Initial Steps you need to develop your Trading Plan

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  • Step One: Decide on the amount of your initial trading capital. This should be money you can afford to lose, and not be borrowed or loaned.
  • Step Two: Consider your family and financial commitments carefully and the time you may have available for trading. Think about the markets, the best times to trade and how this fits with your own personal work/life balance. If you have a job – keep it – your trading plan has to fit into your life, not the other way round. Look for the best fit, and adapt your trading approach accordingly.
  • Step Three: Which approach are you going to take? Purely technical, purely fundamental, or a mixture of both. Explore them both. Read and digest arguments from both sides, then make your own mind up. Relational comes later, much later, as your experience grows.
  • Step Four: Think about the advantages and disadvantages of various trading approaches. Your chosen approach may be dictated by your personal circumstances. If not, then consider the pros and cons of each, and in particular how each will suit you, your temperament and your personality. This is extremely important and needs careful thought and consideration. There is no right or wrong way to trade, just the way that suits you.
  • Step Five: Set yourself realistic, simple and achievable targets, which should be non-financial. Do not set monetary targets. Trading success is about two things primarily – consistency and money management. If you can be consistent over an extended period, then the money will flow. Being consistent is about the number of pips you make in a week or a month, not about how much money. Twenty pips a week may not sound very much, but at $10 per pip it’s $200 and at $100 per pip it’s $2,000 per week.

Once you have a solid set of money management rules in place with your plan, then you are looking for consistency. From consistency comes money – it’s just a question of increasing your contract size on each trade.

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  • Step Six: Define your money management rule depending on the amount of trading capital. The minimum is 1% and the maximum is 5%. The rule you set is the maximum – you do not have to use it for each position!
  • Step Seven: Based on your decision about your approach to the market, both in terms of timescales and technical, fundamental, or a combination, you now need to start thinking about how you are going to define an entrance to the market. What is the trigger? How do you decide? What are the rules? Are there any rules or are you going to be a purely discretionary trader? All of these things you will need to consider and seek guidance. Again, there is no right or wrong answer here. There are many, many ways. You may decide that a piece of software is the correct way to start, or perhaps using one of the many technical indicators which are freely available?

I will give you my own view later in the book, as this is a huge topic in its own right. Many traders like to define hard and fast rules in their trading plan. In other words, I will do A if B happens. This could be very simple, or complex, but in essence, it is a rule set that defines the entry. It will probably not surprise you to learn that this is not a route I advocate for many reasons, not least of which is that this is too prescribed. It verges on the mechanical, and the market is not a mechanical animal. If it were, then trading would be very easy.

If your entry is going to be discretionary, then that’s fine, but within your plan, you just need to try to define what the parameters are that signal an entry or what’s often called a ‘set up’ for your new position. What you will probably discover is that your entry decision will be based on a combination of elements, perhaps, as in my case, volume, price action and a simple indicator.

  • Step Eight: Define your management and exit rules. This is another very grey area for novice traders, and I’m afraid one that non-traders write about a great deal, and sadly write a great deal of nonsense. Again, I am going to cover this in much greater detail when we start putting everything together, and the reason I include it here is simple. You do need to say within your trading plan how you are going to manage any position, and what your exit is based on – if it is purely discretionary then that’s fine and no problem at all.

Many trading books at this point will suggest a simple risk-reward relationship and once that has been met then you exit. This sounds very simple in theory, but that’s where it stops – in theory! The practical is very different. After all, why should the market give you 20 pips if you are prepared to risk 10? Or 30 pips, or whatever target you have in mind. The market does not work this way and never will, which is why you have to be discretional in your trading management and exit.

Let me explain with a simple example which combines the entry and the exit and uses the hammer candle, and the shooting star candle that we looked at in one of the early chapters.

Suppose your entry rule for a long position is a hammer candle and the associated exit rule is a shooting star. The opposite would be a shooting star for a short position as your entry trigger and a hammer candle for your exit rule. A very simple rule set, which can then be applied to your trading timeframe which might be a 5-minute chart, an hourly chart or a daily chart. That is your rule.

Do you follow this rule blindly and without thought of each position? Well possibly, but I doubt it very much.

