Checklist for Successful Trading

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Don Dawson

29 Dec, 2009

in Getting Started

Each year as we prepared for these holidays, we planned for all those we had bought gifts for and careful thought was put into each person's gift:

* We planned where we will shop for the gift
* Our trips to the stores were planned to eliminate too much back-tracking
* Consideration for the type of wrapping paper and bows was given
* After all this, we then had to plan on how we would get the gifts to the people and still allow for the time to get it done

Wow, seems like a lot of work? Believe it or not, most traders will plan this type of event out on paper so that there will be no mistakes. Come that special holiday morning, they will be sitting back and enjoying the holiday because everything on the checklist was done just like it was supposed to be. However, when it comes to their trading, many will simply just "wing it" with no logical or systematic set of rules in place. Being this is the season of giving, I thought we would work on a "checklist for traders" to give them some guidance in the coming New Year.

Principle #1 KISS Principal
We have all heard of this acronym - Keep it Simple Silly. As traders learn more and more about trading, a common trap they fall into is they start to add too many confirmations to their setups. Making your strategy complicated will cause you to have indecision when it is time to take action. Confirmations are used to add confidence to your trade. When you have to start looking at too many, you start second-guessing them. There is nothing wrong with being aware of these added confirmations, but I would suggest you back-test all the ones you use and take the one or two with the highest percentage of success and only use them. By use them, I mean have them identified in your trading plan as the "only" tools you will use to confirm your trade.

Principle #2 Plan the Trade, Trade the Plan
This is where all the thinking in trading comes into play, while writing your trading plan. Once you have created your rules to trade by, you become more systematic and logical in your thought process for executing successful trades. Your personal trading plan will include every step of the trade from identifying to exiting your trade. By having your setup written down in your plan, you will have a better chance of using patience and discipline to wait for your entry. Otherwise, you will use emotions to enter trades and we all know where that will get you. After entering your trade, you will have more confidence because you have back-tested your strategy and know that it has a successful track record and will give you that extra edge over your competition. Identifying your entry strategy will help you execute your strategy in an efficient manner with no hesitation. There will be no guessing or wondering what to do once your setup is identified, you just click and go. Your risk management is also pre-defined so your initial protective stop is set on entry and you know when you will be moving your protective stop to breakeven after the market moves in your direction by a certain amount. Of course, our price target is also known in advance and how we will exit the market at this target. Will we have a set price target, a trailing stop, a time stop, etc.?

Principle #3 Sitting on Your Hands
This is probably the most difficult part of trading. We have this well-thought-out strategy and now we must wait for the setup to materialize. Who ever thought time could pass so slowly? Many of us are raised to think we must always be doing something or it is not work. So we end up taking boredom trades because our market is not cooperating at the moment. One of the advantages to entering a trade is that we can set the conditions and the market must come to us in order to offer us a low risk/high reward setup. This is where discipline can help when patience runs short. You must remind yourself that you will only have your "edge" if you wait for your setup. Otherwise, you will just be gambling and not following your plan. Keep in mind that no one strategy will work all the time in the markets. There will be times when you will miss a market move because you had no setup, or the price did not come back far enough to get you in - do not get upset. Keep this in mind, "The markets were here before us and they will be here long after us." Simply stated, there will always be another opportunity to make a trade. I would much rather miss a market move because I had no signal than know that I chased a market because I let my emotions get in the way. This is a very low probability of success choice.

Principle #4 - Trade in the Direction of the Trend
Trading with the trend is much easier than trying to pick tops and bottoms. Trends offer traders the opportunity to stay with a trade much longer than merely trying to take a couple of points out of the market because they picked a minor top or bottom. Bragging rights for top and bottom pickers will eventually cost them their accounts. My experience has been when I meet somebody that likes to try and pick these tops and bottoms that more times than not, they also have a very large ego. As we have said before, there is no place in the market for ego. Let me mention here that using support and resistance levels as turning points does not necessarily make you a top and bottom picker. These can be logical turning points. People who try and pick turning points based on a bias, opinion or the phrase "It just felt like it should turn," are the ones who are in trouble of blowing out their trading accounts.

Entering a trade in the direction of a trend can be much more forgiving than countertrend trading. With trend trading, you have the momentum of the market in your direction to help if you get in a little too early or a tad bit too late. When countertrend trading, you have to be very precise with your timing or you will take some very quick losses. Trading with the trend allows for a better risk/reward. You will be in the trade for a longer period of time to capitalize on what the market has to offer.

