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Elements
of a successful trading plan:
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1. Trade with the trend:
Trading with the trend is hard to do because a logical give-up exit
point will be farther away, potentially causing a larger loss if you are wrong.
This is a good example of why so few traders are successful. They can't bring
themselves to trade in a psychologically difficult way. You can define the concept
of trend only in relation to a particular time frame. When you determine the
trend, it must be, for example, the two-week trend or the six-month trend or
the hourly trend. So an important part of a trading plan is deciding what time
frame to use for making these decisions.
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2. Cut Losses Short:
This is a sensible-sounding concept that is much
easier to acknowledge than actually to execute when real
money is on the line. No one wants to exit a trade with
a loss. They don't want to lose money. More importantly,
they don't want to admit they were wrong. You can always
think of many reasons to hold on to a losing trade. You
can hope that the market will suddenly turn around and
give you a profit instead of a loss. Professional traders
accept that losses are part of the game. Since the markets
are mostly random, the best trading methods will always
have numerous losses. Professionals do not equate losses
with being
wrong.
It is precisely because correct trading methods invariably generate many losses
that it is important to keep the individual losses small in relation to the overall
size of the account. In order to keep trading, you must preserve your capital.
If you can keep trading in the direction of the trend, the big profits will come.
However, if you take too many large losses, your capital will be wiped out before
you can enjoy the big profitable trades.
While there are more sophisticated ways to decide when to exit a losing trade,
getting out after a loss of a predetermined amount is as good a way as any. The
important thing is to respect your plan. You can place a stop loss order with
your broker that instructs him in advance to exit a trade if the market hits
your loss limit.
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3. Let
Profits run:
Stay with your profitable trades as long as possible because
the trend
is likely to continue and make your profits even larger. It
is not so easy to do when real money is involved. The difficulty is that although
your profit may become much larger if you stay with a trade, it may also decrease
and even disappear. Human nature is such that it values a sure profit much more
highly than the probability of a much higher profit. Thus, traders are inclined
to take their profits too soon. This can be fatal to long-term success because
big profits are necessary to overcome the inevitable collection of small losses.
There is a good way to let profits run while still guarding against the possibility
that prices will turn around and take away much of your accumulated profits before
the trend actually reverses. It is called a trailing stop. You include in your
plan a method for moving an exit point along some distance behind your trade.
As long as the trend keeps moving in your favor, you stay in the trade. If the
market reverses direction by the amount of your trailing stop, you exit the trade
at that point.
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4. The Markets you Trade:
Another trading plan consideration is the markets you trade.
There are about forty futures markets with sufficient liquidity to allow
prudent speculation. However, it is important to select a good universe
of markets that are appropriate for your account size, risk level and
trading style. It also important that your market universe be diversified.
There are always a number of big market moves every year, but no one
knows in advance where they will be. If you trade a diversified portfolio,
there is a greater chance that you will catch some of the truly big moves
that make for successful trading. Another consideration in choosing a
market to trade is its historical propensity to have more big trending
moves. Since the trend is your edge in trading, you can maximize your
edge by selecting the most trendy markets. The key to success is to test
whatever strategy you intend to apply before you trade with it. Remember
that the conventional wisdom that you read in books is mostly ineffective.
When applied consistently, most trading methods don't work. The rules
must be precise and objective. Having a thoroughly tested plan is crucial
to maintaining the confidence necessary to keep trading the plan through
the inevitable losing periods that every good system and every good trader
must endure.
The reliability of non-computerized testing is highly suspect. Using computer
software that tests a particular approach or a variety of approaches is preferred.
You must learn the correct way to test and evaluate trading approaches.
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5. Manage Risk:
The final cardinal principle of trading overlays all the rest.
It is Manage Risk. This is as crucial as the others because it is by
managing risk that you limit losses and preserve your capital. The most
important element of managing risk is keeping losses small, which is
already part of your trading plan. Never give in to fear or hope when
it comes to keeping losses small. Preventing large individual losses
is one of the easiest things a trader can do to maximize his chance of
long-term success.
Another element of risk is the market you trade. Some markets are more volatile
and more risky than others. Some markets are comparatively tame. If you have
a small account, don't trade big-money. Don't feel you have to trade any market
that might make a move. Emphasize risk control over achieving big profits.
The biggest risks to commodity traders come
from surprise events that move the markets too quickly to exit at their pre-determined
give-up point. While you can never eliminate these risks entirely, you can guard
against them by advance planning. Pay attention to the risk of surprise events
such as crop reports, freezes, floods, currency interventions and wars. Most
of the time there is some manifestation of the potential. Don't overtrade in
markets where these kinds of events are possible.
Trade in correct proportion to your capital. Have realistic expectations. Don't
overtrade your account. One of the most pernicious roadblocks to success is greed.
Commodity trading is attractive precisely because it is possible to make big
money in a short period of time. Paradoxically, the more you try to fulfill that
expectation, the less likely you are to achieve anything.
It is better to shoot for smaller returns to begin with until you get the hang
of staying with your system through the tough periods that everyone encounters.
Professional money managers are generally satisfied with consistent annual returns
of twenty percent. Don't be enticed into trading options as a less risky alternative
to futures. While the dollar risk of buying puts and calls may appear lower and
more certain, the probability of long-term success is remote.
Although the commodity markets appear complex from the outside, making money
trading is quite simple. You trade your system in a carefully-selected group
of markets. You start with sufficient capital and pay close attention to managing
risk.
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