Lessons from the Pros

Components of a Personal Trading Plan

Let’s imagine you are going to build a house. Most of us would not have a clue where to start without some kind of plan to follow. In this case, the plans are called blueprints. Without these blueprints we will be lost as to what needs to be done when that big lumber truck pulls up and unloads a couple of thousand board feet of lumber on your lot. Obviously, there is a lot of expense in building your own home and you certainly don’t want to waste anymore material than you have to. Some of you may be able to relate to this saying in the building industry, "Do it yourself, it only costs a little more." This would be the case if you attempted to build without your blueprints. Just like the markets, you need some structure during the building process. The blueprints will help you build from the ground up and create a very sturdy foundation so your home is strong and secure.

You may have noticed the word "personal" in the title. I put this here because each of our trading plans will have to be personally and uniquely designed for each of us. Many people feel they just need a copy of somebody else’s trading plan and they can make money. If only it were that easy, right? Each of us brings unique trading and risk styles to the market. This creates the necessity to have our own trading plan. For example, you could give five traders the exact same trading style to trade for a week. When the week is over, you will probably see very random results. Some of the traders will take fewer risks than others and exit quicker when the market moves against them. Others will want bigger profits and stay in the market longer than some who would be content with making a smaller profit. This all comes down to our own psychological makeup.

Trading is a business and you will find that the majority of startup businesses that fail do not have a written business plan. Just because a trading business can be started for about $5,000 does not mean it does not need a written plan to operate successfully. If you were going to open a franchise somewhere, you could expect to have an initial capital outlay of $100,000 or more and I am sure you would have a written business plan for that business. Do not neglect your trading business plan simply because of the smaller cash outlay. If anything, having a smaller account size would make having a trading plan even more crucial simply because you don’t have much room for error in your capital base.

With all the software out there to use, creating a trading plan should be relatively simple after you figure out what components need to be in your plan. Keeping your plan up-to-date is very easy to do on a regular basis. After you first create your trading plan, you will probably have to tweak it about once a week. Then after a few months you can start making changes on a monthly basis until you are satisfied with your results and then just check your plan on a quarterly basis. Your trading plan should never be updated while the markets are open. Set a date to review and edit your plan. If you start changing your plan while the markets are open, you may find yourself making changes based on your emotional state rather than notes from your trading journal. Once you have a tested strategy and have written your plan, you will find that most of the problems you experience are not in the strategy itself, but within you. Having these rules in writing will help keep you on track with your strategy and remove most of the emotional portion of trading.

In trading, the only time you really have to think is during the process of writing your trading plan. I say this because once you have a tested strategy and have put it in writing, you should become like a machine looking for setups based on your plan. Once you see the setup, you immediately place your orders regardless of what is going on in the markets. This is not the time to be sitting there second-guessing yourself or the strategy. Have you ever had a setup and then looked at another chart or indicator you don’t normally look at and say something like, "Well, I had better wait and see what happens here, the stochastics is overbought and the Yen is not moving in the right direction either?" This is what gets so many traders in trouble. By doing this, you will be late or worse yet, miss the trade all the time. If looking at these two indicators for confirmation is part of your plan, then it is fine to use them, but if they are not part of the written plan, then you have no business even thinking about them.

Another problem with overriding your plan is it opens the door for emotional trading to step in. For example, if you get into the trade too late because you did not follow your plan, your stop and profit objectives have been skewed. Now you have to start trading with emotion to tell you when you want to take profits and where your new stop is. The odds are very high you will mismanage this trade and end up losing or cutting your profits short with an upside-down risk/reward scenario.

Let’s discuss some of the components you want in a successful trading plan:

