Over the past two days, I have made some decisions that have violated my cardinal rules of trading. I am posting this excerpt from my trading plan to once again remind myself and our members why we have them in place. Know your plan, trade your plan, and have the discipline to stick to your plan.
1.1. Plan every trade: Before executing a trade, know exactly what prices you plan to enter and exit. Know exactly how much money you are trying to make for every trade and how much money you are willing to lose. Properly planning a trade and executing within the parameters of that plan demonstrate discipline, the most important quality for a trader to possess. Remember, he who fails to plan plans to fail.
1.2. Always trade according to the pivot signal: When trading to the long side, the equity must be on an S3 or R4 buy signal. When trading to the short side, the equity must be on an R3 or S4 sell signal. If you are trading on a signal, you should stop out as soon as the opposite signal is confirmed.
1.3. Every trade must have a risk to reward of at least 2 to 1: Knowing your risk to reward ratio is an important part of rule number 1, planning your trade. By achieving a risk to reward of at least 2 to 1 or greater on every trade, over time you will be able to be profitable by keeping your winning trades greater than your losing trades. Remember, your risk to reward is greatest the nearer you are to your stop and least the nearer you are to your exit point.
1.4. Space out your entries: By spreading your entries over a greater price range, you will be able to improve your average cost and maximize your risk to reward ratio. Sometimes, traders are tempted to build into large positions quickly believing that they are right. The market has a tendency for inflicting the maximum amount of pain and will almost always squeeze these traders out of a winning trade because they are forced to cut their positions to limit P&L losses. By spreading orders, you avoid this pain when the trade is working against you and maximize your winnings when the trade eventually moves in your favor.
1.5. Stick to your stops: If you follow rules one through three, you will always have a chosen stop out price. Remember that this price was chosen for a reason and falls within the guise of your plan. Changing your stop once it has been set shows lack of discipline and will almost always lead to failure. If you believe that you are being stopped out too frequently, consider revising the way you plan your trades rather than changing your plan once it has been set.
1.6. Be aware of the time of day: Different periods of time throughout the day session tend to have different characteristics. The market tends to have higher volatility and volume during the earlier and later parts of the day and tends to be relatively slow during the lunchtime hours. Being aware of movements in the stock market that typically occur at certain times during the day can help you maximize your larger trades and help you avoid trading during a sluggish market. Also, mark your P&L each hour and analyze your data to know when you make or lose the greatest amount of money.
1.7. Be aware of external forces: Before entering a trade, be aware of any external forces that may cause the trade to behave in an unexpected manner. These forces include economic numbers, earnings reports, M&A activity, major news, and unexpected exogenous factors. When planning a trade, be aware of these forces and be prepared in the event of an unexpected shock.
1.8. You can’t pick tops or bottoms: Many traders believe that they have the ability to determine exactly where a stop it going to halt its current trend and begin a reversal. This leads many traders to build into a large position too quickly and stop out before the trade ever has a chance to work. Instead, scale into the trade up to your determined reversal point and give the stock room to move through your level before the trade begins to work.
1.9. Keep a journal: Collecting data and thoughts on your trades is the only way to evolve as a trader. At the end of every day, write a few paragraphs regarding what you did well and what aspects you need to improve upon. Ask yourself, what type of trades have consistently made money? What is my edge in this business? What types of situations should I avoid entirely? Failure to keep a journal often leads to trading decisions based on emotion and presumption. Documenting the facts of your trading will allow you to know precisely what works and what doesn’t.
1.10. Plan for the next day: Once the market has closed, reflect on the day’s action in the market and develop a thesis for the following day. Think about what type of trades you will be looking for and familiarize yourself with important levels on your names and the overall market. It is important to formulate several different plans to account for every potential market scenario.
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