Trading is serious business. Learn how to treat your trading like a business with these 5 essential components of a trading plan.
As Benjamin Franklin wisely said in the 1700s, “By failing to prepare, you are preparing to fail."
Fast-forward to 2016 and apply this to your trading or investing approach. How much have you prepared?
Any small business owner knows a business plan is essential. No bank would ever give you a loan without a business plan. The goal of investing, of course, is to grow your wealth and let your money work for you, similar to a small business investment. So, if you haven't taken the time to write out a business plan, carve out some time this weekend. By the way, this is something you can share with your partner.
(Hint: Good communication with your significant other about investing plans can help keep everyone on board with the approach, the desired goals, and the time investment needed for successful trading and investing.)
1. Buy criteria: This could take weeks or months to refine and could evolve over time as market environments change. Spend time studying, learning, and developing an approach. Do you buy stocks based on fundamental or technical analysis, or a little of both? Are you a fundamental stock picker, but like to use charts to fine-tune entry points?
2. Sell criteria: One of the cardinal rules of successful trading is knowing where to exit before getting into a trade. How do you determine a trade objective? If you’re a technical trader, you could utilize resistance points from long-term charts (think weekly or monthly) or chart pattern targets. Make a plan for exiting profitable and losing trades, write it down, and automate an exit point.
3. Time frame: Determine your trading time frame. Are you a short-term swing trader, looking for two- to three-day opportunities, or do you want to hold positions for multi-month moves? Write it down.
4. Risk management: It can’t be overstated how important risk management is to successful trading and investing. Set specific risk parameters that you’re comfortable with and follow them. For instance, some traders look for a risk/reward ratio of about 1:3, which means they are willing to risk $1 to potentially earn $3.
5. Specific financial goals: Write down your specific goals, but try to dig deeper than simply "saving for retirement." Determine a dollar amount within a specific time frame. For example: “Grow my investment portfolio to $1.2 million by age 65.”
It’s been said: “I'm a great believer in luck, and I find the harder I work the more I have of it.”
When it comes to trading, hard work can pay off. What is work when it comes to trading? Keeping a trading journal and reviewing trades on a weekly or monthly basis. What went right? What went wrong? Are you following a trading plan, or did emotional trading take over? A review process can help keep you accountable and allow for adjustments as needed to help you reach your goals and approach trading like a business.
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