While it is true that a map will not take you anywhere – without one you will probably get lost.
Pre-planning is the essence of good trading. It forces us to think. It removes the impulse to jump into a situation followed by the need to scramble to get out.
I recommend that all planning be done in writing. A good method is to figure out what you want to trade and why. This reasoning should be based on your original mission or goal and then printed out on a chart.
On the chart, you need to make all of the necessary notations. You need to show where you plan to enter the trade, and where you will exit. You also need to calculate the size of the position based on the amount of loss that could be incurred if the stop loss is hit. You also need to check your math to be sure you are complying with your 2% risk management rule, or whatever risk management rule you have adopted.
You also need to make a note of where you intend to take profit, and if necessary how you will move your stop, once the trade is profitable.
In a separate section of the chart, you should list why you are entering the trade and the circumstances or conditions you will be looking for as the trade unfolds.
For example, you may enter a comment that you will reevaluate the trade if the Federal Reserve changes its policy on interest rates. This action may affect the demand for the stock, commodity or currency you are trading. By highlighting the event, you will be prepared for it.
When you prepare a trading plan, you may need to plot other charts for other timeframes and other instruments. If you take a position or swing trade on a stock, you may want to show the chart for the particular sector your stock trades in.
You should also note industry or company news that is likely to affect the stock that you are following.
By going through this process, you build up a case for making the trade. You may be right or you may be wrong. The important thing is that you will have rehearsed in your mind the situations that will cause you to act.
If circumstances other than what you have anticipated should occur, you can abandon your trade or go back to the drawing board to fine tune your approach. There is no perfect science in trading. Trading is a craft, which means that it is a blend of science and art.
By doing the necessary actions repeatedly, you start to develop a process that eventually becomes a habit. A habit is a channel of least resistance in your mind. The more you do something the easier it gets.
The formation of habits takes place whether you practice good habits or bad habits. So it is up to you to have the discipline and patience to implement a program built on habits that an “Artful Trader” would repeat.
A good solution for developing a trading plan is to design a ritual for regular and repeatable preparation.
For example, each weekend when the market is closed, read a newspaper that specializes in the markets, such as Barron’s. Review the activity of the previous week and read what the pundits have to say.
Then, prepare weekly charts of the markets that you are interested in trading. Do the charts correlate with what you have read? Are the prices responding to the news in a way that is logical?
What factors are likely to increase demand? What factors are likely to increase supply? Remember a chart is a picture of the supply and demand for a particular market instrument.