Principle #5 Define Your Setups and Stick to Them
Much like Principle#1, we must identify what setups work best for us. Each trader will have certain styles that they are comfortable trading with. In your trading plan, you will identify your style of trading. Are you going to trade with Support/Resistance? Are you going to be a breakout trader? Are you going to use indicators? Or perhaps you are going to use a combination of the above. The important point here is that you identify your choice and stick to it. Many times a trader will get into a trade and hear somebody say for example, "Stochastics is really overbought." Now you have never looked at this indicator before but you flash it up on your screen and now you start thinking maybe you should exit your long position because you see it is overbought. Of course you exit the trade and it continues in your direction for a handsome profit without you. This is like trading by the seat of your pants. Had you done some research on stochastics and were very comfortable using it, then perhaps you could use it to help you identify your exit. If you do choose to use this indicator or any other method, just make sure you have tested it and you have written in your trading plan that this can be one of the criteria you will use to exit your trades. If it is not in your plan, then you should not use it.

Principle #6 Don't Marry a Time Frame
During the trading day, it is very easy for us to get comfortable watching just one particular time frame. If your time frame is too short, you will lose perspective on where we are trading in relation to some important levels during the trading day. Some of these important levels include: Knowing where previous day's high, low and close are, new swings on longer time frames created during the trading day since your pre-market analysis, speed bars from early morning resulting from news reports and knowing what today's high and low have been. Switch to different time frames during the trading day so you do not miss any of this important information. If you have room on your platform, leave a couple of different time frames open at the same time so you can see them all at once.

Principle #7 Morning or Afternoon Trader
By studying your personal trading journal, you should be able to tell whether you are better at trading in the morning or afternoon. In my opinion, the morning is the best time of day based on liquidity and true supply/demand in the markets. If you find that you are a better morning trader, then adjust your risk if you decide to trade in the afternoons. Perhaps trade smaller contract sizes or only take very high probability setups and don't settle for anything else. My plan also states that I will not initiate a new day trading position during the last half hour of the trading day. This period is just filled with people trying to square up positions and trying to get back to even for the day. Another event at that time of day is that people with small accounts are being forced out of positions because their clearing firm knows they do not have enough equity in their account to hold positions overnight.

Principle #8 Trade What You See and Not What You Think
When you place a trade, make sure there is a setup and that the charts are confirming what you see. Too many times, we start using the words "I think," "Maybe," or "What if" and you can see the pattern here. We must stay in the moment when trading. Do not worry about what happened recently or what might happen in the next few minutes. All we can be for sure about is what is happening right now! By thinking in any moment but the now can let fear and indecision enter your thoughts. This will cause paralysis when you need to execute your trade. This, in turn, makes you late entering your position because you are going to be looking for that extra confirmation.

Principle#9 Trading in Front of News is Like Gambling
We have all seen a news event come out that on the outside, looked bullish. Then a few minutes later, the market sells off in a very unforgiving manner. There are just too many variables to try and trade off of the news. Many large traders position themselves days before the report comes out. Once the news is out, the inexperienced trader is entering the market based on their perception of the news and the large traders are more than happy to offer their contracts to these people and book their profits. The liquidity in the markets seems to evaporate for a short time after these major reports are released. Too many traders try and bracket these reports and take breakout trades from them. They soon find out that they are whipsawed from the news report with larger than expected losses due to slippage. Then the market finally starts to trend in one direction or the other. Let the news come out and the calm heads will prevail again after a short time. Then while the gamblers are licking their wounds, you can identify your setup and take a well-thought-out trade and capitalize on the opportunity.

Principle #10 Stops are a Trader's Best Friend
Learn to like protective stops. They are nothing more than a circuit breaker that will trip before the house catches on fire. You need these protective devices in the market to protect you against huge losses. Once you start trying to trade without a stop, you begin to trade emotionally. All of a sudden, the voices appear in your head asking questions about "What if this happens?" or "What do we do now?" We have all heard them - they are not good voices to hear when you need to be calm and collected. Forget about the stories of people knowing where your stops are in the Futures markets. They only know where they are because we place them at obvious swing highs and lows. We always place our stops in places that tell us the trade is not working, so being stopped out is no problem. We obviously would not want to stay long a market if prices are making new swing lows against us. Trading is a probability business. The sooner we accept that one or two trades should not make or break us as traders, the sooner we will become successful. By thinking in terms of probabilities you will realize that with each loss you are closer to a winner. For example, out of 20 trades done on a consistent strategy (same rules for all trades), you will find that you did not lose 20 in a row and you did not win 20 in a row. You probably had something like 11-9, 15-5, etc. The key is staying consistent. If we trade different strategies every other trade, then we will never obtain this consistency or any kind of long-term success as a trader.

These principals may seem simplistic to some, but they are often overlooked and therefore, cause inconsistencies in many trading accounts. Review these and perhaps you will find that there are a few missing in your trading plan. Rule-based trading will make you a much better trader. There is just no room for using emotions in trading. If you find yourself trading with emotions, perhaps taking some time off will help clear your head. There is no need to try and trade through any kind of issues affecting your business of trading.

Don Dawson can be contacted at The Online Trading Academy

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Good straight forward and solid advice. The bigger question is, however, will we follow it?

May 21, 2010

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