Imagine the following scenario for a
second. You are a trader for a hedge fund with a trading pot of £100
Million. You are in a few trades and some are significantly in profit
while others are in a minus. Your portfolio manager comes over and asks
for an update on what positions you’re in and why. You are not able to
give an answer straight away as you have executed a lot of trades and
need to revisit the reason for each one. As you look through your
trading log you come across some trades which are difficult to remember
the reasons for having taken them. Now you panic because you will have
to explain this to your boss who will not be very happy. Your job could
even be at threat and you swear to yourself that you will create and
follow a trading plan from that day forward.
Now imagine the above scenario but this
time when your manager comes over to ask for your trading rationale, you
are able to produce a document with a checklist that you tick for each
trade you take. Since you follow this checklist each time, you find it
quite easy to explain why you took your trades since the rationale is
the same for each one. How pleased would your boss be and how
stress-free is it for you each time you trade? The question is…
Which Trader would you rather be?…..
Which Trader are you now?
Why Bother With a Trading Plan? Why Not Just Trade?
Having a trading plan is the most
important step to take once you have all the information regarding your
trading strategies, which markets you’re going to be trading and what
your outcome is going to be. The role of a trading plan is to give you
focus and consistency in application. You need focus because it is easy
to develop bad habits such as changing your trading strategy often,
chasing a trade, doing something completely contrary to what you should
have done and many other harmful tendencies. The only fight you have
against this is to follow a plan of action strictly every single time
you trade. Amateur traders will just enter a trade and justify it
afterwards while professional traders plan what they will be trading
very carefully. The crucial question you need to ask yourself is…
Would you trade exactly as you are now if you were given £5 Million capital to trade with?
If not, why not?
The most likely answer is that you do
not have enough confidence in your trading yet. Maybe your trading
strategy is not reliable enough or you may be more discretionary in your
trading and so trading a large sum of money could affect your
psychology and affect your performance. Whatever the answer may be – it
boils down to one thing – you need a trading plan, otherwise, you will
be at the mercy of the markets and your will power – something you want
to avoid at all costs.
Components of a Trading Plan
A Trading Plan doesn’t have to be
complicated and lengthy. It should be kept short and to the point, as
you will be using it on a daily basis. It is a document which you will
be referring to constantly so it must be easy to follow. Your trading
plan needs to contain the following sections:
1. What Markets You Trade and Why
Will you be trading Forex, Stocks,
Indices? Do you like the volatility and accessibility of Forex or do you
prefer the smoother movement of stocks? Do you like the day trading
appeal of Indices? There are a wide array of choices and markets you can
trade – study each market and try them to see which one you prefer,
then stick to that market to become an expert in it.
2. What Instruments Will you be trading and Why?
Spot FX, Futures, Stock Options, CFD’s,
shares? There are many ways of trading a market and although some of
them depend on which country you live in, most are accessible globally.
Forex is the easiest market to access and Spot FX is the most commonly
traded instrument. All you need is a trading platform such as Metatrader
and a brokerage account and you are ready to go. The other instruments
are more complicated and require more funds but are just as lucrative as
Forex.
3. What Will Your Trading Style Be?
Will you be day trading in which case
you would use a 60 min chart for trend identification and 15 min or 5
min for trade execution? You may want to swing trade in which case you
may be using 4Hr for identifying market conditions and 1Hr/30Min charts
for setups and trade execution. You could also use a Daily chart for
trend identification and a 4Hr chart for setups and trade entry. You may
want to position trade, in which case you will use a Monthly and Weekly
chart for the trend and daily chart for the entry.
Whichever style you choose, stick with
it for 6 months before adding any other style to help you focus and
develop consistency. One of the biggest mistakes you can make as a
trader is to adopt too many trading styles. All this does is to ensure
that you are spread thin and unable to develop proficiency in one style.
Be a specialist, not a generalist.
4. Outline Your Trading Strategy
Write out your Trading strategy in a
step by step fashion. Make sure you include everything from what
timeframe chart you look at first to what you need to see in order to
continue with your analysis further. Specify what technical tools you
will be using and any indicators or additional factors you need to look
at as well as what those indicators/factors need to tell you. Once you
have analyzed a chart then how about the entry – what do you want to see
in order to enter a trade?
In a nutshell, detail what a perfect
setup needs to look like step by step in a checklist format so that you
can tick them off one by one as you go down the list. The idea is that
by the end of the list, you will have a high probability trading
opportunity which you can execute comfortably.
5. Risk Management
How much will you risk per trade? 1%,
5%? Where will you put your stop loss in case you are wrong? Remember,
the only two things we know for certain in trading are where we will
place our stop loss and how much capital we will risk per trade. How far
the price goes or whether it goes in our favor after we enter is an
educated guess based on what is probably going to happen but not what is
guaranteed to happen. As a result, this step is critical to your
trading success and hence why you need to include it in your plan.
We never recommend risking more than 3%
per trade. If you are new to trading then we would recommend a maximum
of 1% risk per trade and if you are advanced then a maximum of 3%. Never
risk more than what you are comfortable losing because losses will come
and are a part of trading. How you bounce back from them will determine
whether you will succeed or fail in this business. By keeping your risk
small, you ensure that you are always able to take the next trade
without hesitation.
6. Trade Management
Once you are in a trade, how will you
manage it to a successful conclusion? Let’s say price goes in your
favor, how will you determine where and when to exit the trade and take
your profits? Will you trail your stop loss or will you go for a fixed
target? These are all important questions as good Trade Management will
keep you in this business for the long run whereas poor trade management
will ensure you have an early exit.
Good trade management needs to have a
break-even point – the point at which you move your stop to break even
and then how you manage the trade after that. You could move your stop
to break even once the price has moved a certain distance in your favor
just in case there is a sharp reversal due to something unexpected. You
could close half of your position and bank those profits once price
moves up a significant amount and then allow the remaining portion to
trail a certain distance behind price in order to capture more profits
in case price trends nicely.
Create A Checklist
Once you have written up your trading
plan under the above headings, create a checklist that you follow each
time you are about to take a trade. This will help you fight off any
impulsive trades you might take. This is very important especially if
you day trade as being in front of your screen watching the charts for
several hours will entice you to trade. What if you have been there all
day and haven’t seen a single setup which meets your trading plan? What
do you do? You should simply shut down your computer, however, what is
most likely to happen is that you will be enticed into a trade in order
to “do something”. This urge is easier to shrug off if you have your
checklist printed off in front of.
Conclusion
There is so much more we could say about
a trading plan including going into detail on what strategy to use and
why as well as trade management techniques but for now the key message
we want to communicate is the importance of constructing a plan ASAP.
Without a plan and subsequent checklist, you will be trading on a whim.
It is not good enough to have a trading plan and checklist in your head,
it needs to be in writing as this is far more effective.
At Just About Trading, one of the things
we supply our students with is a tailored trading plan taking into
account how many hours they will be trading each day, their personality,
trading preferences and trading objectives. We even supply them with a
detailed checklist to follow in executing each trade. This way we are
able to know whether they are following their plans correctly or
deviating from it. So if it’s good enough for us then a plan is good
enough for you!
If you wish to know more about our
programs then click on the homepage and read through our various
courses. Until then, happy trading!
