1. Never risk more than 10% of your trading capital on a single trade.
Even if your account is small, don’t risk more than 10% of your capital on a single trade. Use stop orders or get out once you start getting close to a 10% loss. For bigger accounts, you should risk even less. And don’t bet all your trading capital on a single trade even if you plan to have a tight stop loss. Things can happen overnight and the opening price could be much lower.
2. Never overtrade.
Once you enter a trade, you’re automatically down due to transaction costs. Even if you get a broker that doesn’t charge commissions, you’ll still have to buy at the ask and sell at the bid, so you pay a spread. By overtrading, you end up paying fees and cutting into your capital. Also, if you trade too often, it’s likely that you’re impatient and don’t wait for the right opportunities. Be more selective before you trade.
3. Never let a profit turn into a loss.
You can protect your profit in an open trade by increasing your stop loss. Also, some brokers allow for trailing stops where the stop price increases as the profit rises. Note, however, that stop loses do not guarantee that a trade will be executed at a set price. Stop loss simply activates a trade. For example, let’s say your stock closes at $10, and your stop loss is set at $9, but the market opens at $8. In that case, you’ll sell for $8. Some brokers, though, offer guaranteed stop loss orders, however, these cost extra money.
4. Don’t trade against the trend.
Most traders will agree with this. Trading against trends is a bad idea. The thing is to know the trend. On the long-term chart, there could be a bullish trend, while on the short-term chart for the same security there could be a bearish trend. A lot will depend on your trade horizon, but it’s usually better if short- and long-term trends align in the same direction.
5. When in doubt, get out.
If you don’t know what’s going on and/or start feeling uncomfortable, seriously consider getting out or reducing your position.
6. Trade active markets.
Active markets are more liquid, which generally means the spreads (differences between bids and asks) are smaller than with less active markets, so transaction costs are smaller, too. Also, liquid markets tend to have more depth, meaning that during normal markets there shouldn’t be large price drops or rises due to bigger orders. However, opportunities exist in less liquid markets as well. Therefore, you shouldn’t automatically cross out a trade just because it is less liquid. But, you need to be more careful.
7. Distribute your risk among different markets.
This rule apparently refers to trading more than one asset class. Different markets could be composed of stocks, commodities, and forex. Even trading wheat and gas can be considered to be trading different markets. Or trading stocks in more than one country. This rule certainly adds to diversification and should be listened to by investors.
However, when traders are recommended to follow more than one market, this advice demands that they split their attention, which may not always be good. On the other hand, by scanning more than one market, more opportunities can be found. Since W.D. Gann came out with this rule, there must be something to it, especially the diversification (risk distribution) point.
8. Trade at the market instead of placing limit orders.
If you see an opportunity, then enter it then rather than placing a limit order. If you decide to sell, then sell it at the market. This is because by placing limit orders you may miss out. These are the main points of this rule. However, placing orders at market in illiquid markets can bring a bad execution. Also, this rule doesn’t say traders shouldn’t use stop loss orders. It is also true that if the market isn’t very active and you’re not rushing to enter a trade, sometimes placing a limit order can get you in at a better price.
9. Take out some trading profits and put it into emergency fund.
This is a great advice. Even successful traders go through tough times. Therefore, you should have an emergency fund. It’s important to build an account so bigger trades can be made, but take some money out of the market and put it elsewhere. Do not risk it all.
10. Don’t scalp.
Scalping refers to taking small profits. Also, another definition of it refers to times when a trader tries to buy from a specialist on the exchange at the bid rather than at the ask. (Note that the specialists on exchanges such as NYSE will at times sell at the bid to maintain an orderly market.) Also, by using NASDAQ Level 2, some traders watch the market makers, seek to buy at lower price, and right after sell at the higher price.
Moreover, some traders seek stocks that are relatively stable and trade in a small range so they can scalp a bit of a profit on each trade. In such situations, traders will seek to buy near the bottom of the range and sell near the top, often multiple times a day.
Scalping can, indeed, bring small profits that become bigger once multiplied by many trades. But, should a more volatile market come, these small trading profits can be wiped out quickly. Still, scalping is one of the trading strategies and works for some traders.
