Friday, January 12, 2007

The key to trading success in any market - your trading plan

It never ceases to amaze me how many traders I know that are working on finding the perfect strategy. Just the other day I was talking with a gentleman who has a mechanical forex strategy that averages 200 pips per month with an intraday drawdown of about 500 pips. Now mind you that's a pretty good strategy and this takes into account spread and slippage. This is only one of the decent strategies that this guy has at his disposal. So I asked him how much he was making with this strategy. He told me that he isn't ready to trade it and is still looking for improvements. I happen to know that he's had access to successful strategies for a couple years now. But he doesn't trade them. His excuse is that they aren't good enough, but the truth is that he really doesn't have the fortitude necessary to trade.

How many of you are saying to yourselves, well that's not me - I just haven't found the "one". By the "one" I mean the Holy Grail. Well as I'm sure you've heard, the Holy Grail is not any trading system, but about how you trade.

The key to trading success in any market is - Have a plan and then trade the plan. It's that simple. To prove it I'm going to show you one of my trading plans and how I execute it every day.

Trading Plan 1 - Short term momtum index futures trading on the Russell


Every trading plan should have a purpose. The purpose of this trading plan is to provide consistent intraday returns with moderate leverage and moderate risk. The goals of this system is to gain 10% ROI per week with a maximum intraday drawdown of 25%.

Entry setups

Entries are looking for short term scalping moves on the Russell. To achieve this we are looking for extreme overbought and oversold conditions (i.e. we are looking for the market to revert to the mean) and also for breakouts of support and resistence (i.e. we are looking to capture initial trend momentum).

To measure the above factors we are utilizing several technical tools including support and resistance as measured by TRO's red and blue S/R dots (see to learn more), RSX which is a indicator similar to RSI (see to learn more) and lastly price (never forget that).

With these conditions and tools we now dicate that there are two types of entry setups: 1) we are looking to buy when the market is oversold or sell when the market is overbought or 2) we are looking to buy when the market is breaking above resistence or to sell when the market is breaking below support.

See picture for explanation.

Exit setups

These are straight forward. We are utilizing a scalping method which has a near 1:1 ratio of risk/reward. Thus we are risking about 1.5-2.0 points to make 1.5-2.0 points. We will only exit when either our take profit or stop loss are hit.

Money management

For the above setup and exits to work, it is critical that we have a win ratio of greater than 55%. In fact based on testing it looks like our win ratio is approximately 70%. Additionally, for our ROI requirements and risk requirements to be met it is critical that we risk about 4.5% of our account on each trade in a fixed fractional methodology. This ensures that if your account goes up or down we will still trade the correct size for our account. Also to ensure that our psychology remains intact we will set a limit of losing no more than 10% per day or 20% per week.

Final Touches and Putting it to work

Of course we would be remiss if we did not include some mention of when to trade this methodology and as I mentioned earlier I trade this plan between 6:30 a.m. and 8:00 a.m. PST because that is when I feel I can get the most out of it. Additionally, I utilize market sentiment from the other minis ES, YM, NQ to make sure that I am only taking trades that are market moves.

So that's an example of a trading plan. Once you've completed your own trading plan the key is to test it thoroughly - preferably in real time. Take at least 30 trades with the system and then alter the plan as needed at the end of those 30 trades (or maybe not at all). Once you've completed that you are ready to trade. Keep a journal of your trades (like the one at my blog) and tell yourself that you will take the first 30 trades exactly the way they are outlined in your plan. This will ensure that you gain the confidence to trade your way to success.
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Banker said...

Excellent post. The plan is the key. I have been trading for many years and at times (to many to be honest)I have deviated from my plan. Any trader can learn from this post.

Lord Tedders said...

Thanks. I too have deviated from many trading plans. That's why I really love the idea of once having formed a plan to commit to it for at least 30 trades.

Banker said...

I am currently reading "Inside the house of money" by Steven Drobny (excellent book). In it he interviews Macro traders and one Yra Harris, a floor trader, talks about leaving stops with somen=one else (in his case it was his sister). He claims this is what saved him alot of money when the UK announced that they would join the EMS at 2.95 (he was short). He said if he was watching he might have hesitated. A non partial/biased person does not.

Lord Tedders said...

Yeah I personally don't understand the concept of mental stops. If you've placed your stop in the strategically correct position then it will only be hit when the trade proves itself wrong.

I suppose that if you feel that you need to use a mental stop (say like you're trading 150+ cars) then leaving it with someone else would be a good idea. If you're not trading any serious size I can't see why you would bother.

Those who complain that their broker "hunts" their stops are typically the ones who don't have a trading plan in the first place. And that isn't your broker's fault.