If you don’t have a trading plan, markets will take a harsh way to make you learn.
BE YOUR OWN TRADER!
There’s an old expression in business that, if you fail to plan, you plan to fail.
If you already have a trading or investment plan, congratulations, you are in the minority. It takes time, effort, and research to develop a systematic approach or methodology that works in financial markets. While there are no guarantees of success, you have successfully eliminated one major roadblock by creating a trading plan.
The plan can be improvised with changes in market conditions and might see adjustments as the trader’s skill level improves. Each trader should chalk down their plan, taking into account personal trading styles and goals.
A trading plan defines what is supposed to be done, why, when, and how. It covers a trader>s personality, personal expectations, risk management and position sizing rules, and trading system(s).
With the right trading plan, every action is spelled out, so that in the heat of the moment you don’t have to make any rash decisions. You just simply stick to your trading plan.
A trading plan helps you to:
◆ Minimize the odds of suffering irreversible losses.
◆ Maximize the chances of achieving sustainable gains.
◆ Not let your emotions come between and the market screw up your mind.
◆ Avoid the noise (News & Rumours) & focus on the system.
◆ Improve trader’s psychology.
Here’s the complete guide to how a what all has to be there in your trading plan and the right approach:
► TRADE PLAN:
A trade plan refers to the predetermined systematic plan of deciding the target price, stop loss, risk management, and position sizing.
When followed, a trading plan will help limit trading mistakes and minimize your losses. Your emotions can consume you when money is on the line and cause you to make irrational decisions, but a trading plan won’t let the market screw up your mind and that to happen.
Elements of a trading plan:
◆ Entry Price
◆ Target Price
◆ Stop Loss
◆ Quantity
◆ Risk Management
◆ Position Sizing
◆ Risk To Reward Ratio
► ENTRY:
An entry point refers to the price at which an investor initiates a position in a security. A trade entry can be initiated with either a buy order for a long position or a sell order for a short position.
Example: Let’s suppose ICICI Bank is trading at Rs. 650 and if you decide to buy it at CMP, then your entry price will be Rs. 650.
►EXIT:
An exit point refers to the price at which an investor exits the security.
For example: Let’s suppose you bought ICICI Bank, as you are expecting it to go up to Rs. 700 because you are expecting good results coming. Then here, Rs. 700 will be your target price.
► QUANTITY:
Quantity means the number of shares per order.
For example:-
SBI at Rs. 500 price, here you are required to decide what quantity you are going to purchase. In the case of the spot market, if you want to buy 20 shares of SBI at Rs. 500, so here 20 shares would be the quantity.
In the case of F&O, SBI has a lot size of 1,500 shares, i.e 1 lot =1,500 shares. So, here if you are buying 1 lot then the quantity would be 1 lot/1,500 shares.
► RISK MANAGEMENT:
Risk management refers to the process of pre-determining and analyzing the loss, a trader/ investor can make from a certain stock.
Though the market risk cannot be avoided altogether, it certainly can be managed. Risk management is to minimize the impact of market volatility on your investments.
Having a strategic, systematic, and objective approach to cutting losses through stop orders, profit trailing and taking, protective puts is a smart way to manage the risk and stay in the game.
Depending on the size of the account, one should risk a maximum of 1-3% of total capital on trade and never keep more than 10% exposure in any stock.
For example:
Case 1: The total account size is Rs. 1,00,000, and you set the account risk limit per trade at 1% i.e. Rs. 1,000 is per trade risk.
So here, the total risk will be Rs. 1,000.
Case 2: The total account size is Rs. 1,00,000, and you set the account risk limit per trade at 2% i.e. Rs. 2,000 is per trade risk.
So here, the total risk will be Rs. 2,000.
So, your risk will depend upon your Risk per trade (RPT).
► POSITION SIZING:
Quantity matters and just the right quantity matters more.
Position sizing refers to deciding how much capital will be exposed to a particular trade and how they will be building up their positions.
For the correct position size, traders need to first determine their stop loss level and the percentage of their account that they’re willing to risk on each trade. Once they determined these, they can calculate their ideal position size.
If your bets go wrong, and you do not hold enough scrips, you stand to bear just a small loss but if your bets go right and still do not hold enough scrips, you stand to make just a small profit, which will adversely affect your profitability.
