Trading with a Plan

Any time anyone speculates on any financial asset, there must be a plan in place to seek to achieve the financial goals in mind which motivate the speculation. Even in cases where people enter positions with no distinct plan, for instance with buying an index fund for no other reason than that’s what people do, with no regard to the market in other words, there still must be some sort of exit strategy.

Perhaps this exit strategy may have nothing to do with the asset itself, for instance to just hold the investment until the money is needed, this consists of a plan, even though such a plan may not be a good one.

Trading with a PlanIt’s possible that one may not even have a specific exit strategy, to just see how things go and decide what to do as the trade progresses, that’s in itself a plan, so there is always some sort of plan involved of varying qualities.

Since trading by definition involves a more active role in managing one’s trades than investing does, where investing often takes a passive approach to trading and often may not even be actively focused on the trade itself, the importance of having a good plan in place to trade becomes even more important.

Historically, one has been able to hold stock positions over the long term, such as 30 years or more, quite randomly and be able to achieve decent returns on average, so being actively involved hasn’t been that necessary even though this strategy may be far from optimal.

Traders, on the other hand, are at least striving for optimal performance than merely beating the market so to speak, and to do so, one needs to go beyond a random approach and impart skill is to the equation, otherwise one’s performance becomes just a matter of luck.

A random approach to trading would actually produce the same results as the market, less transaction costs, although that is not the goal of traders generally, otherwise there would be no point in attempting to time markets and one would be better off just buying and holding like the investors do.

Learning to Ride the Waves

Over time, the price of financial assets experience a lot of ups and downs, and these fluctuations can be viewed from the longest term charts, like 100 year charts, right down to tick by tick charts. Contrary to what some people think, these fluctuations are not random, and even what most consider to be “random noise,” movements of smaller magnitude that are not considered to be meaningful, are not random at all, although they may not be viewed as significant.

The meaning of significant as far as trading is concerned means movements that would indicate that a trend is more likely to reverse than not. Trading is never about knowing what will happen, it is about figuring out what is more likely to happen over a given period of time with the price of the asset being traded.

This is where the trading plan comes in, which sets up a set of rules and conditions that will direct the actions of the trader as far as which trades to enter, when to enter them, how long to hold them, and when to exit trades.

Computer trading, or algorithmic trading, is designed to use a fixed set of rules to enter and exit trades, designed to capitalize on extremely short term inefficiencies of price. Due to the dynamic nature of markets, price is never completely efficient, even though we may want to assume it is for our theoretical models.

Rather, there is always an ebb and flow, because price is driven not by what is known about anything, even though that may affect price indirectly. Its effect is limited to the degree it may influence the supply and demand of the security, and this fundamental knowledge only emerges infrequently, while prices fluctuate by the second.

Prices of securities are indeed information driven though, but this information is the movement of the prices themselves, where changing prices change the supply and demand dynamic. There are other technical considerations at work as well, such as levels of supply and resistance, trend lines, and other patterns which directly influence trader behavior.

All of this becomes self-fulfilling to some extent, as a rising or falling price will influence price momentum to some degree, which will reverse when the momentum driving it in its present direction wanes and the opposite forces take over to reverse its direction.

All this depends on one’s perspective though, and all of this happens on different levels, which each perspective telling a different story as far as who is in charge at the present time, the bulls or the bears.

A security may be seen as going up in price on one time frame and going down on another, and therefore the time frame we use to measure these waves, as well as the tools and criteria that we employ to measure the significance of these moves, are both going to matter as far as the design of our trading plan is concerned.

Selecting A Trading Time Frame

The first decision a trader must face when constructing a trading plan is the time frame that one is looking to trade in. Do we want to attempt to trade the daily chart, the 4 hour chart, the hourly, or do we want to hone in more on smaller price movements and go with a shorter time frame?

These aren’t decisions that can be made in a vacuum entirely, being just a matter of trader preference, ability, or opportunity, as the assets we are looking to trade may conform more to one time frame than another.

However, there are personal factors that are going to exclude certain time frames. For example, in order to trade intraday, one must at least be able to monitor one’s positions throughout the day. As a rule of thumb, at a minimum one should be able to check one’s trades every bar, so if one is trading a daily chart one needs to check their trades at least once a day, if one trades hourly bars, once an hour is the bare minimum, and so on.

Depending on the strategy used, if the plan allows for making decisions intra-bar, one may want to monitor one’s trades even more often. Very short term trading requires that one watch the trade continually, and of course if one is unable to do that, then this form of trading simply cannot be executed properly.

Casual traders, those not trading full time, tend to focus on daily charts, because they can assess their trades just once a day and this may be all that they are able to manage. It is also possible to do that with trading 4 hour bars though although you really need to be checking things every 4 hours to do this properly, but that’s something a lot of traders can manage.

Should one have the opportunity to check their trades more often than this, this will allow for more frequent trading to be performed with an acceptable level of efficiency. The more you can monitor your trades the better though, although this can also work against traders who are not skilled enough, where this provides more opportunity for mistakes.

Mechanical Versus Discretionary Trading

One can also use strategies like trailing stops, or construct trading rules that can be monitored and have your computer trade for you, although these approaches aren’t going to be as efficient generally than having a skilled trader exercise at least some control and discretion.

Markets can be quite dynamic, and while it is certainly achievable to construct mechanical trading systems to do quite well, designing these systems properly does require quite a bit of skill, and this is not just a matter of back-testing something and looking to optimize it that way.

Most of the trading that goes on is mechanical in fact, but these aren’t everyday traders that are trading them, it is large institutional investors who have teams of experts designing and monitoring them. Still though, individuals can design and implement mechanical trading systems on their own which can work quite well, although one can achieve even better results by exercising at least some discretion with these systems when appropriate.

The problem with mechanical trading is that it only takes certain things into account, and also has a limited ability to adapt to changing conditions, which can only be revisited periodically and is subject to a much longer look back than human intuition may require.

Purely discretionary trading would mean that one would need to rely on one’s intuition entirely, and while there are traders who, by way of their very substantial skills and experience, can do well with this approach, not many traders can pull this off.

There may be something to be said for purely intuitive trading, as it is said that this involves using a broader range of information, using our subconscious as well as our conscious in other words, but most traders do not have the skills for this and therefore have to rely to a significant degree on a set of rules as their trading foundation.

From there, one may choose the degree that these rules may play and the degree of latitude that one gives oneself to override the rules or allow them to be more flexibly applied, depending on what produces the best trading results.

More discretion means the potential for more mistakes though, and this is the undoing of many traders,  as this can lead to poorer trading decisions quite easily, especially if one does not have the psychological discipline to get in and out of trades at the right times.

This lack of discipline is the biggest reason why many traders struggle and lose, and one may for instance be able to do well at paper trading, but when real money is in play, they may wilt under the pressure, leaving money on the table by being too anxious to book profits, refusing to book losses when they should, entering trades when they should not, and so on.

Being more rule based can help traders manage this, where the focus then tends to be more on what it should, the performance of the asset and not one’s net position in it. As one strengthens one’s ability to perform this, which is a requirement to be able to trade well, one can allow oneself more flexibility.

Whatever plan we end up with, it never can be seen as stagnant, and we must always look to adapt our trading and seek to always improve our trading plans so that we can move further in the right direction.

Andrew Liu


Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.

Contact Andrew: [email protected]

Areas of interest: News & updates from the Consumer Financial Protection Bureau, Trading, Cryptocurrency, Portfolio Management & more.