4 Questions Your Trading Plan Should Answer
A trading plan gives a day trader points of reference as market action unfolds quickly in real time. It enables them to always know what to do next, and how to do it. Specifically the plan should answer four key questions.
1. When should a trade be opened?
You must specify some trigger which will signal you to take a trade, for example: (i) Buy if price moves down to a key support level or penetrates a resistance level. (ii) Sell if a "fast" moving average crosses below a "slower" one. (iii) Buy if an expected news item meets some specific criterion. The trigger must be clear, unambiguous and easily determined in the heat of battle. When the trigger is detected, you act.
2. How large should the trade be?
A signal to buy or sell is not enough unless you also know what size investment to make. In futures trading, this means knowing how many contracts to buy or sell. There are various strategies you might choose. For example: (i) Always trade the same number of contracts. (ii) Identify where the initial stop loss order is placed, calculate the level of risk per contract, and divide this into the highest level of acceptable risk per trade to find the number of contracts to trade.
It is very easy to get this wrong and find yourself carrying too much risk, or missing opportunities by being in too small a position. Trading with the right position size is possible the factor which makes the greatest contribution to the ultimate success or failure of the trader.
3. Where should the initial stop be placed?
Never enter a futures trade without placing a stop loss order to guard against catastrophic loss. Choose a strategy for setting the stop loss level, such as: (i) Use a "money stop". Knowing how many contracts you want to trade, calculate how far away from the entry the stop must be placed to limit loss to a fixed amount. (ii) Use a "technical stop". For instance, place a stop below a previous support level for a long trade, or above a previous resistance level for a short trade.
Whichever method is chosen, the plan must clearly specify the process so that you do it automatically in the trading session.
4. How will the trade be exited?
Before you get into a trade you need to know how you will get out! You should already have a stop loss order to exit if the trade loses, but what if things go your way? Various approaches are possible, for example: (i) Set a target. (ii) "Trail" the stop loss order to lock in profit as the market moves your way. (iii) Exit after a certain time period, or just before the end of the session.
Whatever your intention, you need to know ahead of time and the plan must specify exactly what to do. If you have a target, where is it? If you trail stops, when do you move the stop and where do you move it to? Ensure that each element of the plan dovetails neatly with the other parts. Write it down and learn it thoroughly through practice trading before using it in a live situation.
David Bennett is a futures trader based in Australia and the author of the unique TradeOnAuto software. It may be that you are compelled to look at books you never looked at before. Trust your inner feelings and go with the flow. Einstein was right: You can't change something with the same mind set that created it.
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