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A Disciplined and Organized Approach to Trading in the Stock Market
from: Yves MailhotA Winning Approach to Trading in the Stock Market
Many traders lose simply out of ignorance. They base their
trades on hunches, news, or tips from friends, and do not define
specific risk and profit objectives before placing trades.
Others have the merit of educating themselves but fall victims
of their emotions. They hold on to losing positions hoping they
will turn into winners and sell winners by fear of losing a
small gain. They overtrade to fulfill a need for action or by
fear of missing out.
The consistent winners follow a winning approach:
- They have a strategy to enter and exit trades - They use good
money management - They take consistent actions, they follow a
trading plan - They keep good records so they can review their
actions - They avoid overtrading - They have a winning attitude
- Trading Framework was designed to help you build those crucial
elements into your trading.
A strategy to enter and exit trades
You need to a strategy to put the odds in your favor for each
trade you take. Your strategy should be as objective as possible
and include the following elements:
- Entry: conditions required before you can enter a trade - may
include technical analysis, fundamental analysis, or both. -
Initial stop loss: price at which you will close the entire
position if it does not go in your favor. The risk per share is
the difference between the entry price and the initial stop. -
Initial price objective: price at which you will take some or
all profits if the trade goes in your favor. - Trade management:
set of rules that dictates your actions while a trade is opened.
It may include trailing stops, closing position, etc...
For every action you take, the reason should be clearly
described in your strategy.
Example: Buy pullback - stock in an uptrend on daily chart
- Entry Setup: Price above rising 30 day moving average with 3
or more consecutive days with lower highs - Buy signal: $0.05
above the previous day's high - Initial stop Below lowest of
previous and current day's low - Initial objective At the
previous pivot high - sell half - Trade management Move stop
below previous day's low daily
A more complete strategy would include market and industries
conditions, technical indicators, conditions from different
timeframes, etc..
Money management rules to keep losses small
The goal of money management is to ensure your survival by
avoiding risks that could take you out of business. Your money
management rules should include the following:
- Maximum amount at risk for each trade. The different between
your entry price and your initial stop loss is your risk per
share. Your maximum amount at risk for each trade determines the
share size. - Maximum amount at risk for all your opened
positions. - Maximum daily and weekly amount lost before you
stop trading - avoid trying to trade your way out of a hole
after a loosing streaks.
Example:
Maximum amount at risk for each trade: $200 Maximum total amount
at risk for all my opened positions: $800 I stop trading until
the following day if my realized loss for that day is over $600
I stop trading until the following week if my realized loss for
that week is over $1000
During your learning phase, your goal should be to survive, not
to make money. Start with low limits and raise them as you
become a consistent winner otherwise you will simply go broke
faster.
Good record keeping
Although the process of gaining experience cannot be rushed, it
can be made much more efficient by keeping good records of your
actions. Good records will allow you to:
- Review your actions at the end of each day to make sure you
followed you strategy, not your emotions. - Learn from your
losses - they cost you money, make sure you get the education in
return.
You should also keep a journal of your observations.
A trading plan to keep emotions out of your decisions
During trading hours, emotions will turn smart people into
idiots. Therefore you have to avoid having to make decisions
during those hours. This requires a detailed trading plan that
includes your strategy and your money management rules.
For every action you take during trading hours, the reason
should not be greed or fear. The reason should be because it is
in the plan. With a good plan, your task becomes one of patience
and discipline.
You have to follow the plan without exception. Any valid reason
for an exception - for example, correcting an oversight - should
become part of the plan.
Overtrading
Sometimes the best thing to do is to do nothing. Not trading on
those bad days is key to becoming a consistent winner - in some
situations it is very tempting to overtrade:
- If you trade to fulfill a need for action, to relieve boredom
- If you can't find the proper setup but can't wait - If you
fear you are missing out on a great trade or on a great market -
If you want to make up for losses (revenge) - If you trade to
feel like you are working instead of sitting around. Trading
involves a lot of work other than the actual buying and selling.
You should not trade under the following conditions
- You are not following my trading plan - You have reached your
daily or weekly maximum loss - You are sick or very tired - You
are very emotional (upset, pressured to make money, self-esteem
destroyed) - You are using new tools you are not completely
familiar with - You need time to work on your trading plan
A winning attitude
Losing traders look for a "sure thing", hang on hope, and avoid
accepting small losses. Their trading is based on emotions. You
must treat trading as a probability game in which you don't need
to know what is going to happen next in order to make money. All
you need to know is that the odds are in your favor before you
put a trade.
If you believe in your edge, which is you believe that the odds
in your favor for each trade you enter, then you should have no
expectation other than something will happen.
Your attitude will have a direct influence on your trading
results:
- Take responsibility for all your actions - don't blame the
market or world events.
- Trade to trade well and for the love of trading, not to trade
often and not for the money. The money will come as a result of
trading well.
- Don't be influenced by the opinions of others. Reach your own
decisions and follow them.
- Be rigid with your rules and flexible in your expectations.
Most traders are flexible with their rules and rigid in their
expectations.
- Never think that taking money from the market is easy and
never assume that you know enough.
- Have no particular expectation when you place a trade because
you know that anything can happen.
- Don't try to guess the future - trading is a game of
probabilities.
- Use your head and stay calm - don't get excited or depressed.
- Handle trading as a serious intellectual pursuit.
- Don't count how much money you have made or lost while you are
in a trade - focus on trading well.
Yves Mailhot http://www.tradingframework.com For A Disciplined
and Organized Approach to Trading in the Stock Market
About the author:
Yves Mailhot http://www.tradingframework.com
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