Five market scenarios that may cause cracks in your trading plan. And, how to patch those cracks.
A plan (and sticking to it) is the backbone of a solid trading approach. But what happens when your plan shows cracks? Consider 5 occasions that may demand course correction.
Trading on a gut feeling can leave you with a stomachache. That’s right. Your wisest decisions should be devoid of fear and greed, sometimes to the point of being counterintuitive. That’s why many experienced traders tout the benefits of drawing up a plan to help stave off anxiety, boredom, and overtrading. That’s because trading sins may cause you to rack up more heartache and costs than you counted on. Certainly, they can leave you obsessed with a single trade, or a single sector, at the expense of the big picture.
Trading plans often cover entries, exits, and money management. They might include placing stops that automatically ding out your trades in either direction—to stop your losses on the downside and preserve profit on the climbers. Your plan might limit the total amount of capital earmarked for short-term trading. It might limit your buying to only heavily discounted tickers. In the end, naturally, it all depends on your particular goals and strategy.
Dramatic rewrites should be few and far between. After all, it’s not much of a plan if it changes with every whim. Still, there may come a time when you realize a plan is flawed and you need to make a change. Below are five scenarios that may prompt scrapping your trading plan (or at least parts of it)—if only to pave the way for a better one.
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Sure, ignorance can be bliss. But education is essential to managing trading surprises. As you learn more about trading and become more knowledgeable about the specific products and contracts that you trade, you may come to realize that some approaches to the markets don’t work the way you thought. There’s at least one well-worn market tale of a trader who created an elaborate trading plan based on extreme volatility. One day, he learned that the data field labeled “Vol” actually stood for volume, not volatility. If a key portion of your trading plan relies on something you mistakenly thought was true, that’s a good reason to consider tweaking your trading plan.
In calm waters, everyone is a sailor. There’s nothing like a strong, consistent uptrend to give the seal of approval to just about any trading plan. However, when the uptrend ends and market conditions change, you may find that your entry, exit, and money-management assumptions were skewed for a particular type of market. At this point, you may need to broaden your plan to encompass changing conditions.
New regulations or legislation can force a trader to alter her trading style. For instance, during the 2008 crisis, governing bodies banned the short sale of financial stocks. If your trading plan relied on signals that helped you initiate short-stock positions, the new rules may have impacted your approach. You’ll be wise to track any new rules that could have a direct effect on your strategies, and consider your trading options.
As traders, we change and mature. Look back on the first day you decided to begin trading. It’s likely current habits look nothing like the early days. You may have learned that your old approach ignored crucial market nuances and is too reckless for the new you. On the other hand, with your additional knowledge, you may want to take on more risk because you feel comfortable managing larger positions. Whatever your personal narrative, your plan needs to reflect your trading preferences, maturity, lifestyle, and financial goals. As you grow and change in life, it’s likely your trading strategies will too.
When you first learned to trade, chances are you mimicked what other traders did. You obsessed over their books and blog posts. After all, why reinvent the wheel when you could simply adopt what worked for others—at least some of the time? Eventually, though, you may have realized that in order to be comfortable trading, you needed to make the experience your own. This, in turn, boosted your confidence, and helped you trust the many decisions you made in the course of a trading day.
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While there may be good reasons to dump your current trading plan, you may want to proceed with caution—perhaps make a simple adjustment or two within your existing framework before throwing the proverbial baby out with the bathwater. Most importantly, the idea that you should “plan your trade and trade your plan” still applies. If your current plan needs a refresh, go ahead and fix it. But if there’s still frustration, don’t leave yourself without a scaffold. A flawed plan is certainly no excuse to trade with no plan at all.