Proper position sizing limits the emotional emotional impact of a single trade. Also you need to get an idea of your winning percentage and the average size of your wins and losses. If you experience a high level of stress during trading, then your position size could be too large. So make sure that you must size your position as per the 1-% risk management rule.
Although there are many different ways to position size, which by the way, also means (unfortunately) that there is no single guided technique to position size. One as a trader needs to experiment and figure out what works for you.
IDEAL RISK MANAGEMENT:
Position size for trade= Account risk limit/amount of trade risk
For example:
The total account size is Rs. 1,00,000, and you set the account risk limit per trade at 1% i.e. Rs 1,000. Then your risk per trade will be Rs. 1,000.
Now suppose for stock ABC Ltd, you want to buy that scrip at Rs. 50, and you set up the stop loss at Rs. 40, then your total amount of trade risk is Rs. 10.
So, the ideal position size for the trade would be: 1,000/10 i.e. 100 shares.
So, as per your risk management, you will buy 100 shares of ABC Ltd.
IDEAL POSITION SIZING RULE:
20% on BO/BD+ 50% retesting+ 30% on rally in the desired direction
As stated above, as per the risk management one will buy 100 shares of ABC Ltd. So as per the position sizing rule, one can go with 20 shares on BO, then add up 50 shares on retesting and the rest 30 shares after the stock moves in the desired direction.
► AVERAGING:
Averaging refers to the process of buying additional shares at a lower price of a stock one already owns at a relatively higher price.
Averaging reduces the cost of stocks purchased at higher prices.
A volatile market does not allow an investor always to follow the principle of buying low and selling high, averaging down here comes to the rescue.
If the sector and the company you are invested is facing a momentary setback, however, the company’s fundamentals are robust with low debt, high cash position, and a good P/E ratio, then the best strategy in such a case is Averaging.
Averaging should always be done after considering both Technical and Fundamental Analysis:
◆ Technical analysis: Technical analysis can be very fruitful while averaging. If the stock is in an uptrend, then until and unless the stock remains in an uptrend, on any correction the stock can be added with a ‘Buy On Dip’ stance.
◆ Fundamental Analysis: If you have invested in a company then any short term correction can be considered as the ‘Buy On Dip’ strategy as the correction can be a result of some negative news for the company, but that hasn’t resulted in any change in the fundamentals of the company.
Averaging, in this way, can lower your overall average cost and can enhance your returns, assuming you hold the asset long enough and higher valuations prevail over time.
► PYRAMIDING:
Pyramiding is the method of step by step adding positions as the price moves in the desired trend direction. If done correctly, you can compound your significant profit on a winning trade. Although pyramiding increases profits if the trend continues as hoped, it also increases losses if the trend reverses, so risk control is the key.
There are two main methods of pyramiding:
Standard pyramid: It starts with a large initial position and is followed by predetermined additions that decrease systematically in size as the price moves in the trend direction.
Inverted pyramid: It starts with an initial position and then adds in equal share-size increments as same as that of the initial positions.
► RISK TO REWARD RATIO:
The risk/reward ratio, also known as the R/R ratio, is a measure that compares the potential profit of trade to its potential loss.
To effectively use the risk/reward ratio, you need a trading plan that consists of a target and a stop loss.
A trader should always look for trades that carry at least or more than 2:1 R2R.
Below is the table that shows the relation between the accuracy and the risk to reward (R2R).
►ANALYZING PERFORMANCE:
A mistake done once should never be repeated.
After each trading day, adding up the profit or loss is secondary to knowing the why and how.
Remember, there will always be losing trades, but for a successful trading journey, it’s mandatory to analyze the trades and jot down the conclusions in one’s trading journal so that the trading mistakes will be minimized in the future and can increase the odds of profitability.
Profitable trading is often boring. You will learn that your system makes you money in the long term, butyouregolosesyou money intheshortterm.So, tradeyoursystem and notyour opinions.
Successful traders have a plan for success. If you want to win in life, you must study, work hard, and be disciplined. There are no shortcuts, especially in trading. So, you need to enter the markets with a detailed plan, and weather the storm.
Always stay humble. Always know the market is too big for anyone to master.