What happens when your entry rule, a hammer, for example, is then followed on the next candle by a shooting star? Do you exit immediately? Probably not, and the reason, is simple. You have only just entered the position and your mindset is still in ‘hope’. You are hoping for a profit and not yet prepared to consider exiting at a loss after such a short space of time, which is one of the reasons these types of rules simply don’t work.

The corollary to this is that you might say, well I will adjust the rule to say after X bars. In other words, if my exit candle appears within 1 or 2 candles from my entry, then I will ignore it under my rules. Very soon, your rules become discretionary, or very complicated!

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Let me give you another example which is a common rule that traders apply when trading in a market that has a physical exchange with an open and close – stocks for example or an index future. The rule here is generally something along the lines of: ‘never take a trade in the first ten minutes of the open’. This sounds very plausible. In other words, let the markets settle down before taking a position. But why 10 minutes, why not 9 or 11 or 15 minutes? And what happens when an opportunity appears after 9 minutes and your rule states that no position is to be taken before 10 minutes have elapsed. Do you wait? Do you take it? Is one minute important? This is what happens when you put these sorts of rules into a trading plan, which is why I have a problem with them, and I hope that you can start to see why!

I’m going to cover this in more detail later in the book for you, but this is perhaps the one area that is the most difficult for new traders. The only rules which are set in stone are your money management rules. Everything else is discretionary, they have to be. Traders who have trading plans which have no leeway will fail ultimately. The plan may work for a while, but market conditions then change, and the old rules no longer apply. It is rather like opening a shop and saying that today I want to make X. Well you may want to, but what if the weather is bad, the road is being dug up, it’s a Monday, or a shop close to you is having a sale? All these factors will play a part. Nothing stays the same day to day, and it’s the same with the markets. Every day is different, every day there are different forces at work, and to think that a mechanical plan will work consistently is somewhat naive.

Your plan needs to reflect this and needs to be practical. If you are going to take your signals after a break out from congestion, then say so. If you are going to do this in conjunction with a technical indicator, then say so. What your plan will not say is precisely when you are going to act. Equally, if you are going to exit when the market moves into a congestion phase, then say so in your plan and you will then need to explain how that congestion is defined on your chart. At least you then have a basis, a framework around which to work, and not some hard and fast rule set which is unworkable, inflexible, and probably much too complicated.

Don’t worry, if this doesn’t make sense right now, it will be the end of the book, but remember, I will be teaching you what I believe is the correct approach – you may disagree! But I hope I can convince you.

  • Step Nine: Then choose your broker with care – there are many good ones out there, but quite a few bad ones. Make sure you carry out due diligence before sending off your hard earned trading capital. I explain all about the good, the bad and the ugly of the trading world later in the book, as well as the various types of brokers and the questions to ask.
  • Step Ten: Execute your first trade with the minimum contract size available. I do not believe that paper trading in a demo account teaches anything of value, other than perhaps how to use the trading platform. In many cases, the live and demo feeds are very different from one another, and any strategy you decide to test in a demo account simply will not work in a live account. Spreads may be very different and some orders may simply not be available. My advice is to go straight to a live account, but trade using a micro lot as a starting point as you get started. This will allow you to become familiar with the platform, with trading, with entering, managing and exiting positions, using the smallest financial risk possible.

When you have a live position, focus on the pips, not the dollar amount. This will help to reduce the trading emotions, which I will cover shortly in more detail.

Finally, keep a diary of your positions and why you opened them. This can be very simple but will help you to improve the insights gained when you look back at your trading history. Note down what you traded, and when, the entry trigger, and why you closed out, along with details of what happened next. This will then build into your own personal trading diary and also help to highlight possible problem areas. Perhaps you are being stopped out too often, in which case you may need to adjust your lot size and increase the pip loss per trade. Perhaps you are closing out too early and existing strong positions too early. Perhaps you are trading with a bias, always short or always long.

All these things and many more will be revealed in your trading diary. It does not have to be pretty and no one else will ever see it, but keep one you must. It is the diary of your trading journey and will help you enormously with your skills and knowledge develop.

Finally, your trading plan is a living thing. Don’t be afraid to make changes to it, to tailor it or adapt it, as your circumstances change and your knowledge grows. Nothing is cast in stone forever and provided you maintain your money management rules, everything else can be modified to reflect changes in your personal life.