Ed Seykota is one of the best traders of our time, if not the best.
Although he doesn’t trade currencies or use price action per se, the lessons we can learn from him are just as valuable.
I find this to be true of all successful traders. The market doesn’t make the trader. After all, it’s just the playing field.
What actually allows someone like Ed Seykota to trade on such a scale, and with such tremendous success, are a defined set of technical and mental rules.
I’m about to share those rules with you.
If you are still struggling to achieve consistent profits, this post was written for you. Even if you have found success as a trader, today’s lessons will serve as a refresher.
Read on to learn the five rules Ed Seykota has used to achieve massive success over the years.
- Who is Ed Seykota?
- Rule #1: Cut Losses
- Rule #2: Ride Winners
- Rule #3: Keep Bets Small
- Rule #4: Follow the Rules Without Question
- Rule #5: Know When to Break the Rules
- Final Words
- Resources and Additional Reading
Who is Ed Seykota?
Ed Seykota has always kept a low profile. If it weren’t for Jack Schwager’s Market Wizards books, chances are I wouldn’t be writing this post.
He began his trading career in the 1970s, when he was hired by a major brokerage firm. It was there that Ed developed one of the first commercialized trading systems for managing money in the Futures market.
After a few disagreements regarding the way management was interfering with his system, Seykota decided to go out on his own.
So what was his trading performance like in the 1970s and 80s?
As of mid-1988, one of his client accounts—which was started with $5,000 in 1972—was up over 250,000 percent on a cash-on-cash basis.
If we normalize for withdrawals, the account would have been up several million percent.
Those are truly staggering results. Keep in mind that those figures spanned more than a decade of trading, so this was not a fluke or some lucky win streak.
What follows is a rather detailed explanation of Seykota’s five most cherished trading rules.
It includes some of my own interpretations and insights, as well as quotes from the man himself.
Rule #1: Cut Losses
I’m sure you have heard the old adage about cutting losses and letting winners run. It’s been uttered countless times over the years.
But you know what? It’s true.
There’s a reason why Ed Seykota’s first trading rule is to cut losses. It’s because protecting your capital is your primary job as a trader. Making money comes second.
I will add one thing to Ed’s rule, however. Instead of simply saying ‘cut losses’, let’s change it to ‘cut losses early’.
Think about it. Without money, you can’t trade. So if you fail to cut losses early you’ll eventually blow your account.
You do that and it’s game over.
Here’s some advice from Ed Seykota on losing:
Embrace trading losses.
Simple yet so true. To get ahead in this business, you have to learn to lose like a winner.
That means accepting a loss the moment the market invalidates your trade idea.
If you make the mistake of hoping for the market to turn around in your favor, you’ve already lost.
The best way to embrace trading losses is to have a plan. Combine that with small bets and you’ll be lightyears ahead of other Forex traders.
If you can’t take a small loss, sooner or later you will take the mother of all losses.
Anyone who has traded for more than a month can relate to the quote above.
We all have at least one story that involves taking a significant loss. And if you have been trading for years, you likely have several stories to tell. I certainly do.
The takeaway from Ed Seykota’s advice is straightforward. Either learn to handle small losses or risk blowing your entire account. If you can’t do the former, the latter is inevitable.
Losing a position is aggravating, whereas losing your nerve is devastating.
This quote goes hand-in-hand with the last one.
What Ed is saying is that it’s okay to take a loss. Although they’re never pleasant, losses are part of the business.
What is never okay is losing your nerve.
The best way to ensure you never lose your nerve is to cut losses early. It’s one of the simplest ways to maintain your discipline and avoid emotional decision-making.
Rule #2: Ride Winners
Want to know how to become consistently profitable?
It’s actually quite simple.
Cut losses and ride winners. That’s according to Ed Seykota and just about every profitable trader I have ever talked to or studied.
There’s a reason why I recommend a favorable risk to reward ratio. It’s because your winners have to pay for your losers.
You see, trading isn’t about having a win rate of 70% or 80%. It comes down to how much you make when you’re right and how much you lose when you’re wrong.
That’s the only thing that matters. Everything else is trivial.
Allow me to expand on this idea for a moment.
Each one of the names listed below is a multi-millionaire (or billionaire) trader or investor.
- Bill Lipschutz
- Paul Tudor Jones
- Ray Dalio
- Warren Buffet
- Carl Icahn
I’m sure you have heard these names at least once in your lifetime. Most likely they have come up over and over again in your search for consistent profits.
