Trading Plan

Trading Plan

The simplicity of the trading plan is absolute gold dust in trading. But many wannabe traders get the trading plan all wrong.

I have delivered a few presentations over the last few months and for those who have heard me speak know that the first question I usually ask the audience before I even start is:

"Who here is interested in money?"

Almost everyone in the audience raises their hand and laughs as they think what a silly question it is. Of course, they realise that money is something that most people are interested in.

I then follow that question up with:

"And who here is making all the money they want to with their trading?"

Down go the hands .... the laughs turn into some mumblings ... the smirks and smiles turn to blank faces.

I follow it up with one last question:

"Who here has a trading plan?"

A few hands are raised scattered across the room. Clearly there is something amiss.

Most people know that one of the keys to trading success is having a plan and then implementing that plan ruthlessly. Yet, it is obvious that most people don't have a plan - why not?

They know about the idea and importance of cutting losses, following the trend, letting your profits run and others, yet fail to compile it all into a solid robust plan.

One of the biggest reasons that our mindset is such an influence on our trading success is because our emotions influence our actions. Our emotions have little place in our trading, however removing our emotions from our decision making is much easier said than done. It is our emotions that largely influence our actions and therefore coerce us to break the time tested trading rules that have worked for hundreds of years.

A solid step in the right direction to reducing the influence of your emotions is the compilation of a written trading plan. The three broad areas in your trading plan should be:

Mindset (or psychology) Money management, and Trading Method

Some questions that should be considered under those areas include:

Mindset

Why are your trading goals - what do you expect to achieve in the next 6 months, 1 year, or 5 years (or any time period you set)? How you will overcome any fear or emotions when you trade? How you will eliminate any possible distractions from where you trade? What are you strengths and weaknesses and how will they influence your trading style?

Money Management

How you will determine your position (trade) size? What is the maximum percentage of your trading capital you are prepared to commit to a single trade? What would you describe as an adverse move against you and what will you do should it happen to you? Second, under what other circumstances will you consider selling regardless of what exit points you set? How you will apportion your trading capital (float) for different strategies and financial products?

Trading Method

Will you trade 'at market' or 'at limit' and why? If you are going to use technical analysis, what items are of most interest to you? For example, are you interested in trends? If so, over what time frame and how are you going to identify them? Are you interested in reversals of short term or medium term trends? If so, how will you identify them and then what will you do once you identify them? How about technical indicators? Will you use any of them? How you will manage your watch list?

Writing your trading plan down will greatly assist you because it will force you to think different scenarios through and make you commit to it. It also forces you to formalise your approach rather than relying on emotions and hunches when an important decision is needed.

When you don't have a plan, your trading decisions are largely based on hunches, instincts and emotions and when you base your decisions on emotions, the chances are you will not achieve long term success, because humans are naturally inclined to fail. Having the plan greatly reduces the influence that your emotions have on your trading and therefore makes you think more logically about doing the right thing.

In my opinion, having a written trading plan also provides you an edge over most market participants and in an arena where most people fail, how can you afford to not give yourself an edge?

In my time as an instructor mentoring and developing newly commissioned officers in the US Army, I was very critical when it came to the delivery of military orders. I always said that the quality of military orders could be measured with the number of questions asked by the recipients afterwards. When the question time was longer than the actual delivery of orders, there were clearly some fundamental flaws in the preparation of the orders. I think the quality of your trading plan can be measured the same way.

A good test for your trading plan is to hand it to someone else to read thoroughly and then see if they have any questions regarding it. If they can easily understand all the rules and the requirements of the system with very few questions, then you have compiled a sound trading plan - it may not make you money, but it is a start.

You should be able to hand it to someone else and have him or her know exactly how you trade. Your trading plan should be considered as valuable as any business plan or company manual which guides and governs your trading actions. Give yourself an edge in your trading. Develop your individual approach, follow the time tested trading rules and then document it all in your trading plan.