The Six Stages to Trading Success: Stage Two
The first three stages are obstacles, while the second three involve the process of learning to trade.
Today's lesson covers the 2nd phase to achieving trading success: planning. Nothing that has stood the test of time in this world was built without a plan. It is essential in your journey to become a master trader that you have a plan. You will definitely need a trading plan, which will tell you what and when to trade, and how to manage your trades. But before you get to writing out your trading plan, you need to make the most important decision you will make, which is to identify what methodology you will use. The methodology will define how you trade; whether you are to be a trend trader, or a mean reversion trader -- counter-trend trader. Which time frame you trade also needs to be determined depending on variables from if you have a job other than trading, to your attention span, to how much sleep you need. Most of us learning to trade gravitate to counter-trend trading because it dovetails with our perception of value. Counter-trend trading in simplest terms means buying price dips and selling rallies, which supports our existing believe to buy when something is cheap and sell when it's expensive. It can be said that the vast majority of us have mean reversion mentalities; meaning we have a rough idea of the worth of something so it does not make sense when price goes too far beyond that value in either direction. This mindset supports a method that takes advantage of sideways markets. Given prices goes sideways the majority of time, most traders initially opt for a counter-trending method. The potential drawback to a mean reversion method is over the long-term, markets are anything but mean reverting. Historic charts of stock indices and currencies show long drawn out price trends that often last for many years. We have to take a closer look to make out the sideways price action when markets pause or eventually do reverse. While markets do spend up to 75% of time moving sideways, the directional price movement the other 25% can be extensive. For example a market can jump quickly during the first hour of the Asian session, then move sideways for 12 hours, before jumping quickly again on the opening of U.S. session, before resuming a sideways pattern for the rest of the day. A strategy to try to take advantage of the impulsive or trending price action won't work in the slower moving sideways price action. The opposite of counter-trending is impulsive or trending price action. A trend trading method is designed to get in a trade aligned with the longer-term trend, or price pattern and stay in it, allowing the market to do the work for you. It also has the advantage a lowering your transaction costs because you trade less. In stocks, futures and Forex you pay a transaction charge every time you trade, therefore the trader looking to take smaller bites by trading more frequently such as a counter-trend trader, will have a higher cost of doing business than a trader whose goal is to stay in a trade for a more extended period of time. One of the reasons trend trading is not as popular with beginners is our own mindsets are often out of sync with extended periods of growth or shrinkage. Without experience it's hard for the average individual to see continued value in something that has increased sharply in price over the previous season. Likewise when we see a market that was in demand the previous year and trading at $100, and is now trading at $75, it's not our natural inclination to bet it will continue lower to $60.
All these considerations take planning, and testing, and adjusting over time and through different economic seasons. And then there is fundamental news, such as scheduled economic releases and breaking developments concerning everything from natural events to social occurrences to national and global economic events. How do you plan for these? For example take scheduled economic releases such as employment data or Federal Reserve decisions; do you exit trades ahead of these potential price determinants, and await their release before going back into the market? These contingencies must be planned out ahead of time. And while it is your goal to craft a trading plan that defines how you chose a market to trade, and what trade set-ups and signals you're looking for, you also need a plan to determine how you identify the different trends at play in the markets and how you measure current direction. You need to know when direction has changed as this will determine the timing of your operations. And then there are market correlations and the interference - divergence and convergence - they create to consider. Whether they are considerations for you or not has to be determined ahead of time. It's starting to sound more like work isn't it?
I'm very familiar with the work aspect of learning to trade and the thoroughness needed in your planning. In the past when I've set out to compile plans to help myself and my clients improve their trading they ended up literally becoming books. You will find in learning to trade there will be necessary detours along the way you will need to follow in order to stay on the right path in your journey. Don't worry about this, you are exactly where you are supposed to be. In the end your trading plan will be boiled down to one simple page which will be the tip of a much larger plan known as your trading education and experience. And it does stand to reason that the traders with the most education and experience are the ones whose capital is preserved and multiplied.
Our next lesson will cover "working", where we will see that our current perceptions about hard work and reward may be holding us back as traders.
Trading is a risky endeavor and not suitable for all investors.
To see Jay Norris highlight trade set-ups and signals for free on the London / U.S. overlap go to Live Market Analysis.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.