All successful traders have one common, yet very important ingredient in their trading methodologies: a game plan.

“When it comes to planning, many traders can be compared to the German army during World War II–in that the invasion of Britain was planned but never executed, while the Battle of Britain was executed, but never planned,” said John C. Tirone, senior technical analyst for Chase Manhattan Bank in New York, and a trader for 30 years. “Many traders and investors go through their sometimes very short investing lives planning trades they never execute and executing trades they never plan.”

Tirone was speaking at the Technical Analysis Group (TAG XVIII) meeting in New Orleans, held last week and sponsored by Dow Jones Telerate.

“Experience has proven that success follows the wise trader/investor who identifies an effective strategy, and has the discipline necessary to carry it out,” said Tirone. He said there are two key elements that distinguish the successful trader from the unfortunate majority: strategy and discipline.

Tirone said many traders take positions “based on impulse, hunch, or what they read from a newsletter–instead of reason–and then wait to get lucky. They have not learned or probably even thought about the fact that even the very best traders consider themselves fortunate to be right on most trades, or even to make significant profits during most years.”

“If the trader will take the time to plan his trades properly, he can possibly have the odds on his side in the long run, which is something few gamblers could ever attempt to achieve. Over the long term, those traders/investors that are still operating in the markets–and who have followed a carefully thought out and well-defined plan in a disciplined manner–expect to have favorable results,” said Tirone.

The basic elements of a trading plan should provide the reason for logically entering and exiting a position, whether it proves profitable or not. “Once a position is entered, the price can only take three paths: rise, fall or remain unchanged . . .”

“The heart of a game plan must indicate, unequivocally, how the trader is to exit from a trade he has entered.” Likewise, this critical area consists of three parts: 1) accepting losses if a position shows adversity; 2) a plan for accepting profits; and 3) a plan for exiting a trade if the price, over time, is negligible or does not meet expectations.
Exiting from a trade that shows a loss is best done with a stop that is implemented at the time the trade is executed, said Tirone.

Trading plans may be mental or written, but written plans are best, said Tirone, as they are more likely to be followed by the trader.

In a written trading plan, traders should include: markets traded, long or short positions, risk exposure per trade, total portfolio loss (not win) if wrong, and commissions paid. Also, considering each trade on its own merits may result in having a number of positions all long or short, and the risk exposure thus being heavily skewed in one direction (even if it may be the correct direction).

Traders should plot the amount of capital exposed per trade and its relation to total capital. “This is one way to force the trader to think of the dollar value of such a trade before it is entered,” said Tirone.

Other factors to log in a written trading plan include:

  • Reasons for entry into the position. This is “critical because you have to know why you are in this particular market at this time, said Tirone.”

  • Note the actual price of entry into the market, and how it compares with your plannedentry price. “The differences between planned entries and actual entries are sometimesgreat and could affect trading results.”

  • Note the stop-loss price level and the liquidation plan once the market is entered, aswell as the minimum profit objective and does it correspond with the risk involved in thetrade.

  • The trader should check his record of closed profits and losses, to ensure that resultsgenerally parallel the plan’s expectations regarding profit or loss.

“The final section of the plan is the ‘trade evaluation,’ which is commentary and control of the trader’s discipline. It is like a diary the trader should keep for a very long time, to compile his trading statistics.

“In essence this is what all successful traders do, and the results of the plan should be in accordance with his objective and risks parameters.

“The trader should have a plan form that is complete for every trade, and a strong enough discipline so that there is seldom a significant variation within his control between the actual and possible events,” said Tirone.