Chapter 10. Developing Your Plan

I’m going to assume we share the same understanding about the lucrative potential stock trading holds, and that you are seeking to implement a strategy that enables you to make consistent profits over time. What I do not know, however, is what your understanding is of the work ethic it takes to become successful within this field. I am consistently dumbfounded at the number of people who believe that with just a little work they can make consistent money trading stocks. It is true that the barriers to entry are extremely low, and almost anyone can open a trading account online and within minutes be in the game. However, to correlate the ease from which you can start trading stocks to the success you will have is a terrible mistake. You must know that the minute you sit in front of a computer screen studying the markets, you are facing not only the smartest people in the world, but the most competitive. You are facing ex-professional athletes who already know what it takes to succeed in the athletic arena. You are facing Ivy League scholars who calculate risk as if they were ordering a pizza. Finally, you are facing institutions that have an endless supply of capital from which to move markets, move stocks, and bounce you around like a Ping-Pong ball in the wind. After opening a trading account, like David facing Goliath, you are undermanned, underequipped, and the odds are significantly against your success. If you are not ready to commit the time and energy it takes to gain an edge against these challenging odds, do yourself a favor and find someone capable of managing your money with a proven track record of success in a variety of markets. If you have the drive, determination, and humility to learn, however, let’s press on.

While I’ve made my frustration level for those who believe this is an easy game evident, I always must check this attitude at the door. It is these traders who think it’s easy who will fall on the other side of your trades. Although equity trading is not always a zero sum game, those that do not understand or appreciate the work it takes to become successful do provide liquidity in the market, making your job and subsequent profits possible. I have been involved in many activities in my life, from athletics and academics to relationships and parenting. I can honestly say that stock trading trumps everything I have ever done when it comes to the work ethic needed to keep my edge. In my opinion, the stock market presents all participants with endless opportunity five days per week. However, only a small percentage of investors truly understand this and do the hard work required to become consistently successful. Are you ready to do the work needed to succeed?

“Plan your trade and trade your plan” is one of the oldest axioms passed among traders everywhere. Successful traders know that the less emotion they bring to the table when a trade is placed or being managed, the better off they will be. You are human and therefore possess emotions that can alter your actions, especially when you see your money increase and decrease before your eyes. Simply put, you must have already laid out what you should be doing ahead of time so that you do not make snap decisions on-the-fly.

Planning all the facets of your trade from the entry point, stop loss, risk taken, and exit strategy is as fundamental as the play called in a huddle for a football team.

Yes, a trader can be as free as a quarterback to call an audible, but the premise of planning ahead, before the action heats up, remains the same. Imagine a football team snapping the ball and the quarterback waiting until the defensive linebacker is running full steam at him before calling the play. I’m going to go out on a limb and say that the quarterback would be walking around with a few bumps and bruises after that game. This will not work during a football game, and it will not work during trading.

As someone who has made himself accessible to other traders and is always willing to help, I am often requested to diagnose various trading issues and investor styles. It is an experience I am always humbled by. However, over the years, I have now found that most conversations don’t go any further than the initial dialogue. The reason for this is the first question I ask any trader I am working with: May I see your trading journal? This is not a trick question. After all, it is through written words I can better understand just what the trader was thinking before placing the trade. I can then see how the trader executed this plan and exactly what went wrong. As you can imagine, few who reach out to me actually have a written trading journal for their stocks, and therefore have no documentation to follow when they are in a trade. These are the traders attempting to call a play when the center has already snapped the ball. It just won’t work.

I suspect most traders revert to a trading journal after they reach a certain level of frustration in their trading. My adoption of the journal-writing habit was similar but unique in that I had already been experiencing a level of success, but one that was far from consistent. As I began to review the only trading logs I had, my brokerage statements, I could tell very little about my actual trading strategy. It seemed easy to be a rearview mirror trader looking over buys and sells, cross-referencing those stocks to where they were months later, and surmising I just needed to either stay in a winning trade longer or cut a loser quicker. Regardless of how often I tried to implement such changes, however, it just never worked without a written record.

