The Elements of a Trading Plan
Trading is an exciting and incredible world. It is also the world in which money flows easily and, considering that the majority of people lose money, it must mean that the money flows away from the majority to the few. In this world of excitement, it is very easy to either go broke or at least lose all your trading account.
The four elements of a complete Trading Plan
In general, there are four key elements to a successful trading plan.
1. An overall strategy for the management and control of your money
2. A method of determining entry level
3. A method for determining an exit level
4. Stop Loss / Profit levels
Intertwined with these key areas is an in-depth understanding of why it is that you trade. So maybe, before we move on to look at each of these key points, you could ask yourself three questions.
Why do I trade?
Can I afford to trade?
What do I expect to get from trading?
Some people are gamblers, some trade for entertainment and excitement, some do it for a living to put food on the table for their family, while others use trading to relieve emotional and psychological pressures. Very, very few actually trade to buy private jets and Porsche!
Your trading plan is a very personal document. It has to suit you. It has to suit your financial profile and enthusiasm for risk. It has to be YOUR TRADING PLAN.
An overall strategy for management and control of your money
What markets do you want to trade? What is the size of the margins? How many options can I buy for $X? These are the common questions which many would-be traders ask when they first start out. And as most people starting out on a new journey, they are asking all the wrong questions.
Anthony Robbins, of Awaken The Giant Within fame, says that the quality of our life is determined by the quality of the questions we ask. Maybe what we need to do first is find out what the best questions are to ask. Often people are surprised when they consider the questions I am about to raise?
How much money do you have to put into this venture? (This is the easiest one)
- What portion is it of your net worth? (It needs to be a small percentage)
- How much money could you lose in one event and still feel okay about yourself and your plan? (Because trading is all about learning how to take losses)
- Are you aware that you are setting up a business? (Because you are)
- Where have you sought advice to date in developing your own trading plan?
- When do you intend to start? (Certainly not until after your education is underway)
- What education have you undertaken to help you in your trading? (Many of life’s skills may help or hinder. You need to learn a great deal about trading before you call a broker)
There are many more pertinent questions that need to be asked but these will suffice for the moment to indicate that trading is a serious business which involves a great deal of learning. Losing trades must be viewed as learning experiences, especially the expensive ones.
All things considered, I would hope that it is becoming apparent that trading education is appearing to be a wise investment
Often early lessons, formerly called losses, need to be reviewed and explained so that the underlying, and seemingly obscure lessons about market emotions and market action can be understood. In some of these cases, you may have learned a lot but paid a higher than necessary price.
A method of determining entry levels
Your approach for determining entry levels also needs to include a process for selecting a market sector, stock, commodity or futures contract. Whether you feel the indicator ADX is better than triple moving averages is for you to determine. But you must determine it for yourself in the market sectors you want to trade.
Currencies, equities, and futures all have their own idiosyncrasies which may have an effect on your trading style. So might your personal knowledge. For example, while ‘mineral’ people know a lot about minerals and mineral markets, they probably know little about IT high tech areas.
It has often been said that Technical Analysis is about probability. You need to satisfy yourself that the statistics being bandied about work for you in your market.
Remember the quality of the analysis depends on the quality of your questions. Although, initially, any questions will do, as long as you do ask and then seek the answers. In time you will develop a feel for improving the quality of your questions.
A method for determining an exit level
A study of trade in progress management was made where different traders were all given the same opening position (i.e. ‘X’ shares bought at $’X’). One would have thought, that if entry point technique was so important that they would have all ended up with the same amount of money. Profit or loss.
The reality was very different!
In another survey traders and brokers were asked whether entry technique or money management was the most important. ALL of them replied that the exit (money management) strategy of the trade, once the order had been filled, was far more important than simply getting into the market.
So once again, it is back to statistical research to identify what may be the best methods of managing a trade. As the techniques are a mixture of your personal trading profile and your risk strategies, it would be unfair to do more than touch on them here.
On the other hand here are some thoughts to think about.
- Trader Vic Sperandeo and others say to never give back more than half of your profit
- Stops can be loosened up or tightened depending on market momentum
- Never loosen stops
- Always get stopped out. Never just get out
- Set a target. Once reached, get out
- Use trailing stops based on a particular percentage of the range
Different sectors behave differently. Make sure you know your sector.
In putting this list together I know that some of these ‘rules’ and ideas contradict each other, but this is where your personality comes in. You have to decide which strategy you are going to use and, more importantly, why.
You need to prove to yourself that these ideas work. They are your ideas, your strategies. It is YOUR trading plan. Your own research is the only way you can be sure of anything.
Stop Loss / Profit levels
Westpac’s senior technical analyst, Peter Pontikis at the 1996 ATAA conference and at the 1997 SFE Trading Expo made the point that when a trade moves into profit and you are moving your stops up, you need to continually review your risk management. A trade in progress is a dynamic entity.
As a trader, it is easy to think you are playing with the market’s money, but you aren’t. You are playing with your own money. Money which represents your profit, or income, from the trade.
And as it is your own money, you need to be careful with it.
While there are some successful traders who don’t believe in stops, most traders do.
With the brutality of Ockham’s razor, stops are there to say when the market has proved you wrong.
As a novice trader you need to write your stop levels down and, if possible, have your broker act on them automatically. I say ‘if possible’ because some brokers will do it for you while others won’t. And with the ones that will, double check to see what they charge for the service and whether they offer some sort of guarantee. Generally, you get what you pay for.
A Trading Plan is a living, evolving document that has to be your trading bible, your guide and your support as you trade. Some parts of it will be in a book or folder while other parts need to be on the wall.
Your plan must be reviewed regularly. Some parts should be reviewed daily as you apply your entry and exit strategies, while other components may be left for weeks without being looked at.
This implies, of course, that your written plan should be concise and simple to follow. The rules must be easy to implement and have time frames in which results can be expected. The faith you have in your plan must come from your own hard work.
In putting your plan together consider multiple outcomes and potential disasters, and plan for them. The more planning you do, the easier it will be for you to respond to situations rather than react.
Develop Your Plan, Trade Your Plan, but first and foremost, make it YOUR PLAN!!