Your trades, your rules.
      It’s a decision you will have to make based on how aggressive or prudent your trading style is and on the confidence you have in your trading strategy. Generally speaking, however, a 2% RPT seems common among stock day traders.

      Once you have decided on your RPT, set the rule, write it on your rulebook, and follow it.
      

      Risk Management rules

      Set rules on measures to put in place to ensure your RPT and RPD are not breached.
      Now that you have rules regarding your max RPT, you are going to have to set rules on how to protect it from being ever breached.
      For most traders, this often includes the use of Stop-loss and Trailing Stop-loss orders. However, you must ensure your stop-loss is always set according to your RPT.
      By being executed automatically, Stop-loss orders guarantee that the losses are contained within the RPT without any emotional interference.

      Some traders also like to include “risk-per-day” (RPD) rules in their rulebook.
      If you would also like to set a maximum loss for each trading day relative to your trading balance, you would need to ensure that all the Stop-loss orders on each of your open positions are set in such a way as not to cause a loss larger than your RPD even if breached all at the same time.
      For example, if you set rules for your RPD to be at max 6% and your RPT at 2%, it would mean you would only be allowed to open no more than 3 positions, each with a stop-loss at 2% of your account balance. Alternatively, you could choose, for example, to open 4 positions instead, each with a stop-loss at 1.5% of your balance.

      See more about risk managementon on our “Top Techniques From Top Traders on How to Manage Your Trades Effectively” podcast:
      

      Risk/Reward Ratio rules

      Set rules on the relation between the risk and the expected reward of each trade.
      Many traders choose to adopt rules that only allow them to enter trades that meet pre-set criteria based on potential risk versus potential gains.
      Traders who set a rule for the risk/reward ratio to be at 2, for example, would start by analyzing the chart of the stock they intend to trade and establish at what level they would intend to place a Take Profit Order (TP) based on their analysis. Then, once SL and TP are highlighted, the trader would check and verify that the potential profits up to the TP are at least twice as large as the potential losses caused by the SL being breached.

   3. Rules on Trading

      Your “Trading Rules” section is at the heart of your rulebook and is its most technical component. It derives from your research, back-test results, learning, and experience, and, ultimately, will be what you call a “trading strategy”.

      It too contains different components: “Opening Positions”, “Closing Positions”, and “Contingencies”.

      Rules on opening positions.

      Set rules on the necessary conditions that MUST be met to open a position.
      In simple terms, this section of your Day Trading Rules Book includes instructions on deciding what positions to open and when.

      Let’s just simplify it to the extreme for the sake of an example
      A day trader could set some of his trading rules on opening a position as follows:

      – A stock is to be bought – when and only when:
      1) Price is shown as over-sold by the Bollinger Band
      2) Price has been in a downtrend for at least the last 3 weeks
      3) And only once the third consecutive candle on the 30-minute charts has closed above the MA8.

      Rules on closing positions.

      Set rules to determine when and how a position MUST be closed.
      Once you have your rules on opening a position all setup, you will need to establish rules on closing those positions too.

      Some traders close their entire position as soon as price hits their profit target and in that case, your rules on closing position will probably be focused on deciding where the profit target should be.
      Other traders chose to close only part of their position once the take-profit is reached and then set a trailing stop order on the remaining. Either way, this should be clearly indicated by their – and your – trading rules.

      Whether you choose to use a technical indicator, the ATR, or any other means to adopt as your exit signal, remember to make it a rule and make sure you always stick to it. If your exit signal has not been triggered, do not close your position and vice-versa.

Note

These are the three key concepts you’ll need to consider while building your Day Trading Rules Book and, while it will already make a difference in your trading success as it is, it is not the end of it.

In addition to these three concepts, most traders adopt other trading rules targeted and contingent on their own trading style. Timing, edging, scaling in and out of trades, and news trading, for example, can all be aspects that you might want to consider to create further rules.

Well, I hope this post can help you create your own Trading Rule Book for 2024 but remember, it’s not enough to just set rules, you’re going to have to stick to them too!

Have a great emotions-free trading day!

If you liked this post make sure to share it!