There are three key decisions you need to make when trading and if we think in these terms and your trading plan answers each question, then you may have the makings of a simple yet robust trading plan.
• Under what circumstances will you enter a trade?
• How much money will you commit to the trade?
• Under what circumstances will you close the trade?
Having a trading plan facilitates your decision-making by helping reduce the influence of your emotions from the equation and, therefore, will hopefully make you trade more efficiently.
The best way to ensure you get the most from your trading plan is to write everything down.
I believe your trading plan should take into account three broad areas:
• Your trading mindset (or psychology)
• Your money management (position size, hedging strategies & using stop losses)
• Your trading method (requirements for entering a trade or exiting, technical analysis tools used and your daily routine.)
Many people accept that a trading plan is an essential requirement to trading well, yet they don’t know where to start to put one together. It can be overwhelming at first to tackle this issue, so some of the things you must ask yourself first are:
Why do you want to trade the markets?
1. Increase and grow your money for retirement?
2. Increase your yearly income?
3. Create a monthly income to help pay for bills?
4. To save up for a new boat, holiday house, trip overseas?
5. Pay for your children’s college?
What is your time frame for achieving your goals?
10 years plus
How much money are you going to invest?
60K or more
How much of this capital will be invested into the market at any one time?
50% or more
How much of your capital are you prepared to lose before you stop trading?
What are you going to trade? (Stocks, Options, CFD’s, Forex, Futures?)
What is your time frame for holding positions?
Do you understand the risk with the trading tool or strategy you choose?
How many trades do you want to do?
One per day [ ]
One per week [ ]
One per month [ ]
How many trades per year?
How much of your time can you commit? (It is important to take into account your lifestyle, family and personal commitments)
1. One hour day [ ]
2. One hour per week [ ]
3. 5 hours per week [ ]
4. 10 hours per week [ ]
You must set in stone the most important thing with money management – protecting your capital.
Even though your primary motivation is to make money protecting your trading capital is even more important.
How can you make money, if you don’t have any money to trade with?
The most important trading rule is to cut your losses. One way to do this is using stop losses.
A ‘stop loss’ is a pre-defined level (price) at which you will exit a trade based on the premise that it is not moving in the direction that you had anticipated, and therefore you are losing money. Your prudent level of loss has been met by the risk you are willing to take.
The first thing is how are you going to set your stop loss point?
One of the best ways to manage your risk when trading is to limit or set a cap on how much money you put into a single position.
What is the maximum percentage of your trading capital you are prepared to commit to a single trade?
Another crucial part of money management is position sizing. How are you going to position size?
What is going to be your maximum risk exposure across your trading portfolio at any one time?
Will you limit the number of trades based on how much risk capital you have at risk across all of your open trades?
What happens if you keep losing money? This question has little to do with trading but rather your own financial situation.
Are you prepared to lose every cent of your allocated trading capital before you are forced to stop, or do you think you would like to hold on to some of the money and commit it somewhere else, with the plan of waiting or being patient to review why it’s not working.
There are numerous products available to trade including shares, futures contracts, options on futures as well as options on stock, currencies (foreign exchange), CFDs and more, and they all have different risk profiles. If you are trading multiple products, how are you going to allocate your capital accordingly based on the different levels of risk?
How are you going to trail the stock price with your exit once the price moves higher?
How are you going to calculate this?
Are you going to trade short term reversals in medium term trends?
Are you going to trade in only blue chip stocks and look at medium term trends with a view to buying stocks as they trade above 12 month highs? Or below12 month lows?
Are you going to trade more speculative stocks at the other end of the scale and trade breakouts from trading ranges?
If you are going to use technical analysis, what indicators are you going to use?
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?
If you are going to use fundamental analysis, what items are of most interest to you?
For example, are you interested in earnings, dividends, growth, acquisitions? If so, how will you use that information?
Human nature and behavior over the years, remains constant in the market. All market participants are driven by similar emotions and will often react to situations in the same way. Moreover, there are always a continual flow of new participants into the market and they are generally ignorant of the way the market has behaved in the past.
For this reason, the same mistakes are often repeated by each new group of market participants – this is why chart patterns often work.
First, will you consider a particular chart pattern as a setup (lead into) for a trade entry? Second, are
there any chart patterns that will immediately stop you entering a trade or at least have you waiting until the pattern has completed or dissolved?
Strategies for Low risk traders max 10% risk
Holding positions up to 12 months or more
Selling covered calls
Vertical spread strategies
Calendar Leaps min 12-month option expiry to max 3 years
Strategies for medium to high max 20% risk
Holding positions 3-6 months
Min 6-month option expiry
Buying calls and Puts
Selling calls and Puts
Selling covered calls
Strategies for high-risk tolerance max 30%
Holding positions 1 day to a couple of weeks
Min 3-month option expiry
Buying short term calls and puts
Trading CFD’s, Forex, Futures,
What kind of education have you done to qualify your knowledge?
Have you tested your plan before committing your capital?
How long are you prepared to paper trade for?
What is your goal and time frame?
Are your goals realistic and achievable?
Some of the more important factors include your personality traits like patience, confidence, decisiveness, emotional stability, mental agility, and the most importantly – your ATTITUDE.
Trading has a greater potential for reward than investing but with that extra potential for reward is greater risk. Those who trade well have been well educated and prepared. Very seldom does somebody start trading and make money from day one. Putting together a proper trading plan can seem time consuming, however I can assure you that it is one of the best things you can do and will greatly assist you in achieving the results you want.