In order to manage your emotions effectively when trading, you need to create a written plan that you can review regularly to stay focused on your goal of trading success. By writing down your plan, you put yourself in the top 3% of individuals who have written goals and plans, giving you an immediate edge on most traders.
Make sure you have answered these questions, which are covered in further depth in my book Big Trends in Trading:
- How you will enter trades? The key to good entries is putting on trades where there is relatively low risk compared to much higher reward. You also should write down a clear catalyst for the expected stock move.
- How will you exit trades? You should define an initial stop point for your trade, at the point where the trend is invalidated. You will also need a 'trailing stop' technique to protect your profits.
- What type of orders will you use to enter and exit? When entering, I like to use limit orders, good for the day only, while exits are often market orders. Why? Because limit orders allow me to define my risk and reward clearly on the entry of a trade, while when I need to get out, market orders allows immediate exit compared to the risk of missing my exit with a limit order.
- How much capital will you need to trade successfully? There are economies of scale as you increase the amount of capital you trade with. Costs related to commissions, quote systems and equipment begin to diminish as the percentage of capital invested goes up.
- What percentage of your capital will you invest in each trade? The amount of capital I typically use is 10% per trade in my own accounts. I know traders who commit anywhere from 5% of their account per trade to 20% of their account per trade. You goal should be to keep portfolio risk per trade at less than 2% per trade (for example if you invest 20% of your portfolio in a trade, a 10% loss on that position would lead to a 2% loss on your portfolio).
- How many positions will you focus on at once? I like to concentrate my portfolio in my best ideas, plus I like to stay focused on how each stock is acting. If my portfolio is too big (I'd say more than 7 stocks is too many to focus on), then I will lose focus and invariably miss an exit on a trade that I should have previously exited.
- What will your Trading Journal look like? In my Trading Journal, I note daily observations, particularly related to my ability to execute my trading plan. I also commit to doing a post-trade analysis every month. I note what I did right and wrong, and seek to learn from mistakes to minimize future errors in similar circumstances, while also looking for winning patterns where I seek to repeat big successes.
- What is your Position Review process? Have an end-of-day routine to close your day. Review your trades, and assess if you followed your plan. Keep a log of all your trades, and make comments on each position.
- What is your Preparation process before trading? You need defined time to prepare for the next trading day to build up your trading confidence. I prepare after the close for the next day's trading, which allows me to formulate a plan of action BEFORE I get into the heat of battle. This keeps my trading proactive instead of reactive.
- What broker will you use? Most traders mistakenly think that commissions are the number one factor they can control. In reality, commissions are a small cost compared to the broker's effectiveness at executing your trade. Your focus should be finding a broker who gets you speedy and fair execution of your orders.
Once you have defined these facets of your trading plan, you are in an excellent position to have a strategy to control your emotions when trading. Make sure to review your plan on a regular basis to create effective trading habits.
Price Headley is the founder and chief analyst of BigTrends.com.