Chapter 01 · Designing a trading method
A method is a set of rules
A method is a written set of rules that decides what you may buy, how much, when you are wrong, and when you are not allowed to decide at all. This chapter is about the document, not about a favourite indicator.
If it is not written, it is a mood
‘I buy strong companies when they dip’ is a preference. It does not say what strong means, what a dip is, how many you may hold, or what you do when the dip continues. In a rising month the preference feels like a method because most buys work. In a falling month it feels like betrayal, and you invent exceptions. A method is the text you can hand to a sceptical friend. If the friend cannot apply it to a fresh chart without asking you what you meant, it is not finished.
The minimum contents
| Section | What it must answer | A weak version |
|---|---|---|
| Universe | Which instruments are even eligible? | ‘Good stocks.’ |
| Entry | What observable fact opens a position? | ‘When it looks ready.’ |
| Size | How many, in rupees of loss? | ‘As much as I can.’ |
| Exit when wrong | What observable fact closes it at a loss? | ‘If the story changes.’ |
| Exit when right | What closes it at a gain, or what would make you hold? | ‘I’ll know.’ |
| Stand-down | When are you forbidden to trade? | Nothing, which means never. |
Notice that none of these sections is an opinion about next week. A method can be fundamental, technical, or a mix, and it still has the same six slots. The slots are what keep you from using a new reason to justify an old urge.
One method, small enough to obey
Here is a complete, deliberately plain example for a person who reviews weekly and does not trade intraday. Universe: equity delivery in the Nifty 100, no more than eight holdings. Entry: the weekly close is above the 30-week average, and the latest annual report showed operating cash flow positive for three years. Size: the loss from the entry to 8% below it is at most one month of household surplus. Exit when wrong: a weekly close 8% below the entry. Exit when right: a weekly close back under the 30-week average. Stand-down: no new entries in a week when the account is already down three months of surplus, and no entries in the first fifteen minutes of any day, because this method was not built on the open.
You may dislike every rule in that paragraph. Good. Replace them with rules you will actually follow. Do not replace them with blanks. The example is there to show that a method fits on half a page. If yours needs twenty pages, you will not read it under pressure, which is the only time it earns its keep.
A method does not owe you a profit every month
The test of the text is whether you can follow it, and whether, over a sample you defined beforehand, the results are something you can live with, including the losing stretches. A method that you obey and that loses money is information about the method. A method that would have made money, had you not overridden it, is information about you. People mix these up and then ‘improve’ the text when the failure was the override. Keep an override log. If the overrides are where the money went, the text is not the suspect.
What to remember
- A friend should be able to apply the method without telephoning you.
- Universe, entry, size, wrong-exit, right-exit, and stand-down are the six slots.
- Half a page that you follow beats a manifesto that you reinterpret.
- Judge obedience and judge results as two separate reviews.
- Overrides belong in a log. They are data, not personality.