Whether you trade using fundamentals or technical analysis, use a discretionary or systematic approach, or a combination of all of these factors, a plan is really what separates traders who are profitable from ones that are less so.
Of course luck can play into performance, but in my experience luck can only last so long and a trader who is in the markets for many years will need much more than luck if they are to be successful.
Personality will naturally play into a trading plan, as will lifestyle and ambition, and new traders will look at these traits to shape the parameters of any strategy.
A stringent risk and money management strategy is always at the heart of any plan. Identifying the instrument, potential entry and exit points are also included, while other factors such as goals and emotional controls will also be considered.
At the end of the day a trading plan is designed for a trader to understand why exactly they are trading, the controls around managing each position, and what exactly gives them their edge.
Think of trading like a business. You would never just open a business on a whim and a business owner would put significant research into understanding issues such as potential demand, costs and competition and only when they feel they are ready will they start operating.
The same principles can be applied inside your equity strategy- is the company you want to trade growing its revenue? Is the earnings growth due to cost cutting or organic behaviour? Is profit sustainable or is it declining due to internal or external factors? Research of these areas will give you a good base for developing your strategy for trading equities.
Why is it useful?
Firstly we have to understand why we are trading and what exactly we are trying to achieve. From here we can shape a plan.
We need to remember that we are only human and despite society leading us to believe we have to be right every time, the sad reality is that is very difficult. Therefore we need to put a plan in place that creates an edge, something that gives us an advantage over the competition, a positive expectancy so to speak and ultimately gives us the confidence that despite being wrong better days will be ahead.
Experience has shown me that emotion is the single biggest factor that impacts new traders, which of course stems from not having a plan. The idea that we have to be right will often see traders panic and close a trade early, just to ensure a profitable trade.
When a more experienced trader (with a plan) would not close unless the rules specified so and as a result often the position would keep on running despite that momentary hiccup. Of course on the other side of this equation a trader will often let his/her losses run in the hope that they make some profit regardless of how much and subsequently the price keeps going against them, forcing them to act irrationally.
A plan will hopefully eliminate much of this emotion and invoke a sterner discipline.
So if we apply those principles to our equity trading strategy, if the share price moves against our research and trading plan, a disciplined trader will not wait to have his or her research proven right, they will cut the loss and look to add to equity positions that are following their strategy.
How do you develop a plan that suits your personality?
It can take time to achieve a plan that really fulfils the sort of confidence to succeed. However there is plenty of education online, as well as education providers who will claim to give you the tools to be equipped to become a better trader.
The first thing I would ask is ‘what am I trying to achieve from trading’? From here I would look at the time I can invest in trading and the level of capital I have to use. Naturally an understanding of markets, technical analysis and of course leverage (if you chose to use it) is required and that in itself is a constant learning curve.
Understanding risk and money management is key though and this is central to any plan, so whether self-studying or choosing a provider who will give you a guide, these aspects must be integral to the plan.
I would then use a demo account to trial out any system and then more importantly use live money, as this is where emotion will play a role – naturally start off small and when you are comfortable you can increase the size to fit the risk parameters.
However I wouldn’t follow a rule that states I have to put 1 or 2% of my total capital on each trade – if using leverage let leverage be the guide here and the greater the leverage the less you effectively deposit on the trade. Major equity securities (such as Singapore Airlines or DBS) may give you sizeable leverage and thus only need 10% of your capital.
Nothing beats experience
Traders can be actively trading for many years and still feel they lack that real edge. For a business to really mature it takes time and this is how you should approach trading.
The number one reason why I see traders stop is the inability to stick to a plan, with emotion taking over and every rule thrown aside. For me there are really only two ways to control emotion; use a systematic approach and the other; experience.
Until that point, mistakes will be made and that is where money management helps.
Ten key questions to ask yourself:
- Do I really understand leverage and how to use it to my benefit?
- Which is the best instrument to take advantage of my trading theme? The AUD is not the best proxy of China these days.
- Am I a trend or breakout trader, or do I trade reversals for example?
- Do I have a strong money and risk management strategy?
- What is it that I want to achieve from my trading account?
- Do I have a firm understand of technical or price analysis? Do I need one?
- Is the technical and fundamental story saying the same thing? Put the odds in your favour.
- What time frame do I want to trade (i.e this could be 30 minute or daily charts)? This is personality driven and will dictate my risk management as well.
- How do I manage the emotion attached with trading?
- What tools, research and resources do I need to make a success of trading? Is my broker helping me gain the edge?