Developing a trading plan
When someone decides to start a business, the first task usually tackled is drafting a business plan. Most people would see this as mere common sense, however it seems the same logic does not apply to many new traders. Rather than planning how and where their capital is to be allocated, many new traders will launch headlong into a trading career with little regard as to their risk and profit objectives. By failing to have a trading plan, a trader will not know what to do when the market goes in their favour or worse still, when it moves against them. Without the structure that a trading plan provides, you will find yourself not only at the mercy of changing market conditions but also of your own conflicting emotions -a sure recipe for disaster.
While a plan will not prevent losses, at least it provides you with some guidelines to follow. You can and should make minor adjustments to your initial trading plan throughout the trading period, but do not let the ups and downs of the market affect your overall game plan. Do not abandon your original objective, unless the market conditions that led you to place your trade change. The trading plan therefore imposes the disciplined structure that is essential for long term success. Concentrate and focus on a few select markets and completely master them – this is the tendency of professional traders.
- Select your investment universe (either markets or stocks)
- Appropriate account size (capital that you can afford and allow for diversification).
- Have an entry rule (eg. 21 day break out)
- Add risk management parameters stop loss (fixed dollar, trailing, swing)
- How much to risk ( % based on capital)
- Back test the system as well as forward testing
- Performance measurement
- Determine your expectations
- Determine your necessary requirements (resources to get the job done)
- When should I start trading (paper trading first)
Like most things in life, you won’t succeed without it. Discipline is adhering to your established trading plan, including ‘stops’ and entry points. This is the most difficult yet most important rule of them all. For foreign exchange traders to become consistently profitable, they must have a high level of self-discipline with a well defined trading strategy that essentially maximises profitable trades and minimises losing trades. Drafting a trading plan is relatively straightforward – but it is the discipline to follow that plan that will distinguish capable traders from all others. During periods of profit, adhering to a trading plan is comparatively easy. During periods of loss, however, the very same trading plan will appear rigid and constricting – and it is at such times that a trader will be tempted to depart from the plan. Although you might want to deviate from your trading plan, doing so invalidates the reason for preparing it in the first place. Remember the purpose of the plan was to provide guidelines to follow. Breaking from it will invariably lead to risk exposure that you were originally unprepared to take. The difficulty in maintaining the required level of discipline is one of the main reasons many traders adopt a system driven trading approach. These traders include professional hedge fund managers and Commodity Trading Advisers who use computer models to generate their buying and selling orders (ie there is no discretionary or ‘gut feel’ trading done).