“Trading Rules That Work” by Jason Jankovsky

Insurer Aviva notches record sales

[Disclaimer: I work with Jason Jankovsky on trader education]

The markets come with their own basic rules. In the case of futures and foreign exchange, the most important rule is that these are zero sum markets. That is, for every winner there is a loser. The other basic rule is that order flow dictates price action. If there are more orders to buy than sell, as the orders match up with sellers the lowest selling prices get exhausted and prices climb. These two basic rules are enacted by market participants. Each of these participants has the goal to be profitable. What information about the market they are using and when they plan on trading may be in conflict with one another. Despite all the complications that ensue when participants interact, the most basic rule holds, that order flow is the ultimate source of price. If one’s trading plan does not accommodate this basic fact, you will not be profitable.

What’s not obvious is that given these most basic rules, the markets actually allow you to participate very flexibly. Most traders, however, are not profitable. It seems that traders either do not know the rules of the market or do not act upon them consistently. Jason Jankovsky does the favor of clarifying what the rules of the markets are, and explain that since traders are loss averse why they might not act on them consistently. The underlying goal of trading the markets lies in understanding market psychology. The dynamics of order flow are nothing more than trader’s expression of and reaction to this sentiment. A losing trader suffers the double indignity of eventually needing to admit they were wrong by contributing to the order flow pushing against them in order to close.

At the heart of this understanding is a plan. A trading plan is not the same as trading strategy. Trading strategy dictates favorable entry points to the market. Once you’re in, you’re subject to the probability that your plan is effective. What you do when you move to profitability or loss is determined by your plan. A good way to think about this is that our financial goal is to earn money. If you then win the lottery, would you have a plan for retaining that money? Without a plan, you will suffer the fate of many such winners who have no discipline and lose all their money. The most basic part of this plan is determining what your goals are for trading and what your temperamental style is. In sections covering topics such as determining the time frame of your trades, Jankovsky does an excellent job of showing just why there can be many solutions to establish a trading plan and how you determine whether you are matching your trading needs. In this section he also shows how different traders with different objectives may play off each other, as when a long term bullish trader can use the short term bearish trader to accept the order flow in his direction.

By maintaining discipline and a trading plan that suits your style, you will be able to exercise with confidence all the components of your plan. Rules like cutting your losses are well known to traders, but the cost of being strict in your losses can be made up by being generous with your gains by adding to your winners. If you have correctly identified that order flow is on your side, then adding to your winner will strengthen this force. Thus by definition if you are right, adding to your winner is a good idea. Jankovsky also does a good job of illustrating how to select values for somewhat arbitrary factors like timeframe or establishing a ratio for reward to risk for each trade to show how a trading plan can be coherent but based on individual experience and needs. One chapter that particularly merits reading is “All Markets are Bearish”, in which Jankovsky illustrates the logical basis for markets lies in providing hedgers with the opportunity to limit risk and get the best price possible for their asset and this necessarily entails that hedgers will ultimately exert selling pressure on the market.

The market is a machine. If you drive a car and do not understand how to use the car you can be faced with costly loss. There’s no need for your car to break down when gas stations are plentiful. If you needed to fill your tank before an important appointment, that is not the fault of the car but your time management. If you do not have enough money for gas, that is also external to the car. If you drive with the low-gas indicator on, you are constantly in fear of the car breaking down under you. By maintaining discipline and a trading plan, you ensure that you are using the car and that the car is not using you.

Khurram Naik is a derivatives broker at Infinity Futures in Chicago. He is a graduate of Carnegie-Mellon and has worked in research in cognitive science and education at Princeton, Harvard and Carnegie-Mellon University. He is also a former field director for a political campaign. He maintains a blog on literature and cognitive science. He can be reached at k.naik@infinitybrokerage.com


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