I subscribe to the belief expressed by Albert Einstein that the definition of insanity is doing the same thing over and over while expecting different results. Yet I also have learned that without the proper information, reflection, and study, simply altering the action might still not provide the desired result. Accordingly, each year I began reviewing trade record after trade record, coming away with the same realization: I sell too early. With a strong work ethic of reviewing a vast number of charts while playing favorable patterns, there aren’t too many winning stocks I haven’t invested in. Unfortunately, I stayed in those stocks for only a very short period (and they went on to mature into significant winners without me). As I reviewed this behavior of mine happening time and again, it seemed like an easy fix, with a logical adjustment of just holding on to winning stocks longer.

Each year, I made a new resolution to hold on to stocks that were acting well, longer. I wrote about this resolution, I discussed it with other traders, and like the early days of an exercise or diet plan, for the first few weeks I honored this resolution with incredible determination. Did it help me to start producing phenomenal returns? Nope, not even close. Time and again, the exercise merely led to more frustration as I bent my rules, trying to stay in names that no longer were worthy of my capital, wondering whether this would be the one I would sell far too early. It was a vicious cycle for me, but one that I couldn’t properly diagnose, not because I wasn’t studying the trades, but because I wasn’t studying the proper trading material.

I believe it was by accident that I first started a trading journal, but looking back, I’ll call it a divine intervention. I remember counseling another trader who had reached a maximum frustration level to the point of quitting. I could see he had reached the tipping point, yet I couldn’t let him give up the game he loved so much. MeatBaron, his Internet moniker due to his Canadian Butcher Shop business, had all the qualities needed to succeed: passion, humility, and a strong work ethic. Even so, he consistently was being beaten down by the incredible volatility the market had been dishing out for a series of months.

Before he threw in the towel, I issued him a challenge, saying that before he took any trade, I wanted him to articulate to me exactly why he was taking the trade and that I might try to punch holes in his read. Furthermore, I told him that when he became confident in a read, could articulate the read well, and could also defend his reasoning after my interrogation, he would take the trade and watch it play out from beginning to end, regardless of the changing market, his opinion, or anything else that might alter his read. What the trader didn’t know is that I had made a personal resolution to take all the trades along with him, so that I too could experience the emotional roller coaster when real money was on the line. I wanted to get more into his head and learn where his brain went after the trade was executed, but I also wanted to have the stocks he was trading in front of me so that I could study them right along with him.

I suspect there was a bit of intimidation at first because for the next couple days MeatBaron was silent. It is not uncommon for me not to trade for several days at a time, but at this very moment there were trades to be had, so I guessed a fear of articulating his ideas was holding him back. He finally reached out to me, expressing his desire to take a particular trade that was setting up. He told me he had recognized a key level in the stock around a specific price point; we’ll say $20, and the stock looked as if it were going to break above that level with unusually high volume. As I suspected, his read was not the problem, and the stock was, in fact, looking ripe for a significant move higher. I asked him where his stop would be and the various profit levels he was looking for. He answered without hesitation. As we were chatting online, I was copying parts of our conversation into another document, which ultimately became the format for my trading journal I use today. I also suspected I would need to use his exact words again in the future if he started to eventually doubt his read, the market, or the way in which the stock was acting. After some more discussion, we concluded that the trade was worthy of his capital. As I previously decided, I did not hesitate taking the trade and immediately bought an amount equal to the desired risk I was willing to accept on the trade. As the day concluded, the stock broke out and reached not only the first predetermined profit level but also the second. It was a very profitable trade within the first day, and with a raised stop level was certain to not turn into a loser. As I reviewed my notes from our previous conversation, I took the liberty of updating where the trade stood at the end of the day, and was amazed at my own lack of emotions over the trade, because I had simply been following a predetermined plan and not having to guess what my next move would be. A new world was opening for me, and I could tell this was the missing piece. I was also quite excited about the progression I believed MeatBaron had made that day, and reached out to him to discuss the day and the trade. “Excellent read,” I said, as I began the conversation. “I went ahead and took the trade with you and was pleased to see both your first and second targets reached.” I anxiously awaited his response because I believed we were well on our way. It took several minutes for the trader to respond, and when he finally did, he simply said, “I didn’t take the trade.” My heart sank. I asked what happened. MeatBaron simply relayed that he hesitated, and when it was time to commit his capital, he just couldn’t pull the trigger. Regardless of how positive the exercise was, the trader I was working with had confidence issues that went far beyond what I initially thought. It took several more trades, and several more weeks, until the trader who consistently articulated to me excellent reads with excellent strategies was actually taking the trades he was laying out. We spent hours poring over our notes and reviewing trades. They were not all profitable, but eventually MeatBaron saw that he did in fact have a statistical edge, yet in the early going his confidence level had not allowed him to exploit this edge at all.

