Trading the Plan

[Alchemist]

Have you ever heard the expression “Fail to plan, plan to fail”? In case you have not, it’s an old saying in business, which tells it all about how to properly approach any new business endeavor. That is, by having a PLAN. To be successful at anything in life, you have to have a plan. Trading is no exception. Unfortunately, most new traders don’t have a plan. Not having a trading plan nowadays increases your likelihood of failure exponentially, especially when traders are struggling to make it through their learning curves.

In case you haven’t done it yet, I strongly urge you to consider starting working on your own trading plan as soon as possible. That may help you uncover so many pitfalls and “bad habits” in your trading which would surely be left unnoticed without a trading plan. Winning trading plans share several common traits. First of all, they should lay out clearly what your GOALS are both on a per trade basis and on overall trading as a career choice. Then, they should set forth HOW you are going to achieve those goals. This would include setting strict entry, exit, and risk tolerance rules, among others. Last but not least, a good trading plan should provide the possibility for analyzing thoroughly every trading day record and assess how well you are following your previously set rules. Let’s analyze it in detail step by step.



WHAT do you want out of trading?

1. Are you cut for it? First of all, every trader should honestly ask himself this question, “Am I really cut for trading?”. Some will say, “well, you can’t say until you really try your hand at it”. That may be partially right. However, successful traders all have several character traits in common. For example, they have no problem following their trading rules without hesitation. Successful traders rarely cry over spilled milk. They have the guts to admit they were wrong and move on to the next trade. Great traders are all extremely disciplined persons.
2. Got goals? No trader should ever approach trading without first clearly understanding what they want to get out of it. This would require new traders to do some introspection in order to find out what their goals in trading are. Do you want to turn to trading as a quick way to riches? Do you have a true passion for the financial markets? Are you willing to work hard to accomplish your trading goals? If you answered yes to the last two questions, congratulations, you are on the right path to trading success. However, if you ALSO answered yes to the first question, be warned: you may be in for a nice ride! Trading is no get-rich-quick. Trading is just plain, hard work! You should ask yourself these questions.

HOW am I going to accomplish those goals?

1. Develop risk awareness and a sound risk tolerance plan. Risk is there. Risk is in every trade you will ever decide to take. Risk is there. Repeat this 10 times, in case you didn’t know. Now, you have to decide HOW MUCH of that risk you are willing to take. That would be setting your risk tolerance level. How much are you willing to loose on each trade? 1%, 5%, 10% of your trading capital? The actual percentage will vary, depending on your trading strategy and style. As position sizing goes up, stops will be tighter. On the other hand, as position sizing decreases, stops become wider and wider.
2. Develop your entry rules. As is the case with your exit rules, you have two choices to develop a set of sound entry rules:

• Discretionary. In discretionary trading, the trader uses her own judgment to determine whether she should take a trade or not. This involves determining whether a particular indicator reading is meaningful enough to warrant getting into a position, or analyzing price and volume action of a particular financial instrument.

• Mechanical. In mechanical trading, the trader inputs parameters previously validated by an historical back-testing into a computerized system. Then, he should follow rigorously the signals the system will feed him. Otherwise, he risks “sabotaging the system”.

Regardless of whether you will engage in discretionary Vs mechanical trading, you should always make sure to have a proper entry plan and, most importantly, to stick to it!

1. Develop your exit rules. If your entry rules are important, your exit rules are increasingly more important. In fact, it’s your exits that determine whether you will make money on the trade or not. What’s more, emotions and fear of taking a loss will likely present themselves when the time to exit a trade comes. This is the time to pat yourself on the shoulder if you just completed a successful trade, or to start handling your emotions and admit you were wrong if you are about to take a loss! Regardless of whether you are coming out a winner or a loser, every time you enter a trade, you must already have in mind three crucial exit points:

• A stop loss. This is your “forced” exit rule. That is, the point where you have to get out because your position went against you. Always have a stop loss order in if you can, or on paper at least. Mental stops don’t count as you can sabotage them!

• A trailing stop. Congratulations! This trade is making you money. Now you have to keep what you have already earned. Remember: there are no paper profits. No profit is a profit until it is taken. Use a trailing stop to protect your virtual gains in case the stocks should turn south/north.

• An initial profit target. This is self explanatory. This number is what you will ultimately be happy with. Don’t be greedy and don’t let a winner turn into a loser.

AM I accomplishing those goals?

How am I doing? Am I following my trading rules? Am I making money yet? Why do I keep making that mistake? How can I fix that?

In order to be able to answer these questions, you have to analyze in detail your daily trading records. Your trade records are an important barometer of how well you are doing in your trading endeavors. They tell you at what stage of your learning curve you are currently in. In addition, they are the only means to uncover any pitfalls or misjudgments you may have in your trading approach.

Always keep detailed trading records and analyze them carefully. Note the reason why you decided to exit or enter a trade. Include all relevant charts whenever you can. This will help you get a better picture of the whole trade process when you need to go back to it and study. What’s more, take note of trades you decided NOT to take even though your system told you to. This may give additional insight on how well your system is doing and on whether it needs some optimization or not.

[FabMav]

very detailed step-by-step analysis of how a trading plan should be. I wish I had one when I started but it's never too late very nice

[breakout]

Excellent article! Very informative! keep going keep going

[ManhattanTrader]

excellent 3-step approach to a successful trading start. WHAT do I want, HOW am I going to accomplish that, and AM I accomplishing that? That's all there is to it..

[MarkB]

excellent article from start to finish