The Rule of Three –
Every good and disciplined trader has a set of rules & guidelines they follow stringently in order to consistently profit from the market. A professional trader will not sway from or alter their rules to gain a few extra pips, as they know in the long run, disciplined trading is the only way they can become consistently profitable traders. Some of the rules & guidelines traders follow range from; only trading a specific Time Frame, to using fixed stop losses and take profits. There are 100’s of different rules a trader can follow which makes it impossible to list them all here. With each trader being unique and having different reasons for entering the market most traders set of rules will differ from their peers.
The rule of 3 is one of our rules that we follow with great discipline and helps us from making trading mistakes such as entering the market too early or over trading. This rule is only part of our trading plan however it has proven to be an integral part to our consistency.
The rule of 3 is a very simple rule to follow and requires the trader to never enter the market unless there are at least 3 reasons supporting a specific trade. The 3 reasons are very important in helping to enter higher probability trades.
1 – Trend: Is the trade inline with the current trend? If not and this trade will be a counter trend trade is there valid support or resistance in place?
2 – S&R: The trade should only be taken if the market is rejecting a specific support or resistance area.
3 – Chart Pattern/Price Action: The trade should only be taken if there is valid price action in place rejecting the specific support or resistance area already identified.
Take a look at the chart below which is a great example of the rule of 3 in action. The 1st thing we have done is identify the current trend. It’s obvious to see at the time of this trade the market was in an uptrend. The 2nd thing we did was identify a specific area of support/resistance (marked with the blue line). Finally we wait for a price action/chart pattern signal rejecting this area. Once we have all 3 we are ready to enter the market.
As you can see using the rule of 3 on this trade worked out very well with the market continuing its bullish momentum. It’s important to take note that more ‘reasons’ supporting a trade makes for a higher probability trade, (however its equally as important to take note that it is impossible to know what the market is going to do next and a good money management plan should be in place before trading). For example; if we look at the chart above and focus on the 1st bounce of the Support level identified (marked with a red 2); many traders would have seen this ‘bounce’ and ‘jumped’ straight into the market with a long. The market did push higher initially; however as we can see it retraced testing and rejecting this area again. Many traders who would have entered on the 1st bounce would have been stopped out or would not have let the trade run to its full potential. As you can see entering using price action chart patterns as further confirmation allows for higher probability trading.
Including the Rule of 3 in your trading plan can greatly improve your consistency as a trader provided the rule is enforced with discipline. Many traders make the mistake of over trading. Using the rule of 3 is a great way to cut down on your losing trades by lowering your frequency of trading. When trading its important to remember we’re all looking for Quality not Quantity.