Trading has very low entry barriers and can be a consistent and independent business, if executed thoughtfully and planned conscientiously. The goal for every individual should be to bridge the gap between a ‘Trader’ and a ‘Professional Trader’. In order to effectively plan for your trades, the three main price points — entry, exit and stop loss and your position size — are of utmost importance. Inter-operability and your ability to adhere to your trade plan should help you to effectively plan your trades and, thus, successfully manage your portfolio.
1. Trade Plan
Trading is a business, and no business is successful sans a business plan. Reading a few books, buying a charting program, opening a brokerage account, and starting to trade with real money is not a business plan. The trade plan is a comprehensive document that aims to define and clearly plan a strategy around your capital allocation, risk management and most importantly, your short & long-term goals. Key points to consider include the amount of risk as a % of your portfolio, your risk vs reward ratio and your exit levels (both upwards & downwards). A stop loss is imperative; however, equally important is the exit price when the trade has gone in your favour. Therefore, effectively defining your multiple price points (entry, exit and stop loss) in conjunction with the risk profile will help you to effectively plan trades. It’s a pseudo standard operating procedure and the lack of one can get you into serious trouble.
2. Trading is 98% Psychology – key to effectively plan your trades
The power of a clear mind when planning your trades is of utmost importance. We are all dogged by some negative information or scenario in our lives, sub-consciously increasing the pressure and dependence we place on our trading careers. This is a recipe for disaster. Building your confidence, drowning the unnecessary noise and sticking to your trade plan will hold you in good stead over the longer term. Given the ease with which information is available, as a trader it is normal for you to go through a range of emotions when taking your trades. The fear of missing out, trading to recover your losses, and trading in a shell can seriously hamper your gains. 80% of day traders quit within 2 years of trading. It is in your hand to be a part of the remaining 20%. Always stick to your trade plan and make it a point to drown out the noise.
3. Position Sizing
Position Sizing is defined as the quantity a trader buys / sells. The underlying factors driving your position size include risk, volatility and capital you are comfortable with. A combination of these factors, as defined in your trade plan, ensures your portfolio sizing is optimally executed. Subsequently, once you have entered your trade, periodically reviewing your size during the trade and maintaining a balance is equally imperative. Some strategies to employ when your trade is heading in the right direction are scaling up and pyramiding. Simply put, the practice involves adding quantity to stocks when in the right direction or peeling of some shares and / or raising the stop loss and thereby reducing your risk. Sizing strategies helps in increasing returns, decreasing risk and volatility and ultimately improve return to risk.
4. Stop Loss and the importance of adhering to one
The word “Stop Loss” has been overused in the recent past. And rightly so! A stop loss is a pre-determined amount of risk that a trader is willing to accept with each trade, and limits the loss size a trader is exposed to during a trade. Ignoring stop loss, even if it leads to a winning trade, is a bad practice. Exiting with a stop loss, even though it leads to losing a trade, is still a better practice than not adhering to stop loss limits. Using a protective stop loss helps ensure that our losses and risks are limited.
5. Human Emotions of Fear & Greed – putting it all together
Your win size builds your confidence, but there is a stark difference between being confident and over-confident. Stick to your trade plan and adhering to the defined rules ensures your emotions are kept in check. Similarly, a losing trade should not surprise you. It is the cumulative profits that should drive your agenda and ultimately your trade plan.
To summarise, an effective trade plan ensures reduced time spent on charts that are irrelevant, taking trades that do not match your rules, not missing trades and then chasing price, consistent risk management, and not changing indicators or methods to find quick fixes.