Today we frequently hear stories about traders blowing out their entire accounts or about people who started with 100k only to have it near 20k within a very short period. Time and time again, when I talk to people about trading or my career, I often hear phrases like “Its way too risky for me..” or “the market is scary right now, how’s it treating you?” Usually my response to that is “It’s not how the market is treating me, it’s how I’m treating the market.”
What most people and most traders have not realized is the importance of having a plan for trading. Having a plan means a lot of things. In fact, the people who are successful at other careers generally all started with a plan. Trading is like a business and it must be treated that way. When a person is seeking a loan for a business or seeking for help in starting a business, most of the time you’ll hear the opposite party say “Ok, let’s see your business plan” or “what do you have planned?” People want to know where you are headed. The same thing goes in trading. Why would you want to risk your hard earned money in the markets without knowing what could or couldn’t happen? The markets don’t care about you or your feelings. It will gladly take your money in the blink of an eye, so it is extremely important that you have a plan of action.
Here are a few things you should write down:
- What market will I be trading? (i.e. Stocks, Futures)
- How will I be trading it? (daily,intraday, monthly)
- What percentage of my capital will I be risking per trade?
- Do I have a plan that produces a positive expectancy?
- What is my risk to reward profile per trade?
- What are my monthly/quarterly goals?
- What is my year goal?
After you’ve written down those questions, spend some time fully answering them. You should really do this because it WILL CHANGE how you trade. Now, if you get to a question, and you don’t have an answer, likeDo I have a plan that produces a positive expectancy?, what you need to do is really take the time to research and findONE PLAN and MASTER IT. If it’s one of your own plans that you created, have you tested it? Back-testing is by far one of the most CRUCIAL parts to being a successful trader. Why do I say this? Here is an example. If you owned a business, and you wanted to hire someone, would you just let the first person who walked in the door get the job? Most likely not. What you are going to do is interview a few candidates and figure out which person best suits your business. But what are you really doing when you are interviewing though? Well, what you are doing is you are subconsciously figuring out or analyzing if this person is going to produce a positive expectancy for your business. Are you going to hire someone who is going to make you lose money and/or driveaway customers? Of course not! The same thing goes in trading. You want to find a trading model that is going to be a net POSITIVE overall. You cannot take a losing system and turn it into a winner. This is why it is very important to test a model. After testing you will KNOW what to expect. If say you test 200 trades, and you find that 130 of them were winners and that your winners were 1.5 times larger then your losers, what does that tell you? It tells you that you have a positive trading system. So now when you start trading with real capital and out of your next 200 trades, you lose 70 of them, it should come as NO surprise. Losing trades is part of the business daily, weekly, monthly, yearly.
In the book Trading In The Zone, Mark Douglas makes some great statements that I truly believe are important. He states:
I AM A CONSISTENT WINNER BECAUSE:
- I objectively identify my edges
- I predefine the risk of every trade
- I completely ACCEPT the risk or I am willing to let go of the trade
- I act on my edges without reservation or hesitation
- I pay myself as the market makes money available to me
- I continually monitor my susceptibility for making errors
- I understand the absolute necessity of these principles of consistent success and, therefor, I always follow them with confidence and joy.
What you’ll notice about his statements is that it is he is assuming that you have already done the first set of bullets up top; that you have already created a plan and you already have a set of RULES. Now you might ask, how do I know if my set of rules now will work next month or next year? GREAT question. The market dates back all the way into the late 1700’s. There is literally a few HUNDRED years of data. That’s why I say that back testing is KEY. Now that doesn’t mean that you need to back-test 200 years of data. Not even close. You want to back-test a reasonable time depending on your time-frame of trading. For example, if I plan on trading based on a daily system, then I might back-test the last 5-6 years. If I’m going to trade based on an intra-day 3 minute chart, I would probably backtest about a year. There is no way to KNOW what is going to happen, but trading really boils down to probabilities. Time and time again the same things tend to repeat themselves. Why do you think the markets tend do to the same things over and over. Why does it seem that certain stocks that are in the same class look the same from a chart perspective? How come a company will report great quarterly results, but still go down? It’s because there is a greater number of traders that BELIEVE that this is where an equity is too much or too little. Why do you think there are people who are talking about a “recession” right now? Again, it’s because the same things seem to be occurring that did prior to a previous recession and people have that BELIEF.
So what does all this mean? What can you gather from all this? Well, a few things actually. One is to make sure you create, find and organize a PLAN for trading. Think about it as if you wanted to open up a company. Do the research and find out how some of these traders got started and what they did. Once you’ve done that, write down your plan and look at your questions from up top. Once you can answer ALL of them, then you are moving toward being a consistently profitable trader. Then take a look at what Mark Douglas wrote. You have to own these statements mentally. You have to truly believe that you are a consistent winner because of all of the statements above.
“Plan your trade, and trade your plan” – Anonymous
