Transcript:

 'Successful Trading' - Episode 3: Elements of a Trading Plan

Presented by Jeff Bryant, HomeTrader.

Hello - and welcome to Episode 3 in our series on Successful Trading.

In the first 2 episodes, we looked at the differences between Trading and Investing, and Why We Need A Trading Plan. If you haven't seen these yet, I suggest you have a quick look in the archives, because they do introduce some important concepts.

In this episode, we're going to look at the elements of an effective Trading Plan.

But what IS a trading plan? It’s a set of RULES that is designed to govern your actions in any given circumstance in the market.

The market can really only go Up, Down or Sideways - regardless, your rules will tell you what action to take.

A properly constituted trading plan is one that can be written down; you could give it to someone else (preferably someone you trust and have them trade on your behalf - and nd do so without needing to seek any clarification. In other words, your plan will be unambiguous.
    
Furthermore, your plan will preferably be able to be programmed into a computer. The benefits of this are substantial – but more on that later.

We consider a trading plan to have 4 key components. In no particular order, these are:
* Style
* Entry
* Risk Management
* Exits

Style is all about YOU - and we are ALL unique. Your rules need to take into accounta number of things, such as:

* Fund size - different amounts of money may require different trading considerations.
* Risk tolerance - the degree of risk you are prepared to accept in your trading.
* Objective - why are you trading? Is it for capital growth, income - a combination perhaps?

The second component of a trading plan is the Entry Conditions – a precisely defined set of conditions that a stock must meet to ‘qualify’ for your money. This is your plan’s due diligence – and near enough is not good enough. A stock must meet ALL your conditions before you act.

The third component is Risk Management. This is the essential ingredient of your trading plan – the importance of which simply cannot be over-stated.

We know that in course of our activities, we will get losing trades. There will be time when our profit curve is in decline. We call this drawdown. With a proper plan, you can control how much (on average) you are prepared to lose in any individual trade - and you can decide how much drawdown you are prepared to accept. You are in control (Not the market!)

And so,on to the fourth component of a trading plan – the exit strategy. We’ve talked in previous episodes about the need for an exit strategy. This is the main factor that differentiates the Trader from the Investor.

We consider the exit strategy in 2 parts. The first, we call the Initial or Fixed Stop Loss - so called because it’s literally like a safety net under the trade. By putting this mechanism in place, we establish a maximum loss for our position. The stop loss is literally there to stop further loss.

The second part of the exit strategy is to lock in profit when the price moves favourably. We do this with what we call a Trailing Stop. We still give the stock room to breathe,but it also tells us when to take our profit and move on to the next opportunity.
     
Once we have all these elements in place, we can then approach the market in a structured and consistent manner.

Beyond all that, we can apply our rules backwards in time, to get a feel for how they might have behaved over a wide range of different market conditions. This process is called backtesting – and while we recognise that the past is no guarantee of future performance, the benefits of being able to test our strategies before we enter the market are enormous.

Your backtesting can provide information like:
* profitability,
* maximum drawdown,
* number of trades and
* win rates…
     
You can see if your plan works before you start spending money!

Ok that’s it for this episode. Once again, if you’d like more information, just visit our web site at hometrader.com.au - and book in to one of our free Information seminars.