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What 99% of Traders Lack in Their Trading Plan

Your trading plan should answer the five Ws and the how

Starting any business without a detailed plan is a recipe for disaster, or better yet, it won’t receive any funding in the first place. But as a matter of fact, the majority of retail traders don’t have a written trading plan, and if they do, it most likely lacks one crucial part. But before we get to that, let’s get started with the equally important items that you will find in trading plan templates on the Internet.

The list below is not exhaustive, but it will provide you with a good starting point to create your own plan. Each of the course modules on CEED.trading covers a particular section of the plan. A template is available for download in the free 01 Trading Plan Development course, which you can complete step-by-step as you go through each course module. Of course, you may add other information that you deem important or relevant to your situation.

Taken together, the following five Ws and the how of your trading plan should ultimately also answer the overall questions: What is the opportunity in trading and why would you hire yourself to trade your own money?

 

Why do I want to trade?

This section answers the question why you are pursuing trading as a business in the first place. Based on your identified trading edge, it states your objectives, motivation, growth goals, and the resources available to you at the moment. Also state the progression you expect over the coming five years including concrete milestones.

5 Ws and how of winning futures trading plan

The free 02 Business Start-Up: Trading course provides additional information regarding the source of your trading capital and training requirements, etc. It also contains resources for business opportunity analysis which will help you evaluate the associated opportunity cost, risks, and possible payoffs of pursuing futures trading as a professional venture.

 

Who will implement the trading plan?

Let’s start with the most important variable. It may seem obvious that this person is you here, but you must remain as objective as possible in your assessment whether you are actually qualified to do so.

This evaluation could include the following:

– your subjective strengths and weaknesses (experience, skill set, training, etc.) and

– an objective personality assessment by means of a personality test to identify

– why you do things the way you do, and how this deviates from your initial subjective self-assessment.

Ultimately, the goal is to reduce or eliminate emotional reactivity and reach full emotional detachment from your P/L in your decision-making. 03 Emotional Reactivity in Trading also covers particular cognitive biases that you need to guard yourself against as a short-term trader including tools and techniques to deal with fear, greed, hope, and regret and counter-balance “detrimental” personality traits identified by the personality test.

 

What will I trade?

Here you state what type of instrument (such as futures) and particular product(s) (WTI crude oil, e-minis, mini-DAX, soybeans, etc.) you are trading and give a reason why. The most important criteria for product selection are:

 

  • Liquidity

Small bid/ask spreads and liquidity facilitate efficient trading. However, most likely you are not a liquidity constrained trader (if your position size is less than the visible order size on the bid or ask), so liquidity by itself should not be a dominating reason to prefer a particular product over another. For example, if someone tells you to trade Forex because it is the most liquid market in the world, you need to consider the following:

The more liquidity, the easier it is for large traders to mask their order flow. So more liquidity = less urgency = less volatility = more noise = low probability trades! Furthermore, the FX market is heavily fragmented, which brings us to the next point.

  • Market fragmentation

Similar to the FX market, the US stock market is heavily fragmented with multiple venues, dark pools etc. which makes it very difficult to track overall volume. Futures exchanges, on the other hand, are centralized and all traded volume is visible there. So the less market fragmentation the better for reading order flow.

  • Volatility

Traders need volatility to make money. The bigger the price swings, the more opportunities throughout the trading day and the smaller the transaction cost as a percentage of the price move your trying to capture. Also be careful not to trade products that do not fit your risk management rules given your initial account balance and trading experience or as specified in your trading plan.

  • Trading costs

Exchanges such as the CME Group (CME, CBOT, NYMEX, and COMEX) give their members beneficial pricing which gives them a leg up on small traders. So consider other exchanges such as Eurex for European fixed income and equity indices and ICE for energy contracts before committing to CME products. You can crunch the numbers here for the WTI Crude Oil contract. For example, the CME Group lures traders with lower market data fees, while the ICE charges more for market data but less for exchange fees and clearing.

Also list your tools and equipment such as trading platform, data feed, broker (incl. phone number for the trade desk), computer, number of screens, internet (backup) and how you plan on improving your performance through trading education, ongoing mentoring, mastermind groups, etc.

