“Many people think that trading can be reduced to a few rules. Always do this or always do that. To me, trading isn’t about always at all; it is about each situation.” – Bill Lipschitz, Market Wizard

Most traders fit into one of these two categories:

  1. Traders that have NO RULES. They follow their gut, placing trades based on tips or a whim.
  2. Traders who seek the “Holy Grail” – a simple set of rules that can be used to guide their trading behaviour from now until forever.

The reality is that neither of these approaches are going to be particularly successful.

A trader with no rules lacks the discipline to perform effectively in a complex environment. A trader whose rules are too simplistic or inflexible is unable to adapt to changing conditions.

A third approach is necessary to balance rules and flexibility.

We have to trade based on discretionary guidelines, with the intellectual and emotional freedom to cast them aside as soon as they stop making sense.

“Mission control”

When I was in the military, we practised a leadership approach called mission command.

The concept behind mission command was to be aware of the objectives two levels higher than your current task.

For example, an infantry commander might have the goal of capturing a hill. But they would also know why they were capturing the hill, and why they were fighting the battle in the first place.

So instead of blindly capturing the hill, the infantry commander can make a new decision that serves the big picture if the hill is no longer relevant to winning the battle (or war).

In Forex trading, your rule is the metaphorical hill. It is only relevant in the context of the big picture. If circumstances change, you need to be prepared to make a new decision that better serves your objectives.

Your compelling market model

Too many traders neglect to develop a decision-making framework based on what moves currency pairs. They have a very limited understanding of the Forex market and it shows.

Instead, they use the crutch of back-tested (and often curve-fitted!) indicators as a model of the market.

In reality, there are a variety of factors that move Forex markets. It could be bank dealing ranges, central banks, macro funds, demographics, geopolitical events and much more.

Unfortunately for those looking for a shortcut, developing a market model takes time and experience. This is no different from any other career. A veteran builder is always going to have developed a more useful “model” of how to construct a house than an eager-eyed apprentice.

Principle based thinking

There are certain tenets that should be kept in mind as you trade.

You want to have a set of principles that guide your behaviour. These are not idle platitudes. They are the influencing force behind your decisions.

Think; is the decision you are making right now aligned with your principles? Or is based on a rule that is being applied in an arbitrary manner?

Trade assessment framework

When you decide what to trade, make the decision based on what is going on right now, not on what happened at some point in the past.

Does the trade make sense in the context of the current market type, the macro picture, and the schedule of upcoming news events? Is the risk appropriate for the reward? And how does it fit into your current portfolio?

For a deeper discussion of this concept, please go here.

Immutable risk management rules

Your risk management rules should be applied with a firm hand After all, they are everything that stands between yourself and ruin.

Risk management is simple to conceptualise. Don’t trade when you shouldn’t, and never trade more than you should.

It’s not about making all your trades the same size and hoping for the best. It’s about sizing up your trades in context, and making the most of every situation.

You can still allow yourself flexibility based on your conviction levels. But it does mean that you never exceed your predefined risk parameters.

Example rules

To help you tie this abstract thinking together, here is an example of how (new) rules that achieve the right balance might look contrasted with the typical rules I see from traders time and time again.


Old rule: Go short when the stochastics cross below the 70 line, the price is below the 200 period EMA and the ADX goes above 20. Go long when the stochastics cross above the 70 line, the price is above the 200 period EMA and the ADX goes above 20.

New rule: Wait for a high quality set-up and a fundamental expectation of a trend, then stalk a low risk entry with a risk/reward profile that meets my objectives.


Old rule: Exit when the 15 period EMA closes over the 30 period EMA.

New rule: Identify the market type and apply the correct exit for the market type. Protect profits by taking a portion off early and maximise big wins by letting a small portion of the trade run on a wide trailing stop.

It does not mean that you don’t use technical analysis or specific rules, it’s just that you are aware enough to apply them when the time is right. Maybe in the current market type, with the objective you have for the trade, the best thing to do will be to close the position when the 15 period EMA crosses the 30 Period EMA. But perhaps things have changed and a different approach is now a better fit.

Remember you are a rules based discretionary trader who makes good decisions based on what is in front of you. You are not a mechanical system trader who follows each trade generated by your indicators automatically.

Second level thinking

“The thing I find most interesting about investing is how paradoxical it is: how often the things that seem most obvious—on which everyone agrees—turn out not to be true.” – Howard Marks

Investing legend Howard Marks is a proponent of second level thinking. When you practice second level thinking, you move beyond the obvious conclusion to find the deeper meaning.

By definition to be successful in the markets you need to be different from the majority. The majority of Forex traders are either too focused on their rules, or don’t have rules at all – they are first level thinkers.

Second level thinking in Forex trading is thinking beyond the rule to the purpose behind the rule. It is truly noticing what is going on, and being prepared to act based on principle and purpose.

Start by noting down the reason for each rule in your trading plan. After that, when you are called to make decisions, use a mission command approach to decide if the rule is appropriate to what you are looking to achieve.

Be sure to persist though the learning curve and soon you will find your trading goes up a notch or two.

Please feel free to ask me questions.



About the Author

Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders (get free access). He is the owner of  www.fxrenew.com a provider of Forex signals from ex-bank and hedge fund traders (get a free trial). If you like Sam’s writing you can subscribe to his newsletter.