Trading is a business like any other. A major part is the evaluation of risk for a potential trade. Everyone who has been actively involved in the financial market for a while knows to appreciate a trading plan.
Market participants who have been hurt with losses regret not having had one from the first moment on. Some are still trading out of gut feel after several years, but that is different category of traders which we do not want to discuss further here.
Questions to Ask Yourself
Imagine you were about to buy a property. Wouldn’t you balance the pros and cons of the neighborhood or the layout? Could the valuation grow faster at a different location? You certainly will not buy the first property that you find.
Unfortunately, this is how beginners generally approach trading. They have heard of a company’s stock and proceed to purchase without thorough research. The hurdles of opening a trading account and depositing some cash are low. Before developing your trading plan, you have to understand yourself most of all.
- Why do you want to trade? If your goal is to find entertainment or thrill, a trading plan isn’t really what you are looking for anyway.
- How much time can you dedicate to trading? This indicates whether you can harness large trends, or quick trades throughout the day.
- Can you handle a loss of $50, $500, or $5,000 per trade? This will narrow down the types of instruments and the lot size you can take on. How would such a loss affect you or your daily routine?
Your Personal Strategy
The next step is to find the right market and the appropriate time frame according to how you answered the questions above. For example, I have chosen the S&P 500 for myself because I want to focus on one market and trade it well. I also have the freedom to observe price action for several hours at a time, so I can take action when things are happening during the day.
If you prefer not to sit in front of the computer and yet benefit from timely trading signals, you may want to give the Trend Architect Club a try where members receive notifications after I have already done all the analytical work.
My setup is a combination of multiple time frames which are the monthly, weekly, daily, and 4-hour chart. It helps me to have them all at a glance. Even if you trade other markets, this charting setup can be a compelling idea for your own analysis.
Now comes the creative part: Developing a trading strategy. Create one that is as objective as possible because the more you understand what the crowd does, the more you will stand a chance of lasting through various market conditions.
A basic trading strategy comprises an entry and an exit strategy. Try to base these on empirically proven rules as much as possible. I cannot spare you the hours of screen time that you have to dedicate in order to find any insight, but take note of this: I abandoned practically all indicators and base my trading decisions on the price supported by a few moving averages. Your only focus should be on price action, because this is what every market participant is seeing. To learn more about what I understand with price action, check out this post.
I’m still amused whenever I come across screenshots of charts filled with indicators. My thought is, “gosh, can’t this individual make any decisions without them?”
You do not need any indicators. Full stop.
Managing the Risk
Risk management must be in place before you commit to any trade. Possible risk management techniques can be attaching a stop-loss order, or hedging positions with an instrument of high correlation. It comes down to the question of what the worst-case scenario is. We want to make sure to quit the trade if the original reason for entry is no longer given with the least amount of damage. I take recent peaks or troughs to place the stop-loss order at.
For specific entry and stop-loss order management tactics, you may be interested in learning more about it in my book Trading Trends to Maximize Returns.
Document Your Trades
Maintain a trading journal once you have collected some experience and want to get to know yourself better. Write down your reasoning for each action taken, and lessons learned for upcoming trades. It is absolutely fine to get stopped out, but it would be wasted to not take away some lessons learned.
Keeping a record helps to become more objective in your trading decisions. You engage yourself with the decisions made and will be more alert of making mistakes in future. The goal is to detach yourself from the fluctuations of the market. Is the original reason for your trade still intact? Then there is no need to budge. It is best attained by trading as little as possible. Trade within your means to avoid large losses and have enough gunpowder when your skills are improving.