Thursday, November 11, 2010

Trading Tools - The Trading Plan

The Trading Plan is an essential tool to every trader.  No matter what kind of trader you become you still need a Trading Plan.  A Trading Plan is basically a set of rules that guides your trades.  When developing a Trading Plan you want to create a plan that aligns with your goals but isn't to ridged that you can't make any trades.  The key is to establish entry points, how to handle a profit, how to handle a loss, and exit points.

My Trading Plan:

1. Enter on technical analysis
This is there to remind me that I am a technical analysis trader and need to remain that way.  I don't need to enter trades on watercooler talk, hot tips, earnings plays, etc...

2. Risk/Reward = 1:1
When looking to enter a position you want to make sure that you plan to get at least as much as you risk.  Putting more money at risk when the reward is low is usually not a good situation.  There are a lot of setups out there and this will help keep you profitable and at low risk.

3. Set stop-loss around resistance/support = Max 3-5%
You should always look at possible trades with a stop-loss in mind.  This is the price that if the stock goes down you position will be closed out automatically.  This is how you will measure your risk.  I make sure I put my stop-loss position around the resistance and support lines in a chart.  If I am going long then the stop-loss will be below support, and if I go short then the stop-loss will be above resistance.  I like to keep my risk limited to 3-5%, and if I can get 1-2% that would be even better.

4. Protect all profits = 3%, 5%, 10%, 15%
There is a tough balance in managing your profits.  Most people would think that having profits would be the easy part and having loses would be the hard part, but it is not that easy.  On one hand you want to cut your loses short and let your profits run, but on the other hand you don't want to watch you profits turn into loses.  I set these numbers to give me protection along the way in my profits.  As the percentage returns are reached I will move my stop-loss position up to make sure I walk out with a profit.  Some times it will knock you out of a position to early and some times it will be the best move ever.

5. Accept small loses
This is just something every trader needs to learn to accept.  Learn to take the small loses before they turn into big loses.  Taking a loss is always a hard thing to do but the quicker you can accept it the better off you will become.

That is my Trading Plan in a nutshell.  The idea of a Trading Plan is to help take the guess work out of your trades.  Less emotion and more system is a winning combination for any trader. 

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