Written By Gary Stone
When it comes to active investment in the market, it makes a lot of sense to define how you’re going to do it.
The greatest traders and investors in the world define how, when and why they are investing. They understand that they need a map for getting to where they want to go and that their trading plan will help guide them towards making the right decisions at the right time.
A trading plan will provide structure and encourage discipline to your trading actions. It will help you monitor your progress, hold yourself accountable and measure your success. It will provide a basis for you to be clear about your current situation at any given moment; it will reveal your goals, outline your strategy and define the risks and the rewards.
Whether you’re a trading veteran or simply a beginner, a well-thoughtout trading plan is the vehicle you need to reach your destination. As important as it is to have a trading plan, it is equally important to stick to it. For some of us this is easy to adhere to, whilst others struggle with the concept and the reality of sticking meticulously to the rules they have defined in a strict trading plan.
One of the main reasons some traders and investors are unable to stick to the rules of their trading plan is a lack of confidence in the plan. This lack of confidence causes them to exit trades at a price different to what is indicated in their trading plan. Therefore, instead of exiting at a pre-defined price generated by a system, stop loss point, or profit objective, they will jump out of a trade somewhere in between based on news (noise) or an emotional response to the current price action.
So here’s a question for you: If you really do have a trading plan, what percentage of your exits and entries have you correctly followed? I am a big believer that we all need an unambiguous decision support system that helps us stay objective and unemotional about when to buy and sell. However, as unambiguous as any good system might be, how are you following it? With trust and confidence or doubt and question?
Your discipline in sticking to your trading plan can be measured, reviewed and improved. As part of your trading strategy you can include Key Performance Indicators (KPI) and measure how closely you are sticking to your rules and trading plan. The number of errors you make based on aspects such as noise, emotion or oversight can be counted and reflected upon for improvement. Count any errors by comparing when your system generated the buy or sell and when and why you actually executed it. If a large proportion of your trades are not executed in line with your system or rules, it is possible that you’re managing trades by feel and not by the rules of your trading plan. Trading in this manner lacks consistency and will negatively influence your returns over the long term.
While there are occasions when emotion based trading will minimize losses and lock in gains, only an elite few have intuitively mastered this ability on a continuous basis. Eventually, for the remainder of us, emotion based trading does not work because it is not repeatable, thus creating inconsistency and frustration. What may work today won’t always work tomorrow. Furthermore, trading in this manner will increase stress and create bad habits for repeatable indecision. If your trading plan is solid, more often than not, it should be worth following. So, it is important to put in the effort to test the robustness and resilience of your plan before you start trading or increase your exposure.
Traders often bail out of plans when they have not had sufficient firsthand experience with those plans and thus naturally lack confidence. The best way to determine if a trading plan suits you is to trade it with a small amount of capital and with small position sizes, or at the very least in a simulation or “paper-trading” mode. Make mistakes when the risks are small. Follow the rules of the plan religiously for a given number of trades. That will tell you if the plan truly suits you and it will also give you the first hand realization regarding whether or not it is worth following. You can’t expect yourself to tune out noise on a short timeframe unless you have a high degree of conviction in what you see and plan keeping in mind the big picture.
Gary Stone has more than two decades of experience and is founder of Share Wealth Systems, a leading provider of share market trading strategies.