The only time to break a rule is never.

This originally appeared on July 2010

It seems like there has been a steady stream of information and opinion flowing on breaking rules. Originally I had planned to talk about the pros and cons of breaking rules. I realized that would be a disservice.  The following is not negotiable.

Day trader vs professional trader.

Rules are what separate a day trader from a professional trader. The only good time to break a rule is never. Barriers are made to be broken not rules, you can have one or the other not both. If you break a rule, what power does anyone of the other rules have? Do you have a rule for breaking rules and what if you break those rules? It adds unnecessary levels of complication.

The most important rule.

Eventually I will back traders assuming there is not some horrible tax or regulation that makes it a stupid risk. A trader must create their own rules. They know themselves the best. The rule that cannot ever be broken is losing more than limit down. I will fire them that day. I do not even like to take clients who break that rule. They are destined to fail.

It is not just breaking a rule.

Breaking the limit down rule reveals everything. It reveals you cannot accept loss, can’t see the big picture, do not understand the economics of trading, and do not believe you will be better tomorrow. There is nothing wrong with losing. A loss happens, two days or a week of losses should not happen in one day.

When to break a rule.

Have you not been following? I said never in the second paragraph. Breaking a rule reveals a bigger, more costly problem. Adjusting a rule mid trade is breaking a rule. If you feel as if your rules are not serving a purpose, change them for tomorrow. Rules are not made to be broken they are made to be adjusted as new information accrues.

I am a hypocrite.

There are some trading mistakes that need to be experienced. This is not one of them. I first broke this rule with my money and then later when I was backed. I did not understand the full extent that my rule breaking had, that is why I did it again. After the second time, I was embarrassed. I had let my backer down. This forced me to grow up in an instant. It reveled who I was as a trader and it was not good. I had to change.

The next day is the risky day.

I made friends with the risk manager of the clearing firm. I have always been interested in the parts to understand the whole. I realize that he treated people debits (negative balance) differently. Some debits he would hang around watching them and others he would let go a while longer. I asked him about this and he said his experience taught him who would come back and who to shut off for their own good. With clearing firms getting killed, it has changed a little. Man the good old days.

Here comes the slippery slope.

Most traders can withstand a bad day; it is the second day that can ruin a trading career. After the first loss there is a tendency to be money blind. Who cares if I losing x amount, I loss x amount yesterday? That is an emotional thought. Remember the loss was more than they wanted to lose yesterday. As the losses on the second day your focus drifts. The focus drifts to a result and not the process. As the losses begin mount, reality sets in. Now the mind shifts from short term to long term. They start doing calendar math. Ok it is going to take me a week to make this back. Or I can make all back today. That is like saying I broke my leg, but I can still run as fast as ever. Maybe, but not likely.

How to avoid this scenario.

Easy, don’t break your limit down rule. If you feel like adjusting your limit down during the day; two things will happen. You will lose more or even worse you will make the money back. If you make the money back you will get what you perceive as a positive result. Hey rookie, that is borrowed money. Sacrificing short term gain for long term survival.

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