Welcome back! Chris Burgess here with part four of our series on designing a trading plan. However, I want to summarize the steps we've covered already in this series and leave you with some parting thoughts.
As we learned in Part I, the first step to designing a winning trading plan is to decide on your goals for your trading account. Your goals are a personal reflection of your current financial situation and where you want to get to. The goals you set for your trading account now will help guide your decisions throughout the entire process. Your goals determine whether a strategy is right for you or whether a change in approach is required along the way.
Think of your trading account like a ship and your goals as the destination. If you don't know where you're trying to get to, as the Cheshire Cat so aptly put it, "then it doesn't matter which way you go." We don't want to be a rudderless ship, being pulled along and tossed about by any financial wave that happens to come our way. Just like with a real ship, that approach is nearly guaranteed to lead to ruin eventually. Instead, you are the captain of your ship, and you must make intentional decisions about where to steer your account and, perhaps more importantly, where not to go. Only this way can you reach your eventual destination.
No matter what goals you set for your trading account, take a moment to think about where your trading account fits into your overall financial plan. I like to use Robert Kiyosaki's simplified personal financial statement when envisioning my own trading account and overall financial plan. Remember that your trading account is an asset that sits in the asset column of your personal balance sheet. From there, you can decide how cash may or may not flow into or out of your account. By placing your trading account in its proper place and deciding ahead of time how the cash will flow, you can avoid future mistakes that would otherwise come from mistaking the trading account's role in your financial plan.
Once you've gotten that settled, the next step is to determine your time horizon. Are you a day trader? A long-term investor? Or somewhere in between? If you don't have extensive trading experience, I highly recommend beginning with a longer time horizon. You don't have to be a long-term investor but plan on at least holding onto positions for a couple of months. This gives you enough time for your trades to work out without you having to fret about the market's day-to-day movements and being constantly glued to your monitor. With a time horizon of 90 days or so, you can check your positions only once or twice per week and still be able to make adjustments as necessary. It frees up your time and helps get you out of your own way so that your positions have a chance to make a profit.
Knowing how long you plan on holding onto your positions will inform you about what type(s) of analysis you will need to perform. The longer you plan on holding onto a position, the more familiar you should be with the underlying company and its industry. If you plan on being in and out of a position on the same day, you don't need to know anything about the company, but you should be very familiar with how the stock trades over short time frames. Your time horizon will inform the approach you'll need to take for maximum chances of success.
Third, after you've decided on your goals and desired time horizon, you'll need to decide which strategies will most likely help you achieve your goals. I believe this is where most newer traders go astray. It's very easy to get distracted every time you learn a cool new strategy. I'm guilty of this myself. But before you start trying any new strategy, you must ask yourself: "does this strategy fit my trading account goals?" If it does, then it could be an excellent opportunity to add a new tool into your trading tool belt! But if the answer is no, then I would recommend ignoring it for the time being. If you want to try it out, then try it in a different account, such as a paper trading account first or another trading account with different stated goals.
There are endless amounts of strategies available to you in the stock market. You will naturally be drawn to some strategies and repulsed by others. Choose the one(s) you are most interested in, as long as they fit your goals. The more interest you have in a particular strategy, the more work you will do to perfect it and get it working for you. If you are trying to trade an uninteresting strategy, you may quickly lose interest and make costly mistakes.
Once these three steps are in place, you're well on your way to meeting your trading goals. Most people never sit down to figure this stuff out when they first open a trading account. They simply learn some cool new strategy, fund a new account, and start trading. It's no surprise that most retail traders lose money. Now you can avoid those mistakes and instead start your trading journey the right way.
Of course, there is much more to trading than just these three steps, but the rest tends to be more tactical stuff. For example, risk management is a huge topic that is absolutely crucial to protecting your capital. Risk management can be a part of your trading plan, or it can be a tactical step to every trade you take. Most often, it is both. For example, you may decide that no trade will ever risk more than 5% of your total capital at any time. Or perhaps you always set a $100 trailing stop loss or some other R-unit size.
Just like with strategies, there are nearly unlimited ways of managing risk. Stop losses and R-units are two common tried-and-true methods of managing risk, among a sea of others. Just like choosing a time horizon, choosing risk management methods will be determined largely by your risk tolerance. More aggressive traders may opt for wider stops and looser capital controls, while a more risk-averse trader might have tighter stops and small position sizes.
Ultimately, there is no "right" answer, just personal preference when it comes to trading plans. If you struggle to make money in the stock market with your chosen approach, it might be worth taking a different approach for a while and comparing performances to see which suits you better. You may have started the process thinking that you're a more aggressive trader only to find out that you're actually quite risk-averse and your large positions are keeping you up at night. In that case, reduce your position sizes to the point where they no longer worry you and consider tightening your capital controls on future positions.
This is just one example of adjusting as you go. As the captain of your trading account, you must decide when it's necessary to course-correct in order to meet your goals. Always keep in mind where you're trying to get to, as that will inform your decisions every step of the way. As long as your trades are always in line with your trading plan, you will keep working steadily towards those goals. And before you know it, you may have achieved more than you ever thought possible. Until next time!