When markets are volatile, it’s more important than ever to remain disciplined, and stick to your trading plan. Don’t have a trading plan? You should! Over the years I’ve been working with clients, I have observed that very few of them have a trading plan. However, trading is like a business and should be taken seriously. Would you start a business without a business plan? Would you drive across the country without a roadmap? Trading can be very intense. It can be fun, or it can be miserable. I have found that the traders who take the time to learn about the markets, formulate a plan of attack and outline some basic trading rules are the most successful over time. I will outline some key factors to consider in developing your own plan.
Skill Assessment
There are individuals who trade on their own, others who trade using a system, and others who work with the assistance of a broker. No matter what your skill set, you have to understand how the markets work, and what your strengths and weaknesses are. If you are brand new to trading, find a mentor. Work with a professional to help you learn the ropes. Be realistic about your skill set, and plan for virtually any situation that might come up.
Mental Preparation
You want to be mentally prepared when you trade futures, and prepared to execute the plan you set in place even if your emotions might be telling you to override it. Stocks and futures are two different animals. Futures can carry more potential risk and often are more volatile. Not only do you need a plan to control any potential losses, you have to be able to control your greed when a trade is going your way. Keeping your emotions in check is a key aspect of mental preparation. You don’t want to carry personal issues into your trading. You might have a rule not to get involved in the markets on extremely intense days, for example, because you are too emotional and might make a mistake.
Set a Risk Target
I can’t stress enough how important it is to understand the risks involved in trading. You have to have a plan for every single trade. What’s the amount of risk you are willing to take before a margin call comes up? If you have a sound-proof plan, you shouldn’t have to face a margin call. But even if you do find yourself in that situation, you should also have a plan of action so it won’t devastate you or drastically impact your lifestyle. Remember, trading futures should be done with risk-capital only, not money you need for everyday expenses.
So, how much should you risk on a trade? That might differ depending on your financial situation, but no matter how big or small your account size, you don’t want to risk it all on one trade. You need to be able to weather some losses if they occur, and still have capital left to trade. My general rule is to risk 1 to 5 percent of your account value on one trade. If you lose 5 percent on Monday (the maximum loss according to your plan), then on Tuesday, you might scale down to 4 percent of your remaining account value on the next trade. If you wind up being positive, you can go back to risking 5 percent on Wednesday. However, if you are down two days, perhaps you scale back even further on the next trade. Or, perhaps your plan dictates after two days of losses, you step aside from the markets and rethink what went wrong before entering another trade.
Your plan might also outline the specific triggers to enter and exit a trade, taking your 5 percent maximum risk into account. You have your orders ready and waiting when the market hits key support or resistance points, for example. If the market hits those levels, you execute your plan. That way, your emotions are out of the equation.
Set Goals
Goals are also an important part of the plan, other than just “make money.” Where specifically do you want your account to be at the end of the month, the end of the quarter? How exactly will you get there? Outline the steps you need to take to achieve your goal. Keep records of every trade, and every goal met or not met. When you don’t meet your goal, look back and see what went wrong, and think about how you can correct it. Start simple at first. Perhaps you start trading one market, one contract at a time. As you hit your goals and your account size increases, perhaps you increase the number of contracts per trade and expanding into more markets.
Do Your Homework
Understanding the factor that might influence the market you trade is very important. For example, if you trade crude oil, you should know that the Energy Department releases inventory reports every Wednesday. Of course, you won’t know what exactly they will show, but know that this report tends to move the market, so trade could be volatile on that day, and could make a break one way or the other. Perhaps on days like that, your plan says you close out of your existing trades, then wait until the volatility subsides before you enter a new one. Of course, anything can change the course of the markets during the day, but taking the time each morning to prepare yourself not only for routine events but also any unexpected ones is very important. Do you have a plan in place if your computer crashes and you have open orders? Are you prepared if the market moves violently against you?
Exit Rules
I think everyone who trades has some measure of greed in them. That’s part of what makes markets. However, people often struggle with where to exit a trade whether it’s a profitable one, or losing one. Establish rules when you will call it quits on a trade. Perhaps when you’ve made or lost 5 percent, or when the market hits a key technical level. Even if your potential could’ve been larger, you’ll be less upset taking a small profit than a big loss if the market quickly turns—which it can. You want to examine where you get in, what your risk is, and what your target level is. If you don’t want to cap yourself on your winnings with a specific percentage, then you can use a trailing stop. If that’s your plan, stick with specific parameters you have outlined. Everyone handles this issue differently, but I believe it’s very important.
Keep Records
Pay attention to what happened in the markets each day, what your trades were on those days, and the profits or losses. You can start to see patterns develop and it can help you prepare for future trades. For example, if you see precious metals turn lower at key times, and/or you see you keep making the same mistakes during certain market conditions, that information might help you in your future decisions. I keep records and charts of the markets going back about 10 years, so I can see key turning points in the markets, what caused them, and how any trades played out during those times.
These are just general guidelines of what to consider in developing your own plan, and why it’s so important. If you have any questions on this topic, and would like help developing your own trading plan, please don’t hesitate to contract me. If you are new to trading, or you have been trading for years and aren’t getting the results you’d like, I encourage you to talk to professional such as myself to develop a new plan, or hone your existing one to help you achieve your goals. It’s always wise to have a second opinion.
Tim Haberkorn is a Senior Market Strategist with MF Global. He can be reached at 800-993-6601 or via email at thaberkorn@mfglobal.com
MF Global also offers a free brochure, “Develop Your Trading Plan” with more information on this topic. Get it here.
Futures trading involves the substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which MF Global believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
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