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What is a Trading Plan - and Why You Need One?
How do you make money without picking tops and bottoms? I am glad you asked... Successful trading is similar to a successful business. You see, every successful business has a business plan so do successful traders. The astute reader knows that, successful traders have a systematic way they approach the market. The definition of a trading system is a trader's business plan; it defines your approach to trading... 1. A properly constructed trading system will leave no room for human judgment The importance of this trading plan cannot be understated. Without a consistent set of guiding principles to govern your trading decisions, most traders will hop from one trade to the next, guided by emotion or hysteria. I firmly believe that not having a plan, you are doomed to fail. Trading systems themselves will come in many varieties, although they all take the guesswork out of trading. A trading system will determine for you when to buy or sell. System trading has proven itself consistently to be the most effective long-term trading technique. In fact, you may have even heard the story about one of the most famous system traders of all time, Richard Dennis. It just so happened, in mid 1983, Dennis was having an ongoing dispute with his long time friend Bill Eckhardt about whether great traders were born or made. Dennis believed that trading could be broken down into a set of rules that others could learn. On the other hand, Eckhardt believed trading had more to do with innate instincts, and this skill comes naturally. In order to settle the matter, Richard suggested that they recruit and train some traders and give them actual accounts to trade to see which one of them was correct. He named his protégés after visiting turtle farms in Singapore; he decided to grow traders similar to the way farmers cultivated turtles, hence the name: Turtles. To cut a long story short, Dennis taught his trading methodology to these groups of students who later became some of the most successful traders of all time; proving finally, that anyone can become skilled at system trading. Just like the turtles, I too have studied under a mentor who tutored me in the science of trading. Now, I pass these secrets on to you. A trading system is simply a set of rules that address every aspect of a trade such as entry and exit conditions and money management. Regardless of how complex it may be, a good test for your trading plan is to hand it to someone else to read thoroughly. See if your selected candidate asks questions. If they can easily understand all the rules and the requirements of your strategy with little to no questions, then you have compiled a sound investment plan. All successful traders that I meet do this and they have their exact trading methodology written down. Since most traders lose money and do not have their trading methodology written down, does not it make sense to do what the masses are not doing? If you are trading now and have not taken the time to write out methodology, then stop trading and get it done! Why is it so important? When you take time to sit down and spell out how you perceive the markets, you are accepting the fact that you might be wrong. You are beginning to accept responsibility. Once you write down how you perceive the market, the only conclusion you can arrive at, if the market does not behave according to what you wrote, is that your perception is wrong. When you write down how you are going to enter a trade, only if certain events transpire, you eliminate any possibility of blaming the market. You are forcing yourself to have discipline. In other words, if you determined that certain bullish signs show up in your market then you enter into a long position. If these prior events occur, and you did not enter the trade, that failure is your fault. The Components of Your Trading Plan: A business plan has set components; so does a trading plan. In fact, there are three major components within any trading plan and they are entry, exits and money management rules; here is a quick summary: 1. Tested Entry Rules -- Entry rules are a precise set of rules that an instrument must pass before you enter a trade. Entry rules should be simple, direct, and leave no room for human judgment. 2. Confidential Money Management Rules -- Perhaps the most important and least addressed aspect of trading is the ability to manage risk. A profitable trader is one who has the ability to manage the risks associated with trading. A trading system should define exactly how much money you are willing to lose on any given trade. 3. Tested Exits Rules -- Entering a share is all to no avail if you do not know when to exit a position. Having rules that defines your exit is equally important as one that defines your entry. When you take time to write down your trading rules, you transform your mental reality to a physical reality. You cannot fudge the numbers, or avoid taking responsibility. By writing down your methodology, you are forcing yourself to create a series of decisions based on how you see the markets and this my friend is just the beginning. -=-=-==-=-=-=-==-=-=-=-=-=-=-=-=-=-=-=-
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