No two market players above are the same. They each have a unique style and differing opinions about the markets, technicals vs. fundamentals, and even risk management.
However, they all share one incredibly important rule. Can you guess what it is?
They all require an asymmetrical risk to reward ratio. That’s a fancy way of saying that the rewards must vastly outweigh the risks.
The only way to achieve asymmetrical returns is to ride your winners.
It’s great to know that you have to ride your winning trades. But how exactly can you do that?
Knowing you should do something is one thing. Knowing how and having the discipline to see it through is another matter entirely.
Here are a few of my favorite ways to let profits run:
1. Use an end-of-day approach
There’s more than one reason why I favor the daily time frame. We often talk about the greater reliability of daily signals, but there is another equally important reason.
Market trends are vastly easier to identify on the daily chart. They offer a “big picture” view that isn’t available on a 5-minute or even 30-minute chart.
From the daily, I can see where the market has been this year. Using that information, I can quickly determine where the market is likely to go as long as there’s a discernible pattern or trend.
Another advantage to using the daily time frame is that it forces you to stay patient.
If you only need to check your charts once per day, you’re far less likely to exit a trade prematurely. This gives you the ability to ride a trend even if there is some intraday volatility. As Seykota says,
Having a quote machine is like having a slot machine on your desk—you end up feeding it all day long. I get my price data after the close each day.
Yes, the daily chart will be slower than a 5-minute chart. Much slower in fact. But that’s a good thing if you’re interested in letting your winners run.
2. Identify what’s really happening
It’s far too easy to get caught up in trading strategies, risk management and other various aspects of trading.
However, the best traders see the market in a different light.
Instead of just looking for buy and sell signals, these traders understand that there’s something much bigger at play.
Every market tells a story. Look at a EURUSD chart, there’s a story behind the price action. The same goes for the GBPUSD, AUDUSD or any other currency pair.
Most traders are so focused on finding buy and sell signals that they ignore the story altogether. What they don’t realize is that the story, which is formed by a market’s highs and lows, is the key to letting profits run.
Once you’re able to see what’s really happening via the trends and patterns on your chart, it’s simply a matter of positioning.
In order to ride your winning trades, you need to position yourself with the momentum. That’s where the smart money is and it’s where the largest profits are made.
3. Walk away
Apart from the technical factors we just discussed, your ability to walk away from your trading computer is the single most important piece of the puzzle.
It’s no secret that most retail traders hover over their open position.
We also know that most retail traders (over 90%, according to most sources), fail to earn consistent profits.
Is that a coincidence? I doubt it.
In order to ride your winning trades, you must be able to walk away. This is especially true if you’re using the daily time frame.
Give the market some room to breathe. You won’t be able to ride your winning trades if you aren’t giving the market enough space and time to see a trend through to completion.
Rule #3: Keep Bets Small
One of the best ways to keep emotions at bay while trading is to keep bets small. If you risk too much on any one trade, fear and greed will surely find you.
Here is how Ed Seykota manages to keep his bets small:
Speculate with less than 10% of your liquid net worth. Risk less than 1% of your speculative account on a trade. This tends to keep the fluctuations in the trading account small, relative to net worth.
Notice that his risk per trade is less than 1% of his account balance. This allows you to endure losing streaks without losing your account or your nerves.
However, he also defines a percentage of his liquid net worth. This includes cash and other assets that can be readily turned into cash.
As his rule states, he’s only allowed to speculate (using his trading account) with less than 10% of his liquid net worth.
Why is this important?
Because it drives home the importance of trading with disposable income. In other words, risking money you don’t need for rent, utilities, groceries or other necessities.
I wrote about this concept, which is often referred to as trading with scared money.
When you combine all of Seykota’s rules, you will see that there is no room for trading with scared money or risking too much of your account balance.
That’s a winning combination if you ask me.
He also coaches us to,
Risk no more than you can afford to lose, and also risk enough so that a win is meaningful.
I have also written about the idea that a win must be meaningful. What’s interesting is that I didn’t see Ed Seykota’s comment in Jack Schwager’s book until after I’d already written a lesson on the topic.
If you want to get ahead as a Forex trader, you have to strike a balance between risking too much and not enough.
Risk too much and fear will take over. What’s worse is that you stand a good chance of losing your nerve and ultimately blowing your trading account.