• Why do I want to be a trader? Be specific here and identify the reason you are pursuing this career. Is it the money, the freedom you expect to have, time with your family, etc.?
• What are you looking to get back from trading? Obviously, the money is important but not the end result for all. Perhaps you like being challenged by the markets to test your knowledge and skills. Knowing this answer will help you stay focused and know you have a good reason to be trading.
• Do I have some special qualities that will make me different than other traders, perhaps an added edge? Be thinking about your background and past experiences to see if you have something extra.
• We will also want to identify our weaknesses here, too. This will help us to avoid known areas where we have had trouble in the past.
• Having a weakness in an area does not mean you have to avoid doing something. Ask yourself here what you can do to help yourself become stronger in these areas of weakness.
• Is trading going to be a part or full-time venture for you? Here you want to explain the amount of time you are going to dedicate to your trading.
• What type of trader do you see yourself being? This actually comes down to the amount of time you dedicate to your trading. You need to know if you are going to be a day, swing or long term trader. If you are a day trader, this means being flat before going home. Do not carry positions overnight if you are a day trader.
• Identify markets that you want to trade. I am a firm believer in knowing your markets before you trade them. Make sure you list the markets you will trade in your plan and do not deviate from them until you have studied other markets and have a good understanding of each new market you wish to trade. Selecting the markets you trade could be related to the amount of time you have to dedicate to trading.
• Identify your daily time allocation to your trading task. Trading is a very isolated business. Therefore, we need to have some structure of how we will spend our trading day. I like to identify the times of day I will do pre-market, post-market analysis and hours I will spend trading. Also, consider your lunch breaks and hours you will spend in the office each day. Trust me, without this, you can literally spend your life in the trading office. Make time for yourself so you do not get burned out by working in the office too much.
• What is your setup for entering the market? Here we want to put down every detail that will be used to execute a trade entry. If you do not list it here, then you should not use it while trading. Again, this just takes the emotion out of your trading. List how you will enter the market – breakout, limit order, market order, etc. This also takes the thinking out of trading when it comes time to pull the trigger. "See it and do it" is your objective in defining your entry technique.
• Defining how and where you will exit is just as crucial. How many times have you heard somebody say, "Where do I get out and how?", after they have already entered the trade? This is pure emotion trading at this point and is a guaranteed ticket back to a real "JOB." Mention here how you are going to scale out of your position or are you going to use a trailing stop or perhaps you are setting a limit order to exit? Whatever you choose, just make sure you put it in writing. This goes for your protective stop and your profit objective exit.
• Risk Management! This is by far the most important section. Make sure you identify how much of your account you are willing to risk per trade. Also, list what your maximum loss will be for a trading period before you stop trading. These circuit breakers are what will stop you from blowing out your trading account and should be respected. If you do not control your risk, then there is a very good chance you will be one of the losing statistics in this business.
• Identify the trading tools you will need and use. For example, the charting and order entry platform are probably your biggest considerations. Identify which one you will use and list your fees for budget purposes.
• Brokerage. Identify your broker and breakdown your commission rate here. Also, list all the contact information you have for your broker and post it near your computer in case you have to call him quickly.
• Have a plan for your profits and replenishing your trading account. List here your plans for taking a monthly draw of your profits and how much you intend to keep in your account. Try not to keep too much excess cash in your account. What tends to happen is you will get more careless and not as selective with the trades you take. Keep the extra money in another interest bearing account where you can get immediate access, if needed. Have a plan on how much you will replenish your account with if it drops below a set minimum you have established.
• Beginning and maintenance levels of cash to keep in account. List here how much you intend to start with and also the maintenance level at which you might interject more cash if need be.
• List your office hours and the holidays you plan on taking. This part will help you treat your trading more like a business and not a hobby. We are self-employed but we must have some discipline to follow at the same time.
• How often will I update or review my trading plan? At first, this will probably be weekly, then monthly and after that, possibly quarterly. Remember to make changes only after market hours.
• Taxes. Keep in mind we do have to pay taxes on our gains. Either have an accountant pay these estimated taxes or do them yourself, but identify how and when you will do these tasks.

These are some of the most important components of a trading plan and I am sure you can think of some others to go along with these. My goal was to give you a foundation for creating your plan and then allow you to add your own personal touches.

For those of you already using a trading plan, I applaud you; for the others, I strongly urge you to create one for yourself. Ask anybody who uses a trading plan about their stress levels and confidence in their trading plan and you will see a successful trader. Once you take the thinking and emotion out of your daily trading, you will see remarkable results. If you have problems pulling the trigger to enter a trade, this could be from not having a good trading plan. Create a trading plan and you will be amazed at how easy it is to place a trade. All the anxiety goes away because you know what each move will be after you enter the trade. No guessing, just hard and fast rules to follow. The trades are actually run in the subconscious mind where things happen automatically.

Good trading,

- Don Dawson