It is hard to fully explain the importance of trading discipline in the stock markets. Whether you are a short term trader or a long term investor, discipline forms the cornerstone of your trading and investment strategy. What do we understand by discipline? It is the ability to stick to a set of rules and a broad trading plan, irrespective of the circumstances. So, what are these trading rules in stock market and what do we understand by trading discipline rules. Let us look at 10 golden rules of investing in stock markets; both as a trader and a long term investor in stocks.
1. Start off with a trading plan and stick to it
This is the first step in discipline. Your trading plan basically outlines and documents what will be your return expectations, how you will approach the market at different levels of valuations, maximum amount you will risk per trade, the maximum loss of capital you will endure etc. The idea here is to adhere to this trading plan so that the discipline broadly defines the risk and returns of your trading and investment portfolio.
2. Never invest or trade without adequate homework
This discipline applies to both trading and to investing. One can understand homework in investments. You need to understand the macro economy, you need to understand the sector in which the company operates and you need to understand the specifics about the company. Interestingly, you need to do adequate homework in trading too. You need to study the news flows, you need to study the technical charts, and you need to understand supports and resistances and you need to figure out if it is a weak or strong market. Without the discipline of adequate homework, you cannot go too far in trading or investing.
3. Let your investment be part of your larger financial plan
This is more so in case you are investing for the long term. Ensure that your equity portfolio is in tune with your larger equity plan and the equity allocation prescribed in them. Also ensure that your investment strategy is designed in such a way that your overall equity component keeps getting adjusted with your risk appetite.
4. When in doubt, step back
This is, probably, one piece of discipline that is very hard to implement. Trading and investing has to be backed by conviction. Unless that is taken care of, you are more likely to be indulging in mindless speculation. Whenever you find the market conditions too volatile or the undertone too hard to fathom, just step back. Even Jesse Livermore pointed out that there is more money made in trading by staying out of the markets than jumping in.
5. Focus on the pennies, the pounds will take care of themselves
The small details matter a lot in trading and investing. Avoid overtrading to recover your losses. Always keep an eye on your trading costs as it can escalate to quite a level over a period of time. Eventually, it these small things that require discipline and if you take care of these small items then the bigger issues take care of itself.
6. Learn to honour your stop losses
This is more applicable to a trader but investors also need to keep this in mind. The whole idea of a stop loss is that it represents a point where you decide to close out your trade and take a fresh view later. The loss is the cost you bear to stay in the trading business for the long run. If you do not maintain this stop loss discipline in trading, then you are unlikely to be able to survive as a trader for too long.
7. Learn to honour your profit targets
Honouring stop losses is one side of the story, equally important is to honour your profit targets. Remember, profit is what you book; all else is book profits. This discipline can be slightly different in case of an investor. You have the luxury of either hedging your long positions with derivatives or even convert stop losses into rolling stop losses. When you honour your profit targets, you can constantly churn your money, stay liquid in the market and have the resources to latch on to trading opportunities as they come by.
8. Cut your coat according to your cloth
This is one of the fundamental disciplines called prudence. The risk you take must be proportionate to the loss you are willing to take upon yourself. Ensure that your risk appetite is in tune with your loss bearing capacity. You do not want to wipe out 50% of your capital in one trade. That is not smart trading at all! Make it a point to always cut your coat according to your cloth and manage your risks according to what you can afford to lose.
9. Read more, think more, chat less, watch less television
One of the best indicators of how disciplined you are, is judged by the way you utilize your spare time. If you want to really instil discipline in yourself then avoid spending too much time on chat forums. That typically shows lack of focus. Don’t waste too much time watching television or listening to market opinion expressed on TV. They really do not amount to anything and it is not without reason that it is called the Idiot Box. Use your time reading up on emerging trends, scanning leading websites for articles and blogs. Try to spend a lot of time crystallizing your trading ideas and reviewing the pros and cons of your performance. That is the best way to instil mental discipline.
10. Discipline must reflect in every walk of life..
It is said that discipline is not a process but a habit. It is hard to be disciplined in trading if you are not disciplined in other walks. The way you organize your paperwork, the amount of clutter on your table, the way you take care of your health, the way you keep habits in check; all these point towards discipline as a way of life. If you want to be disciplined in trading then you need to bring discipline into every aspect of your daily routine.