Why You Should Have a Trading Plan (and Stick To It)
It’s getting to that time of year. That crazy Christmas season which entangles us all; rushing around madly trying to pick up last minute bits and pieces. Fighting tooth and nail for the rarest commodity on Earth — a vacant car space.
Bags of ice and the smell of barbeques; sausages getting cooked (cremated) to within an inch of their life. It’s the time of year when so many of us try to stop for a bit and take whatever break we can.
But there’s also something else that comes along with the festive season. Newspapers and magazines will produce bumper issues, with list after list spouting their best ideas, and the ‘dos and don’ts’ for the following year.
You might be planning to buy a car, an investment property, or to travel to some exotic location. There will be a list that rates the best five, the top 10, or maybe the number one thing to avoid.
And it’s no different with the share market. Soon we’ll be reading about the best dividend stocks, the best growth stocks, and which is going to be the hottest sector in 2017.
While these best stock ideas can be a great reference to use as a basis for your own research, the one thing that shouldn’t change is how you approach these ideas.
The boring stuff matters
For those interested in trading, one of the great fascinations is the sheer volume of books that have been written about the subject. There are thousands of them.
From the most basic technical indicators (like moving averages), through to complex and obscure candlestick patterns, every author attempts to share their ‘unique’ corner of knowledge with the reader.
Yet the more of these books you read — irrespective of what the actual trading strategy is — the more clearly one underlying message becomes: Create a trading plan and stick to it.
Yep, it all sounds a little bit boring — it’s even painful to type. Yet, despite how many times we read it, it easily gets lost in the haze. Especially when we’re sure that a position going against us will eventually turn around.
But what makes a trading plan really very interesting is that it is custom designed for you. It’s your opportunity to put down on paper a plan that reflects your own personality.
All too often, traders and investors believe that they’ve got to change into someone else before they’ll be successful. That they’ve got to be some robotic-like machine banging out trade after trade.
That couldn’t be further from the truth.
A healthy dose of self-assessment
What it does require, though, is an honest and very frank look at what makes us tick. Before we even get to the point of looking at which trades to do, we’ve got to make sure we’re in the right market.
For example, someone who’s very considered — that is, someone who wants to take their time — won’t usually fit in to a fast-trading environment. No matter how much they may want to trade it, a futures-based market just might not suit them.
Nor will the futures market suit someone who dislikes risk — the contracts are far too leveraged for them.
However, it works both ways. A futures trader would make a really lousy ‘buy and hold’ type investor. For someone used to doing dozens and dozens of trades every day, holding an investment for months and years would be anathema to them.
No sooner would they be in a trade than they’d be looking to take whatever profit out and move on to the next trade.
But the one place where we might need to curtail our personality is when it comes to managing risk. And this is where it becomes harder.
Where to get out
Picture the trader from central casting — they’re super confident (let’s say ‘cocky’), and always prepared to back their own judgement. They’ll often stick with a trade, long after it goes against them. They’ll stay with it until they are proved to be right.
The obvious flaw is that they’re going to ride the stock all the way to the ground. For them, sticking to a stop-loss is particularly hard to do.
But the opposite also applies. Someone who believes the world is against them, that nothing goes their way, will bail out of a position the moment it goes against them. A downtick to them is yet more proof that the universe has placed a big ‘X’ on their forehead.
For them, the opposite needs to be applied. They need to find a way to give a trade enough room to be profitable; to place a stop-loss that is based on something beyond their personal view of the world.
While there might be a little bit of both of these types of personalities in all of us, most are somewhere in the middle.
But, irrespective of our worldview, the one thing that both personality types need is a pragmatic place to exit. And this is determined by a simple rule.
Instead of placing stop-losses at our personal pain thresholds, we need to place them (before entering the trade) at a point on the chart that proves to us that the trade has gone against us.
Or, in other words, at what price level does a stock price need to hit before we know that the trade hasn’t worked out? This is the place that we need to place our stop-loss.
Using a trading plan — and trading in markets — that suits our personalities will enhance our chances of success. But that’s just the first step. The next step is to understand our weaknesses (and biases), and find a pragmatic way to exit our trades.
Editor, Total Income
From the Port Phillip Publishing Library
Special Report: The Lazarus Project, your best chance to double every dollar you invest this year. Click here for more…