11. Never average your losses.
Traders are tempted to buy more once asset’s price declines. Let’s say, you buy 100 shares of XYZ at $10. Then the price declines to $9.50, then $9, and all the way to $8. At that point you may be tempted to add 100 more shares at $8, thus having an average purchase price of $9 (or slightly above due to commissions). This is what averaging your losses means.
Possibly, the price will start rising and you’ll recover, but there are strong chances that you made a bet on a wrong horse and it will only compound you losses as the price continues to slide down. Averaging your losses is one of the major reasons why traders see their accounts wiped out. (Trading with high leverage is another major reason.)
12. Never close a trade because of impatience.
If the trade you made seems to be a good decision, but the price hasn’t moved up quickly, don’t close it because it appears to be boring. Patience is important.
13. Avoid taking small profits and big losses.
Many amateur traders sell too quickly once a bit of a profit shows up. On the other hand, when deep in red, they keep their losers. It should be the opposite: sell your losers and let your winners run. (There are exceptions, though. For example, if you truly have good reasons to believe the stock will recover then consider holding it. Or, if you’ve made a large profit in a short period of time, and there are signs of topping, then consider selling your position or part of it.)
14. Never cancel a stop loss after entering a trade.
This is another amateur mistake. Let’s say, you entered a trade at $9, while placing a stop loss order at $7.95. Then, the price went down and now stands at $8.05. It is only 10 cents from your stop loss, so you cancel it or lower it to $7.50 from $7.95. This is a way to compound your losses just like averaging the losses.
15. Be willing to go both long and short.
Going short involves betting on asset prices declining. When trading stocks, you can borrow shares from your broker or buy put options on them. When trading commodities, you can choose to go long or short. CFD contracts also allow for going long or short.
Remember, though, that going short is more risky than going long. For example, if you go long on a stock at $10, the worst can happen is that the company will go bankrupt. Then you lose $10 a share (given its unleveraged trade). So, you know the maximum loss. On the other hand, if you go short on a stock at $10, there is no fixed limit on how high it can go. It can go to $20, so you lose $10, or it can go to $50, so you lose $40. If you don’t feel comfortable with shorting, then don’t do it or choose put options on stocks where all you can lose is the premium paid.
16. Never buy just because a price hit a low or sell because it hit a high.
When a stock price declines to its 52-week low, it will appear on many screens. It is tempting to buy then, but there’s no guarantee it will not keep on making lower lows as it often happens. Better to wait for signs of recovery. Also, when a stock makes its 52-week high, or an all-time high, it doesn’t mean it is overpriced and should be sold. There are other factors to consider. For example, are fundamentals improving to justify further rises? Or, is technical analysis pointing to further rises or does it indicate the asset is overpriced?
17. Be careful about pyramiding. It should be done once resistance or support levels have been broken.
Pyramiding is adding more to a winning position. According to Gann, it should be done once there’s a strong confirmation of the trend such as when resistance is broken to the upside (for long trades) or support is broken to the downside (for short trades).
18. Never change your position in the market without good reason.
Stay with your trades unless there’s a good reason. For example, things can change. A positive outlook for a stock or commodity could change due to fresh fundamental data.
19. Avoid increasing your trading after long period of success.
Many traders make bigger bets after multiple winnings. Here, Gann’s advice is not to do it. It is a rather conservative rule designed to protect traders from overconfidence.
20. After the first loss, reduce trading.
If you lose, make your next bet smaller. This is a good idea. Some traders make even bigger bets hoping to quickly recover. But, this is risky and can lead to even bigger capital losses. Be patient and conservative, especially if your account has lost much of its value.
21. Don’t guess highs and lows, let the market show you.
Many traders seek to predict highs and lows. Successful trader let the market action show them where the highs and lows are. They wait for confirmation. You can’t force the market to reach a price point you imagine to be a high or low.
22. Don’t follow tips or advice, unless from someone more knowledgeable.
Tips from others can be dangerous. Do your own research. This is not to say you should never follow advice. But, if you follow advice, take it from other successful traders. Even then, take that advice carefully because what works for others may not work for you.
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W.D. Gann was a recognized stock and commodity trader as well as an educator. Here we have selected Gann’s Best 22 Trading Rules together with our commentary.
Find out here how this modern day trader turned thousands into millions.
Gann's rules provide valuable advice to traders