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Your Trading Plan

Posted By Robert On Thursday, December 12th, 2013 With 0 Comments

All good traders have a plan. The best ones also write their plan down and review it regularly. Financial spread betting is not an art. To be successful you need to be disciplined and rigorous in your thinking.

If you fail to plan, you plan to fail.

Once you understand the tricks of the trade and have decided on the ones that will work for you, and perhaps discovered a few of your own, it is important to formulate them into a trading plan. Your trading plan will tell you (or remind you) exactly what to do in each situation, so that you are not wracked by emotion and indecision when the time comes to take the required action.

Your trading plan should answer questions like:

What proportion of your trading funds will you allocate to each serial trade or parallel position?
What will you do when a trade goes against you? Close it down for a small loss, or increase your stake?
What will you do when a trade goes in your favour? Take you profit quickly, or run the profit while pyramiding additional funds?
How will you guard against the potentially devastating effects of price gaps? By diversifying, by applying guaranteed stop orders, or both?

The Life Cycle of a Trade

When devising a trading plan it is useful to think in terms of the full lifecycle of a trade. Some of the trading literature, and much of the investment literature, implies that profitable speculation it is all about clever stock (or other asset) picking; i.e. your trade entries.

For all traders and especially for day traders and swing traders – trade exits are just as important as the trade entries. For longer-term position traders, trade maintenance by pyramiding additional funds or trailing your stop orders becomes just as important and entry and exit. So make sure your trading plan takes account of each of the boxes – Entry, Maintenance and Exit – shown in the graphic below.

Trading Plan

Here’s a suggested outline approach that will help you to trade with discipline and help you to take some of the emotion out of your trading.

Step 1: Decide on your trading parameters

Decide firstly on your investment level. Then set a specific goal for what level of return you want to make. Thirdly, and most importantly, decide what’s the most you’re willing to lose. Then think of your trading as a defined trading cycle which will end when either you achieve your goal or you hit your downside parameter.

An example of this is as follows:

Investment level: £10,000
Target Growth: £15,000
Acceptable Reduction to: £7,500

We will come to why it’s so important to set out your parameters but in essence it gives you a trading compass for when you’ll have to make key decisions on your trades. It’s completely up to you to pick your own appropriate levels – funding, timings, goals and acceptable downside.

Step 2: Decide on your trading style

Are you going to be a frequent or occasional trader? What kind of instruments will you trade… volatile ones or steadier ones? Are you going to be a fundamentals trader, technical trader, trend trader or what? Will you trade lots of things or will you focus on one or two items? How often can you or do you want to check your positions? What’s your time horizon – short, medium or long term?

If you’re a beginner, we recommend that you keep it as simple as possible. Get to know just one thing, one tradable item. Get to know its quirks and what can happen in its charts.

All these things are important but what you’re looking for is the right style and approach that suits your views and your lifestyle.

Step 3: What’s your macro view on the market

It’s generally a good idea to have an overall view on the market. Do you think it’s a bull or a bear market? What things are on a general uptrend? What items are on a consistent downtrend? What sectors are under pressure? What sectors are under-valued?

Once you have your macro view on the market it will help you to decide for or against given potential trades or to go with the one you’re most confident about. For example, say you’re looking at the Pharma sector and you’re generally bullish about that sector. If you’re faced with two possible trades… .one long and one short… … all things being equal, you’re probably going to favour the long trade because of your bullish view on the sector.

Step 4: Hone in on one or two items to trade

Now you are looking for your entry trade. It’s really important to give yourself the best chance of getting off to a good start. There’s no rush. Observe a small number of things closely. Study the charts. Follow the news. Talk to people. Note how volatile or otherwise the instrument is. Where do you see value going long? Where do you see value going short?

The day then arrives when you want to open your 1st trade.

Step 5: Your 1st trade

So you’re ready to trade. Whether based on fundamentals, technical chart indicators, a hunch, a gut instinct, a tip, news, an article or whatever, you see a good value entry point for a trade.

The first thing you do is admit that you might be wrong. Financial spread betting is all about managing your downside risk and, if your general trading instincts are good, the upside should take care of itself. Then you define an amount of money that’s the most you’re willing to lose if you’re wrong.

Let’s say that you decide that £400 is the most you’re willing to lose. You look at the charts again and see what the item’s volatility is like. Markets such as Oil, Wall St, Gold and Currencies can easily move a few hundred points in hours or days. Others are less so… perhaps a low value stock.

If the item is very volatile, you may realise that it’s not right for your opening trade as too much of your capital would be at risk. If you put £1 stake on WTI Crude, max downside of £400, your stop-loss has to be at 400 points away or less. You don’t want to trigger your stop-loss by a short spike against you so you need to make sure your position has adequate breathing space.

So, by defining your a) overall trading cycle parameters; b) max allowable downside per traded view and c) checking the volatility patterns of your chosen item, you’ll have a good framework for deciding on d) whether to do the trade or not e) what initial stake size is appropriate and f) where to put your stop loss order.

Using this discipline will help you to take emotion out of your trading habits. Say you’re going long on a £1 stock and you want to make £100 without losing more than £50 and the stock’s volatility is rarely more than 20 points. Immediately you can see the trade: no more than £1 or £2 stake, stop loss at 75 pence and profit order at £1.50.

No matter what your scale of trading, whether it’s £1 or £100 stakes, these simple disciplines will steer you towards better decisions at key times in your trading cycles.

Step 6: Record and Review

You are underway…Now you’re looking for your entry trade. It’s really important to give yourself the best chance of getting off to a good start. There’s no rush. Observe a small number of things closely. Study the charts. Follow the news. Talk to people. Note how volatile or otherwise the instrument is. Where do you see value going long? Where do you see value going short? The day then arrives when you want to open your 1st trade.

Sample Trading Plan

Here is a sample trading plan that encompasses the aspects mentioned above plus other aspects that should be covered by a trading plan. It may be based roughly on my trading plan, but it doesn’t have to (and probably shouldn’t) become your trading plan.

What to Trade: Only individual equities; no indices, commodities or currencies.

When to Trade (Trade Entry): On market weakness, in stocks which have suffered a short-term price shock but which have good long-term potential.

Position Sizing: Start each position with the minimum allowable spread bet size, with a view to pyramiding a larger position over time.

Stop Orders: Always (and only) apply a stop order when the risk-to-0 is potentially catastrophic, but always apply a stop order as soon as it is possible to lock-in some profit.

Pyramiding: Make additional bets only when (but not merely because) the existing locked-in profit exceeds the new risk.

Diversification: While concentrating on UK equities, hold as many separate positions as possible so that no single company-specific adverse event can be fatal.

Averaging Down: Always average down across-the-board, and do so with less risk each time by placing same-size spread bets at lower prices.

Trade Exit: Never sell out manually except to partial-close a position at the top of a swing while leaving the remainder to run for higher profit. Otherwise allow profit-securing stop orders to close positions.

As I have already hinted: don’t treat this as a concrete trading plan for you to follow. It might not work for you and your trading mentality, and it might not continue to work for me either. But I have a plan that leaves me in no doubt about what to do in any given situation, and so should you.

Summary

In this section we have considered some of the trading techniques or ‘tricks of the trade’ that complement the ‘tools of the trade’ that were discussed in the previous section. Whereas the tools of the trade will enable you to drive the trade, the tricks of the trade will help you to become a better driver.

The section concluded with a sample trading plan that combines elements of the ‘tricks of the trade’ and which takes the emotion out of trading by telling you exactly what to do under various trading circumstances. Not that the sample trading plan was intended to tell you what to do exactly.

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