From that point forward, he and I both began our trading journals, and he has gone on to experience an incredible amount of success in trading. He knows that confidence no longer correlates with his profit and loss. His execution of his edge will bring him the profits he desires.

You must keep a trading journal for each and every trade you place for a number of reasons. First and foremost, your trading journal provides you with a road map you are going to follow when the actual trade is placed. With an ever-changing market, there are constant distractions and many changing variables, all vying for your attention after you are already in a trade. A trade journal helps you to stay focused on the trade you are in. When you feel there has been a change in the environment, or in your trade itself, you can review your initial thoughts via the trade journal to cross-reference. If nothing has changed with your initial read, your trade should remain. It is important for you to remain steadfast when you are in a trade and not allow the outside distractions to change your plan. This trading journal will also give you a paper trail or historic documentation that you can review to gain a better understanding of your strengths and weaknesses, and most important, to improve on your trading regardless of whether the trades were profitable.

It is of utmost importance that if you do not already keep a journal, you begin to do so at once. There is no grand format, and you may develop your own journal according to your own personality. However, a few key variables must be included regardless of whether this journal is kept electronically or in an actual binder. These variables are as follows and should be notated in the following order. At this point, don’t concern yourself with the particulars of the list. We’ll delve deeper into each aspect in subsequent chapters:

1. Stock: Simply notate the symbol so that it can be recalled at another time.
2. Long or short: It’s easy to assume you will remember this basic variable, whether you are buying a stock long or selling a stock short. However, I always prefer to write it down so that my memory will be crystal clear.
3. Stop and reasoning: The point at which you would remove this position and why.
4. Trade reason: You should be able to clearly articulate why you are taking the trade. If you are following the pattern-recognition strategy, this should include a quantitative rationale and nothing qualitative, such as another person’s recommendation or the feeling that a stock will act a certain way because of outside influences. It is this section where the more precise you can be in your reasoning, the better. Over time, and as you become more familiar with charts, this section will become much easier. I always tell my students to pretend they are telling me why they entered a specific trade. I encourage you to do the same. If you cannot do this, you should not take the trade.
5. Risk per share: The difference between your entry point and your stop. (You will usually enter this once the actual trade is placed.)
6. Total risk for the trade: Multiplying the number of shares you have taken by the risk per share will give you your total risk for the entire trade. This number should actually be determined well before any trade is placed, and will be the variable from which your share count is determined.
7. Profit levels: Calculating ahead of time where you will take profits is imperative to a successful trade plan. This allows the trader to remain focused on the objectives after the trade has actually been placed.
8. Updates: Any journal should also contain an update section in which you comment on the trade and relay anything you might be seeing or feeling while the trade is being managed. This section is critical for future growth as you recall what your emotions were at the time of the trade. In this section, you can update where and when the trade is ultimately closed and the gain or loss incurred.

The key to any trading journal is that it is implemented. Do not get hung up on the details at this stage. Instead, understand that your journal will evolve as you evolve as a trader. If you take this process seriously, however, you will have a written account of this evolution and be able to look back on this process and actually see the improvements taking place.

Keeping your trade journal current is not an easy task. However, you must consider that doing so is critical. You would never think of starting a business and not keeping accurate financial records to document your progress. As a business owner, you would most likely pore over these documents to both better understand where your business is and to better understand where it is going. You’d also want to learn from your mistakes, illuminate or reduce your weaknesses, and capitalize on your strengths. In the highly competitive world of stock trading, this is no different, and taking the time to document your progress is essential to your success. Not only should you rigorously document all your actions, you should also you review your trading journal on a consistent basis. I usually review my journal at the end of each day, with a longer review at the end of each month. By this evaluation, I can adjust my game to capitalize on the opportunities that are sure to be presented the next time I sit in front of the screens.

Regardless of how hard, how time-consuming, or how awkward it may seem, start your trading journal now!