BUILDING THE PERFECT MASTER PLAN
What are the components of a good trading plan? Here are 10 essentials that every plan should include:
Skill Assessment
Are you ready to trade? Have you tested your system by paper trading it and
do you have confidence that it works? Can you follow your signals without
hesitation? Trading in the markets is a battle of give and take. The real pros
are prepared and they take their profits from the rest of the crowd who,
lacking a plan, give their money away through costly mistakes.
Mental Preparation
How do you feel? Did you get a good night's sleep? Do you
feel up to the challenge ahead? If you are not emotionally and psychologically
ready to do battle in the markets, it is better to take the day off -
otherwise, you risk losing your shirt. This is guaranteed to happen if you are
angry, hung-over, preoccupied or otherwise distracted from the task at hand.
Many traders have a market mantra they repeat before the day begins to get them
ready. Create one that puts you in the trading zone.
Set Risk Level
How much of your portfolio should you risk on
any one trade? It can range anywhere from around 1% to as much as 5% of your
portfolio on a given trading day. That means if you lose that amount at any
point in the day, you get out and stay out. This will depend on your trading
style and risk tolerance. Better to keep powder dry to fight another day
if things aren't going your way.
Set Goals
Before you enter a trade, set realistic profit targets
and risk/reward ratios. What is the minimum risk/reward you will accept?
Many traders will not take a trade unless the potential profit is at least
three times greater than the risk. For example, if your stop loss is
a rupee loss per share, your goal should be a Rs 3/- profit. Set weekly,
monthly and annual profit goals in rupees or as a percentage of your portfolio,
and re-assess them regularly.
Do Your Homework
Before the market opens, what is going on around the
world? Are overseas markets up or down? Are index futures such as
the Nifty or Sensex exchange-traded funds up or down in pre-market?
Index futures are a good way of gauging market mood before the market opens.
What economic or earnings data is due out and when? Post a list on the wall in
front of you and decide whether you want to trade ahead of an important
economic report. For most traders, it is better to wait until the report is
released than take unnecessary risk. Pros trade based on probabilities. They
don't gamble.
Trade Preparation
Before the trading day, reboot your computer(s) to clear
the resident memory (RAM). Whatever trading system and program you use, label
major and minor support and resistance levels, set alerts for entry and exit
signals and make sure all signals can be easily seen or detected with a clear visual
or auditory signal. Your trading area should not offer distractions. Remember,
this is a business, and distractions can be costly.
Set Exit Rules
Most traders make the mistake of concentrating 90% or
more of their efforts in looking for buy signals, but pay very little
attention to when and where to exit. Many traders cannot sell if they are down
because they don't want to take a loss. Get over it or you will not make it as
a trader. If your stop gets hit, it means you were wrong. Don't take it personally.
Professional traders lose more trades than they win, but by managing money and
limiting losses, they still end up making profits.
Before you enter a trade, you should know where your exits are. There are
at least two for every trade. First, what is your stop loss if the trade goes
against you? It must be written down. Mental stops don't count. Second, each
trade should have a profit target. Once you get there, sell a portion of your
position and you can move your stop loss on the rest of your position to break
even if you wish. As discussed above, never risk more than a set percentage of
your portfolio on any trade.
Set Entry Rules
This comes after the tips for exit rules for a reason:
exits are far more important than entries. A typical entry rule could be worded
like this: "If signal A fires and there is a minimum target at least three
times as great as my stop loss and we are at support, then buy X contracts or
shares here." Your system should be complicated enough to be effective,
but simple enough to facilitate snap decisions. If you have 20 conditions that
must be met and many are subjective, you will find it difficult if not
impossible to actually make trades. Computers often make better traders than
people, which may explain why nearly 50% of all trades that now occur on
the New York Stock Exchange are computer-program generated. Computers
don't have to think or feel good to make a trade. If conditions are met, they
enter. When the trade goes the wrong way or hits a profit target, they exit.
They don't get angry at the market or feel invincible after making a few good
trades. Each decision is based on probabilities.
