Planning: A Key to Successful Trading

Friday, October 31, 2008

Planning: A Key to Successful Trading

From time to time I get some very interesting confessions. Here is a very recent one, along with a solution.

"Hey Joe! I had been looking at a profitable trade setup all day. I studied indicator after indicator looking for confirmation, even though I know many are correlated and redundant. But I just kept on searching. I thought, ’Maybe I missed something.’ My account is now so small that I just wanted to be sure that this was the right trade. My thought was that I must take into consideration anything and everything that could cause this trade to fail. I can’t afford to lose any more money. What should I do?"

Well, my friend, you need to be able to make a decision, but you can’t do it if you are trading undercapitalized and making your trading decisions out of fear and uncertainty.

You are suffering from too much analysis. You are looking at so many things, you no longer can see straight. If you keep on over-analyzing your trades, it may develop into a deep-seated psychological problem.

Carefully analyzing the possible consequences of your trading decisions is healthy, but it becomes unhealthy when it is overdone. When it comes to trading, it’s important to have a clearly defined trading plan. You want to be sure that any given trade is not going to wipe out your trading account. That is one of the reasons we want you to use a time stop in addition to a money stop. When you use both types of stops you are clearly defining the signs and signals that indicate your trading plan is not working, suggesting that you should close out the trade to protect your capital.

Trading, by its very nature, is uncertain. There is little that can be described as security for traders. Every trade is a new event, and every entry is an entirely new business. A trader does not have the luxury of living from his past accomplishments.

If you have an unquenchable thirst for certainty, then trading is not for you. Uncertainty in trading is co-equal with insecurity. If money represents security to you, you have a real problem as a trader. Losing money not only costs you your financial security, but also your emotional security.

At many of my seminars and private tutorings I tell people that I have completely divorced myself from the money involved in trading. I don’t even know until the end of the month whether I have won or lost. I trained myself to think of trading as an endeavor in which I strive to make points. Only later are those points translated to dollars. In that sense, for me trading is a game. But I never lose sight of the fact that trading is also a serious business.

Insecurity in traders who over-analyze manifests in searching for the holy grail of trading, desperately seeking the right indicator or the perfect trade setup. The problem you’re having is that even when you see something, you are not sure it is sufficiently perfect for you to act on. Why? Because you lack confidence in your ability to trade what you see. Because you lack confidence in yourself. And because you fear the pain of another loss.

Here’s how I was taught to do my analytical work.

First, I went through all my charts to get an overview of the markets. During that time, I looked for trending markets. Trend lines were placed on the charts as long as they had a 30° or greater angle. Until I became used to what that looked like, I used a protractor to determine the angle. This action got me used to identifying the trend. These days it is easily done with your software.

Next, I went through all my charts again looking for "against the grain" moves-the intermediate trend that went against the longer term trend. This alerted me to markets that might soon resume trending.

Then I went through all my charts looking for Ross hooks™. I marked each hook with a bright red "h". Then, in light of the size of my margin account, I tried to select those markets that appeared to have the greatest potential, and I placed order entry stops just above or below the hooks. These were resting orders in the market. I tried to never miss a hook. I phoned my orders in daily.

How did I know which markets had the greatest potential? The answer is simple. I selected those markets that had the strongest trend lines.

Now there was a trick to this. I didn’t want too steep an angle, because in a rising market that often signals that the end of a move is near. Markets that break out too fast and go straight up rarely give an opportunity for entry before they start to chop around in congestion. Markets that have been going up at a steady angle, and suddenly that angle steepens-goes parabolic, are giving a warning that the move may soon be over.

In down markets I was willing to allow a steeper angle, because often a market will move down a lot faster than it moved up.

What I most wanted was trending markets that were making a retracement. Then I could attempt an entry as the market retraced, when it reached the proximity of the trend line, and then seemed to resume its trend, and when it took out the Ross hook™ created by the retracement.

Sometimes I had to wait for weeks before the markets started trending. The same is true today; nothing has changed other than that intraday it can happen a lot sooner. There will usually be at least a couple of markets in that condition, but there are times when there are none.

Yet I did my homework every day. The only way to know when an important breakout, the beginning of a trend, would occur, was to perform my daily analytical work.

Finally, I would set my work aside and take a break for dinner. After dinner, when my head had cleared a bit, I would look at my charts again. I would then do my best to come up with a trading plan. I would try to think through what I was going to do. I would ask myself a million "what if’s." I tried to anticipate what might happen in the market.

Often that kind of thinking would cause me to eliminate some of my potential trades. Also, a second look at times resulted in "why didn’t I see this before?"

For instance, what if you look at a market that is approaching its trend line. Isn’t it reasonable to ask yourself, "If this market breaks the trend line, what would I do?" Ask yourself how such an event would change the picture. If you had a position, would you still want to hold it? If you had no position, would this cause you to take a position opposite what was the trend? If it would, then why not place an order entry stop with limit, just the other side of that trend line? Very often, when prices approach a trend line from what has been a trending channel, they are already in a counter trend within the channel. That means a breakout of the trend line would be a continuation of this newly formed trend.

Finally, I would put my work aside and go to bed. In the morning I would look at my charts once again. Then I would write out scripts for the orders I wanted to place.

I would rehearse how authoritatively I was going to give these orders.

I did all this and more before I entered a trade. But do you know what most traders do? They do their analysis after the trade is made. Too often, they do it when the trade is already going against them.

How many times have you entered a trade, and then said to yourself, "Oh no, why didn’t I see that before?" How could you have seen it if you hadn’t looked, and looked again, and thought about it, and then perhaps looked one more time?

Also, many traders do their analysis after entering the trade in search of a justification for having entered. "Now I’m in the trade, let’s see if I can find out a couple of good reasons as to why!"

If you want to be a successful trader, you have to be hard. Hard on yourself and hard on your broker. I don’t mean that you have to be a rat, or be impolite, or be contemptuous. You just have to be firm in all that you do. You can’t afford to be "Mickey Mouse" about the way you do things. This is a business; you must be businesslike in conducting your affairs.

As a business person, you must manage your business. One of the main functions of management is planning. You have to plan your trades. Other things to look for as you go through your charts are: One-two-three formations, cups with handle, matching congestions, reversal bars, and Doji’s. These should all be part of your plan.

Some people give more thought to choosing which flavor ice cream to eat than to which market to enter and how and when to do it.

By not taking the time for preparation, you end up not having enough time to weigh the pros and cons or really familiarize yourself with what you are getting into.

You don’t have time to realize that prices have supported two ticks away from your entry about forty times in the past. You don’t have time to see that you are trading right into overhead selling. You don’t have time to notice that if prices break out of yesterday’s high, they will also probably take out a Ross hook. You don’t have time to see where prices are in relation to the trend line. You don’t have time to really grasp the overall trend, or the wave that is going counter trend. You don’t have time to really consider where you will place your stop. You don’t have time to read the market and to see what it might be telling you.

All of these things can be done ahead of time. If you do not do your homework, you will end up chasing markets in a desperate attempt to get into "the big move."

by Joe Ross