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TRADING THEORY - Your Trading Plan

TRADING THEORY - Your Trading PlanHello team and welcome to the latest edition of Chris’ Corner. I apologise that it has been quite some time between updates but the markets have been throwing up plenty of great  opportunities recently and I have been kept very busy making money for my clients....and a little for myself. In previous posts I have commented that I would help readers to build their own trading plans. The following post will be the first in a series of updates regarding building a robust trading plan.

YOUR TRADING PLAN – YOUR BLUEPRINT TO SUCCESSS The idiom ‘fail to plan, plan to fail’ could not be more true than in trading. For all of those of you out there looking for the ‘secret’ to trading or for that one thing that will give you an edge, well, here it is; unless you have a detailed and clearly defined trading plan that you stick to, you will not achieve long-term success in the market. I don’t know how I can make it any clearer for you. In order to survive, in order to give yourself a better than even chance of not losing all your money, you must have a plan and you must stick to it. The funny thing about what I have just imparted to you is that most people are already aware of this information. All worthwhile trading literature emphasizes the need for a trading plan yet most people don’t develop a plan in any case. An often used and apt parallel is drawn between those starting out a new business and those embarking on a trading career. Just as one would not start a new a new business (especially one they are not familiar with) without a business plan, new traders should not enter the market without a trading plan. When stated like this, it seems so logical and obvious that one should have a trading plan. Yet new traders often come to the market without any sort of plan to trade by and subsequently enter the fray with little regard to their risk and profit objectives, other than to say ‘I want to make money’. This is NOT a plan people!!! Developing a plan seems like work and I believe this to be one of the major reasons why people don’t bother. Unfortunately, too many people these days come to trading with the mistaken belief that they will just be able to ‘wing it’. The trader without a plan tends to rely upon gut feeling, hunches, tips and even dumb luck. For these traders, the experience is usually a nail biting, stressful, rollercoaster ride that more often than not ends up with a decimated trading account. Just as no one in their right mind would start a business without a detailed business plan, no one who is serious about trading should begin (or continue) trading without a detailed trading plan. In following weeks I will dedicate numerous posts to helping you develop your trading plan. Make no mistake; it will take considerable time and effort for you to complete your plan. Once you have completed your plan however, you will have gained extremely valuable insight into both what type of trader you think you are, as well as what type of trader you want to become. What is a trading plan? Before we go any further, I should outline exactly what I mean by a trading plan. I define a trading plan as a detailed set of rules that govern every aspect of your trading, including (but not limited to) your entry and exit decisions, your trade management, your position sizing and your trading psychology. Trading is essentially about decision making. What most people lack however, is a framework within which to make those decisions. They find themselves in a situation in the market that they haven’t prepared for, fear and/or greed kick in, and they end up making a poor decision. A trading plan seeks to eliminate the impact of fear and greed by clearly outlining what will be done in each and every situation that you encounter. If someone who has a trading plan ever encounters a situation and they do not know what course of action to take, and fear and/or greed start creeping into their decision making, it is fair to say that their trading plan is not robust enough. If it sounds to you like I am suggesting you become a robot when dealing with the market, essentially I am. In the past I have had a lot of clients say to me, ‘but Chris, this is not why I wanted to start trading, I did not want to follow rules and have it be boring’. I’m sorry to disappoint all of you who have this idealistic notion of trading but it is hard work, it requires a significant amount of effort and discipline and, yes, I’m afraid some of you might even consider it to be boring. What is not boring however, is achieving positive results, making profit, and securing financial freedom, and the last time I checked these were the ONLY reasons why anyone started trading. That being the case, it stands to reason that you would want to give yourself the greatest chance of achieving those goals, and the best way to do that is by having a plan and sticking to it. Benefits of a trading plan As mentioned above, the key benefit of a trading plan is that it will help to remove the emotions of fear and greed from your decision making. The other major benefit of a trading plan is that it provides traders with an ability to monitor their performance. The best, familiar, real-life example I can provide you with in relation to this is a high school science experiment. In high school science when we conducted experiments, the idea (put crudely) was to test a hypothesis in a controlled environment, measure the results, and then either confirm or reject the original hypothesis. With a trading plan, it is a similar process as the science experiment. Your trading plan acts as your hypothesis, the results are the same, and then you can either confirm your trading plan if the results are positive, or, reject it if the results are negative. The key, in both situations, is that you have a controlled environment and a measured set of results which allow you to make informed decisions. If your trading is going badly, you will know that there is likely to be either one of two reasons why; either something in the plan is not working, or, you are not sticking to the plan. If the plan is a good one which has been backtested and paper traded (or forward tested with a small amount of money) then the fault is likely that you are not adhering to the plan. If you are adhering to the plan, you can go back and do further testing. Rather than completely chuck out your trading plan, you can make adjustments, fine-tuning it until you achieve the desired outcomes. As mentioned earlier, this is the part of the process which can take a lot of time. A trading plan will naturally evolve and may, in fact, never be complete if you continue to try to improve your performance. By comparison, if you are losing money whilst trading without a plan you have almost no way of distinguishing what you are doing well from what you are doing poorly. You have no way to measure your results and, as an extension of that, no way to figure out the problem and correct it without going through the time and capital consuming process of trial and error. Trading plan versus trading strategy Before we go any further I want to clarify the difference between a trading plan and a trading strategy. As outlined earlier, a trading plan is a detailed set of rules governing every aspect of how you engage with the market. It may even go so far as to outline the amount of time you will commit to doing research. A trading strategy however, usually only considers the entry and exit criteria. These are merely elements of a trading plan and, as we will go into further detail later, not necessarily the most important ones. Often time traders will include more than one trading strategy within an overall trading plan.

OK, that’s enough for this update. In the next update I will start posing a series of detailed questions which will help you develop YOUR trading plan. Until then, may all your trades be winners and your profits be large! Cheers, Chris C. This article was written by Chris Conway LLB BEc Dip FS(FP) Dip TA(ATAA) CFTe(IFTA) Chris is the Head of Research at a leading Australian stock market research company. To contact him: cc@egoli.com.au, twitter: @ChrisCTrader Disclaimer Chris' Corner