Trading Rule #2:

Your trading system must be built on quantifiable facts not opinions.

Very few new traders take the step from trading opinions and predictions to trading actual price action and signals. Amateurs take trades based on feelings while professionals have fact based reasons. A signal is a quantifiable reason to take a trade based on its price action, a technical indicator, a trend line, or a price pattern. Even trading the psychology of the market requires price to arrive at a level that aligns with the fear or greed of the masses that the trader is trying to profit from. “Buying a dip” is not a signal while buying a pull back in the S & P 500 Index to the 50 day simple moving average or prices reaching the 30 RSI on a daily chart inside an uptrend over the 200 day simple moving average is a signal based on quantifiable facts. Also any signal should be researched on historical charts or back tested to see the historical profitability of trading off the signal. Historical price patterns tend to repeat over and over and create tradable signals for capturing trends and reversals.

Other types of signals are more discretionary and can rely on pure price action and buying breakouts of price ranges, trend lines, and chart patterns. Trading breakouts of ranges, lines, and patterns are quantifiable but leave a lot of discretion with the trader and are also are difficult to back test.  Traders have to stay consistent with how they draw trend lines and identify chart patterns so they do not start seeing what they want to see or read price action is a biased manner to fit their preconceived beliefs. This type of breakout trading is simply trying to capture the beginning of a new trend as price leaves the previous trading range and signals a potential change in trend. Having a reason for taking a trade is still far better than simply trading off a hunch, a belief, a feeling, or a prediction. I personally prefer using more quantified trading signals like price support and resistance levels, moving averages, MACD, and RSI to take out as much of my opinions as possible from my trading decisions.

In trading it is always important to have a specific reason for entering a trade that will put the odds in your favor for potential winning percentage, risk/reward ratio, and a great chance to be on the right side of the trend in your time frame. Trading without quantifiable signals puts your trades at no better than random and on the side of the majority that are trading their internal beliefs instead of the external realities of the price action of the market. You want to replace as much of your discretionary trading as possible with quantifiable signals that give you a specific reason for entering a trade. Beliefs and predictions about what the market will do, should do, or can’t possible do is not a trading system, quantified entries and exits that express a winning trading system is the path to profitability.

This is rule #2 from my book Trading Habits.

The Power of Trading Habits