But here’s the thing…
If you don’t risk enough, that setup that you waited two weeks for won’t produce a meaningful profit. When that happens, it’s easy to begin overtrading because you feel that the reward isn’t worth the wait.
The solution is to risk just enough that a profitable outcome is meaningful but not so much that a loss forces you to lose your nerve.
Rule #4: Follow the Rules Without Question
Trading rules are vital and Ed Seykota knows it.
Whether it’s a rule that defines how much you’re allowed to risk or what you’re supposed to do during a losing streak, trading rules are critical to your success.
I won’t get into the specifics of Ed’s rules because the truth is he and I are very different. He uses a trend trading system whereas I trade price action.
More to the point, most of his rules are proprietary and are therefore not publicly available.
However, we don’t need to know his rules to know that they’re an important part of any trading style.
As traders we live in a world without many boundaries.
You can put on and take off trades whenever you like and risk as much or as little as you like. You can trade the EURUSD, GBPUSD, AUDUSD or any other currency pair your broker offers.
Now, compare that to the rest of your life.
When you get in your car to drive somewhere, you can’t just do whatever pleases you. There are rules of the road that serve as boundaries to what you can and cannot do.
The same applies to your job. Chances are you can’t show up and leave whenever you want. Your boss also expects certain work to be done within a specific period of time.
These boundaries are everywhere in life. Except for trading.
When you sit down to place a trade, nobody tells you how much to risk or whether to buy or sell. It’s all up to you.
This is why trading rules are so important. They help keep you disciplined in a world without many boundaries.
Visit the link below to get ideas about what trading rules you should develop for yourself.
Rule #5: Know When to Break the Rules
This may sound counterintuitive to what we just covered. After all, we just discussed how important it is to follow the rules.
Now you’re supposed to break them?
Yes and no.
Ed Seykota does an excellent job explaining why a balance between following rules and breaking them is so important.
Here is what he has to say about breaking rules:
Sometimes I trade entirely off the mechanical part, sometimes I override the signals based on strong feelings, and sometimes I just quit altogether. If I didn’t allow myself the freedom to discharge my creative side, it might build up to some kind of blowout. Striking a workable ecology seems to promote trading longevity, which is one key to success.
In other words, gut feel is often just as important as your trading rules.
I will admit that gut feel and intuition are learned. Nobody is born with the ability to predict a market’s likely path forward by intuition alone. It’s something that comes with thousands of hours of screen time.
One thing that struck me the first time I read the passage above is the part about quitting altogether.
What is Ed Seykota referring to here?
He’s saying that if something doesn’t feel right, he stays on the sideline regardless of what his rules are telling him to do.
This is a key observation. As I mentioned earlier in the article, your first job as a trader is to protect your capital and that’s precisely how Ed uses his intuition.
Ed Seykota is undoubtedly one of the most successful traders of our time. He might not be a price action trader, but the lessons we can learn from him are invaluable nonetheless.
He knows that win rate is insignificant. What matters is having an asymmetrical profit to loss ratio.
Ed Seykota is also a huge believer in rules. Everything he does is based on strict trading rules he’s outlined for himself. It’s how he manages to stay calm even when things aren’t going his way.
However, he also understands the importance of knowing when to break the rules. Having traded the markets for several decades, his intuition and “gut feel” have become his most useful assets.
As always, finding a trading approach that fits your personality is vital. Seykota states,
I don’t think traders can follow rules for very long unless they reflect their own trading style. Eventually, a breaking point is reached and the trader has to quit or change or find a new set of rules he can follow. This seems to be part of the process of evolution and growth of a trader.
Who is Ed Seykota?
Ed Seykota is a commodities trader who began his career in the 1970s. He’s known for his end-of-day computerized trading systems that relied heavily on trends.
What market did Ed Seykota trade?
He began trading commodities in the early 1970s.
What trading strategy did Ed Seykota use?
He developed and implemented a computerized trend trading system.
What is Ed Seykota’s net worth?
The exact figure is unknown. However, we know that he grew one of his clients’ accounts by 250,000 percent between 1972 and 1988, so we can assume that he knows his stuff when it comes to trading.
Resources and Additional Reading
Here is the book that inspired this post: Jack Schwager’s Market Wizards
Now It’s Your Turn…
Are you ready to put Ed Seykota’s five trading rules into practice?
Let me know in the comments below.