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How To Trade Successfully (Part 2)

Now let's see what happens on the next trade. You enter a trade, and after just a few days of watching it go your way, you sell out, only to stare in amazement as it continues to go in the direction you had expected, racking up paper gains of several hundred percent. You ask a more experienced trader what your error was, and he advises you sagely while peering over his glasses, 'Remember this forever: Cut losses short; let profits run.' So you reach for your list of trading rules and write this maxim, which means only, of course, 'I should NOT have sold when I had a small profit.'

So trading rules #2 and #14 are in direct conflict. Is this an isolated incident? What about rule #3, which reads, 'Stay cool; never let emotions rule your trading,' and #8, which reads, 'If a trade is obviously going against you, get out of the way before it turns into a disaster.' Stripped of their fancy attire, #3 says, 'Don't panic during trading,' and #8 says, 'Go ahead and panic!' Such formulations are, in the final analysis, utterly useless.

What I finally desired to create was a description not of each of the trees, but of the forest. After several years of trading, I came up with -- guess what -- another list! But this is not a list of 'trading rules'; it's a list of requirements for successful trading. Most worthwhile truths are simple, and this list contains only five items. (In fact, the last two are actually subsets of the first two.) Whether this list is true or complete is arguable, but in forcing myself to express my conclusions, it has helped me understand the true dimensions of the problem, and thus provided a better way of solving it. Like most rewards life offers, market profits are not as easy to come by as the novice believes. Making money in the market requires a good deal of education, like any craft or business. If you've got the time, the drive, and the right psychological makeup, you can enter that elite realm of the truly professional, or at least successful, trader or investor. Here's what you need:

1) A method. I mean an objectively definable method. One that is thought out in its entirety to the extent that if someone asks you how you make your decisions, you can explain it to him, and if he asks you again in six months, he will receive the same answer. This is not to say that a method cannot be altered or improved; it must, however, be developed as a totality before it is implemented. A prerequisite for obtaining a method is acceptance of the fact that perfection is not achievable. People who demand it are wasting their time searching for the Holy Grail, and they will never get beyond this first step of obtaining a method.

I chose to use, for my decision making, an approach which was explained in our book, Elliott Wave Principle - Key To Market Behavior. I think the Wave Principle is the best way to understand the framework of a market and where prices are within that framework. There are a hundred other methods, which will work if successful trading is your only goal. As I have often said, a simple 10-day moving average of the daily advance-decline net, probably the first indicator a stock market technician learns, can be used as a trading tool, if objectively defined rules are created for its use. The bad news is that as difficult and time consuming as this first major requirement can be, it is the easiest one to fulfill.

Robert Prechter is the founder and CEO of
Elliott Wave International
, a global trading advisor. Mr. Prechter has authored several books on Elliott Wave and the new science of socioeconomics.