Investing in the stock market looks deceptively simple but the reality is that most investors lose money. The basic reason is that they lack a trading plan. Without a plan, it is just not possible for investors to know what to buy, when to buy and when to sell.
Instead most investors trade in the market like how you would bet on a roulette in a casino; choosing a number based on a hunch and deciding on a wager based on gut-feel. Worse if you do not know when to stop and only ‘wake up’ after you have suffered huge losses when the consequences could have been disastrous.
Trading is not a hobby. It is not a pastime. It is a real business that requires skills, knowledge and discipline. Just like any successful business that requires a business plan, a successful trader requires a trading plan that has a systematic approach to investing in the market. However, having a trading plan is not good enough. It is also important to have a plan that is well-tested and proven to ensure you are financially successful trading the markets. If you currently do not have a trading plan, a good approach would be to adopt one from a successful trader or find yourself a mentor to help you develop one.
So what is a trading plan?
A trading plan is simply a set of predetermined rules that you follow when you trade. It governs the actions that you should take when certain market situation arises. Most importantly it is one that will prevent you from making trading decisions based on emotions or anxieties.
A trading plan should have the following components :
- Entry Rules
This is a precise set of rules or conditions that must be met before you enter into a trade. For example, if your strategy is to capture only stocks that has a good potential to trend upwards for some time, a good rule would be to enter only if a stock that has surpass the counter’s all time high price. This can be easily set as a condition in your charting tool or software.Of course, there should be more rules that you need to consider before going into a trade but all the rules should be simple and clear. - Money Management Rules
This is perhaps the most overlooked aspect by inexperienced traders and also the reason why you hear of investors being ‘burnt’ in the markets with severe consequences. Money management is very important because it address the level of risks you should take and ensure you do not overtrade beyond your capabilities.It determines your position sizing that is the number of shares to buy per trade calculated based on your risk level. Basically, you will need to determine what is your trading capital and how much you can afford to lose per trade assuming that you need to cut loss.Without strict and proper money management rules to follow, investors may potentially expose themselves to risks beyond their comfort level. - Exit Rules
Having a set of rules that define when you exit the market is equally important as those that defines your entry. In fact, you should already determine your exit strategy before you enter into a trade.There are at least 2 exits criteria that you must set before entering a trade. One is to determine what is the stop loss price if the trade goes against you. The second is the price that you will exit to profit from your trade.The common failings of most investors is that they let emotions get in the way when making trading decisions. Therefore it is important to have a trading plan with well-documented rules for this 3 main components to ensure that a trader makes a decision based on rules rather than emotions.