 

When will I trade?

This section of your trading plan specifies the time when you will actually be trading. For example, 8 am to 11 am GST if you trade the European markets or 14:30-18:00 EST for the US markets). Also specify whether you only trade the main session or also overnight sessions or carry positions overnight. Also remember that automated trading by (ultra-) HFTs dominates the sub-second time frame, so trading around news releases is better avoided by most small traders or left to very experienced traders only.

 

Where will I trade?

Describe the environment from which you will trade and how you plan on keeping yourself from being distracted. State whether you will trade from home, a separate home office in your house or a shared office environment and what changes you would make once you progress through your trader development.

 

How will I trade?

The answers to the aforementioned W-questions form the administrative framework of your business. Now we’re getting to the part where you describe how you actually plan on extracting profit from the market. This includes a description of your 04 Risk and Money Management rules for setting rational risk limits and optimal position sizing for maximizing return on investment. Rational here means appropriate for your trading strategy that you will describe below. This is a somewhat iterative process until you find a proper balance that works for you.

Competitive analysis

competitive analysis futures trading plan
Ill. 1 Information vs. speed by trader type

But before you waist your time looking for correlations in market data by looking at charts with various technical indicators etc., you need to first answer these often completely neglected or brushed over questions:

  • Who’s my competition?
  • What are their constraints?
  • What are their motivations (i.e. how are they compensated)?
  • How do they operate?
  • When are they active?

Bulls vs. bears, pros vs. amateurs, me against the world — is that it? As mentioned earlier, the majority of retail traders don’t have a written trading plan and, most certainly, it will lack a detailed competitive analysis.

So if 95% have no plan and 95% of those who do don’t analyze their competition, that means that only 0.25% or 2 1/2 out of a thousand small traders have a solid understanding of who they’re competing with!

Consequently, most traders have a totally warped idea of their actual competition and what drives prices on a micro-structure level. Mistaking correlation for causation is a common reason why traders lose money.

To guide you in the right direction, 05 Market Ecosystem Analysis explores the trinity of the market composed of algorithmic trading by buy-side institutions, automated trading by HFTs, and automated or discretionary opportunistic traders. These trader types can be categorized by how much information they hold relative to each other and the speed of their market access (see Ill. 1).

Strategy development

If we assume that the market impact of large orders by informed traders represents the profit pie available to all other day traders with a short-term trading horizon such as market makers and other opportunistic traders, you need to describe how you are planning to beat your competition to get your piece of it. Technical analysis based on secret indicators or paid chat room memberships simply won’t cut it here. These gimmicks may even hinder your understanding of the bigger picture and create a dependency that you won’t be able to shake even if you have evidence that it doesn’t work for you.

The understanding that the primary constraint in the execution of large orders is liquidity (or rather the lack thereof) will guide you in developing your own approach in 06 Algo Order Flow Strategies.

Strategy development is an iterative process where you continuously test your hypothesis and evaluate your plan by tracking its performance. This can be supported by keeping a trading journal, using the reports embedded in your trading platform, or some other form of tracking your “forecast errors”.

Remember that proper risk management and control over your emotions by themselves do not give you an edge over other ‒ presumably more sophisticated ‒ market participants that have more information, more capital, and faster market access. Although they are crucial components for the disciplined and consistent execution of your plan, you also need to develop a true edge. Understanding the game you are actually playing and the actions of other players will give you a solid foundation to build on.

Conclusion

Ultimately, the trading plan outlines every aspect of your trading and as such represents a contract with yourself to assume full responsibility of your decisions and take corrective action as specified in the plan if necessary. Your personal business plan will evolve over time and should be reviewed and updated on a regular basis.  It is essential for every professional trader because it will bring much needed clarity and consistency to your trading. If you don’t have enough capital for your trading business, it may also serve as the basis for securing seed funding from friends and family or other angel investors.

Let’s face it: there’s no free lunch out there — you have to take someone’s lunchbox if you want to eat. So if you have you ever wondered whether a comprehensive trading plan would give you the clarity and commitment you lacked up to now, are you finally ready to prepare one for yourself? Don’t think twice and get started now!

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