Don’t Leave Home Without It… your Trade Plan, That is.
Last Tuesday I was daydreaming about the homemade cinnamon rolls they bake at the Hide-a-way Cafe in Solana Beach when the phone rang. It was my friend Mark. Great guy.
Mark has an easy-going charisma I found immediately likable.
He’s a family man, loves his kids, calls his mother once a week – the whole nine yards. Seriously, I bet you catch him in church on Sunday morning..but he’s a lousy trader.
That’s not a character assassination.
Many people with exceptional qualities are their own worst enemy when it comes to stock trading.
Mark wanted to know how he should handle an ETF (Exchange Traded Fund) position which had, earlier that day, moved significantly against him.
Jarred from my dalliance with a piping-hot cinnamon roll the size of a notebook PC, I checked to see if the name was in my database and grabbed a daily chart.
The same trait that makes Mark a poor trader has been the demise of some of history’s greatest speculators: NO TRADE PLAN.
So much is written about the subject you’d think that more investors would have one.
But in order to benefit from this knowledge, we must bridge the significant gap between awareness that a plan is necessary and the establishment of a method that uniquely subscribes to the trader’s style. That, my friends, is the purpose of this article.
First, let’s identify the three (3) components I believe are requisite for any trade management method:
1) an initial (maximum risk) stop;
2) a price point at which the trader moves the stop to break even; and
3) a target or exit trigger.
The first component tends to be static and derives from the price action of the setup in question.
The second and third are variable and lend themselves to extraneous analysis and second-guessing that frequently result in traders breaking their own rules.
Even in absence of advanced trading and tape-reading skills, you should be able to locate a technical price level which, once breached, reduces the trade to an unsuitable speculative venture. This is your initial (maximum risk) stop.
Avoid fixed percentage and static price stops.
The closer this price area is to your entry price the better.
Stick with areas of strong established support.
Astute price action traders can generally locate a stop candidate (unlikely to be hit) with less than 5% risk.
The break-even price point is trickier. Momentum stocks need breathing room.
Place your break-even too early and you’ll be taken out of the trade during morning weakness only to discover a new daily high by mid-afternoon.
Exercise patience and focus on breakouts and percentages.
Wait for a fresh high that exceeds your entry price by at least 5% or the amount of your maximum risk.
This helps to assure that you’re acting prudently but not prior to necessary follow though (best confirmed by a new high breakout).
Undoubtedly the third component is the most difficult to establish and follow once made into a rule.
The reason? Trading is one of the few industries in which you’ll always be aware of the effects of your decisions.
If I take a shortcut across town I’ll never know if I avoided rush hour traffic or saved any time at all.
But thanks to real-time information and human frailty I’m condemned to witness the price action which succeeds my trade decision.
Establish a target, exit your position and a strongly trending equity will leave you in the dust.
Decide to trade the trend with a moving average crossover exit and a Dow correction can sack the bulk of your profit like a 300-pound linebacker.
“You just can’t win!” Yes, you can win.
You can establish the exact details of the three-pronged method that best fits your trading style, leverage preferences, and account balance.
And you can trade every single entry in the same manner. At the end of the quarter or year, you can analyze the results.
You’ll be amazed by the efficacy of disciplined, consistent trade management.
You might even find yourself in early retirement. Forget the American Express but don’t leave home without a trading plan – the one that suits YOUR style.
And the next time you’re in Solana Beach and the waves pound the bluffs while the surf punks Hang Ten long board-style, slip off the sand, and hit the Hide-a-way…hands down the best breakfast anywhere.