A trading plan equals a business plan

August 25, 2010, 3:59 pm By Kathy Lien kathylien

Make sure your stops are appropriate for the market you are trading

In the 1980s, there was a very popular game show in America called Press Your Luck. The rules of the game were simple - answer trivia questions and then spin the 18-space 'Big Board' to win cash or prizes. Within the 'Big Board' were a number of 'Whammies' which if landed on, would take away all of the contestant's money.

In the late 1980s, a similar series aired on the Seven Network in Australia with Ian Turpie and John Deeks as the presenter and announcers. In the American version, most people either hit a 'Whammy' and won nothing, or walked away with less than US$20,000. But in 1984, a man named Michael Larson won US$110,237 in cash and prizes, making him the biggest game show contestant winner of that time.

Michael did not win because he was lucky that the 'Big Board' never landed on a 'Whammy'. Prior to the game show, he spent six months studying the movement of the light used for the 'Big Board' and learned how to consistently hit the squares containing bonuses.

Let's get down to business

He used a VCR to record every episode of the game and then proceeded to look for patterns, frame-by-frame. Then he used what he learned and practiced 'stopping' the board on his VCR at the exact places he wanted. Larson did not break any rules, and the game show let him walk away with all his winnings.

What separated Larson from the other contestants was that he went on the game show with a very clear cut methodical plan that he spent months fine tuning. He knew that he had only one chance to be on the show and had to make it work. His preparatory work and discipline is something that all traders should learn from.

Before you start trading your hard earned money, it is important to have a plan. A trading plan is the equivalent of a business plan. In life, what separates professionals from novices is that professionals always come prepared.

He who fails to plan, plans to fail

Too many traders watch their profits disappear like ice cubes melting in their hand due to lack of planning. In order to avoid this, there are five things that you should know about every trade that you take.

1. Know the rationale

Don't just buy a currency pair because your friend recommended it. Make sure you have a fundamental and technical reason for taking every trade.

2. Know the event risk

Economic data is released on a 24 hour basis. How could upcoming economic data affect your trade? Will it hurt or help it?

3. Exits are just as important as entries

Most traders focus on finding the perfect entry but if you have ever watched a trade move in your favour, only to reverse and stop out, you know that exits are just as important.

4. Know the characteristics of your market

Not all markets are created equal. Some pairs have narrower trading ranges while others have wider ones. Make sure your stops are appropriate for the market you are trading.

5. Know the key levels

Are significant support and resistance levels far enough away to give your trade breathing room? You don't want to be selling into support. Professional traders and people like Michael Larson look at trading more like a science than an art, because emotions can kill profits. It is important to realise that you are the most rational before you place your trade and the most irrational once the trade is placed.

Therefore, it is imperative to have a trading plan to minimise emotions. If you have a trading plan, it is much easier to stick to your original idea and not let a ten-pip move against you sway your conviction. There will always be hiccups, but as long as you trust your business model (in this case, your trading strategy), you won't be discouraged when the trade moves slightly against you.

The bottom line

If you are serious about making money from trading, you should approach it like a business and not a recreational hobby.

What is your biggest hurdle in creating a trading plan? (Share your views below)

Want to learn more about trading CFDs? Download GFT's free CFD guide, get a risk-free practice account and visit gft.com.au for more information. Ready to start trading? Open an account with GFT with as little as $275. Don't forget to follow Kathy's commentary on FX360.com and Twitter.

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