The Truth About Trading Rules

In trading we’re confronted with decisions to go with a trade or to not go with the trade, the go/no-go decision. We want the decision to be easy, hard and fast, no in between, either you risk it, or you don’t risk it. That’s because the “in between” pushes us into the unknown or unknowable, inviting discretion and uncertainty, and that might result in less than desirable outcomes, like the loss of capital.

We need answers and we need action. We need to to see if there’s edge with our set of conditions or not. Each decision is a test that helps builds a statistical story, that story will be used to build on our knowledge, to improve on, or create future trades.

But wait, should trading be strictly rules based, or is there some element of discretion needed to allow for the unknown or unexpected? Is there a place for our intuition?

Markets are incredibly complex, like the weather, maybe even more complex than the weather. And if we were perfect automatons, with computer brains, we might be able to break down every decision into a series of rules.

The reality is we can’t, so we must be able to view any given rule (if-then, go-nogo) contextually, otherwise the rule has no value. It is the lack of context that casts doubt on trading systems. Like chart patterns or indicator-driven trades, without context, there’s no way to measure edge, it’s just gambling.

There’s no doubt that a systematic approach has it’s appeal; the promise of reduced stress, sure profits, lack of personal responsibility, and immediate results—without years of building expertise, and hard work. If the rules don’t make money, you can blame the rules, but if they do work out then you can accept credit for your brilliant decision of following the rules.

Rules help us reduce risk when we lack experience and don’t understand the context. Experience allows us to use the rules in context. If we rely solely on rules we end up hindering our personal development.

Einstein once said, “Few people are capable of expressing with equanimity, opinions which differ from the prejudice of their social environment. Most people are even incapable of forming such opinions.”

If you do trade like the herd, odds are you’ll finish at the mean of the distribution curve, which suggests you’d be a loser like most people in trading. The fact is that most traders employ a rules-based approach.

Rules can be good, so long as they are used properly in the proper context with a well developed intuitive self…this only comes from experience. Let’s look at the dictionary definition of rules…from “a basic generalization that is accepted as true and that can be used as a basis for reasoning….”

Nothing is said about the rule being tested for validity, or how the rule was derived.  We are asked to accept it and move on.  It’s someone else’s version of the truth. That’s why we have Playbooks, this is your version of the truth, born of experience and intuition.

Don’t mistake rules for truth. Rules stunt innovative thinking because they appear to be right, they blind us from all the possible superior answers that may exist, that are outside our rules.

The markets, futures, stocks, are incredibly complex, leaving you to consider a vast number of variables and situations. If a strict rules based trading system were to be effective, there would need to be a rule for every situation…that’s just batshit crazy.

Instead we must use rules intelligently, within context, and everything else, all your other trading decisions, should be built upon a solid foundation or framework, where you can make well reasoned and logical decisions and judgements on constantly changing conditions and a highly developed fluid intelligence, otherwise known as the capital markets.

2 thoughts on “The Truth About Trading Rules

  1. Dustin Wattenberger says:

    Incredibly insightful article I feel demonstrates not only importance of rules, but also what rules with an experienced mentor, such as Ernie, will increase ones odds of success in achieving a higher level of proficiency in whichever endeavor.

    Appreciate the article, Ernie.


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