TRADING PLAN & TIMING RULES (FULLY UPDATED)

This article continues the weekly educational series, primarily dealing with psychology and methodology. Here are the previous articles: 4 Stages of Learning, The Trading Death Spiral, and the Trader's Mindset /w Common Psychological Issues.

I get over 100 e-mails per week and people asked me more questions about the trading plan and some ground rules, so I'm going to combine both topics into one article.

I like to ask myself several questions when constructing the plan. I'll give you 20 of them here and you can brainstorm the rest. The plan is your defense against emotional trading (if you actually follow it). Without a plan, you will be all over the place. The plan must be clear and concise and written down. If you do so, you'll be in the top 3% of individuals who have a plan, immediately giving you an edge over the other 97%. Here are the questions (in no particular order):


1) WHY are you trading? - The simple answer is "to make money", but that's really not a specific answer that describes you. Perhaps I can change the emphasis: "why are YOU trading"? Every person has their own reasons, such as quitting their full-time job, spend more time with their kids, increase their quality of life, take control of their financial future, etc. Why are YOU trading?

2) How will you enter & exit trades? The best entries are when the trades that you put on are lower risk compared to a much higher reward. This requires a through understanding and rationale of WHY you enter the trades in the first place. You can exit trades in many ways, such as setting initial and secondary stops, trailing stops, scaling out of positions. Do what makes you the most comfortable.

3) What type of orders will you use? There is a vast array of orders. I like to use market orders 99% of the time. Others like limit orders, and of course, there are stop limit orders and trailing stop orders. Make sure you know when to use what.

4) What broker, software, hardware will you use? Compare brokers and see what you like. Don't make the mistake of simply going to the cheapest broker. You get what you pay for. Instead, aim for a balance of reasonable fees, fast execution, excellent service, etc. You can choose what software and platform you want to use as well. Try out a couple. Finally, I'm not very knowledgeable in the hardware field, so just get a fast computer with lots of memory.

5) How much capital will you need to reach your goals? I think the absolute minimum to feel safe and without most restrictions is $25,000. To be adequately capitalized, I suggest a min. of $50,000. If you suffer a large drawdown in a small account, then you will have some problems. A larger account ensures flexibility and the ability for you to remain in the game, provided that you don't go crazy in your trading. If you hold a smaller account, limit the downside risk.

6) What ARE your goals? This goes with #1. Make sure your goals are 1) written, 2) believable, 3) challenging, 4) measurable, 5) specific, and 6) with deadlines.

7) What's your % allocation of capital per position? On average, I like to use 10% per position or side. Depending on my conviction level and the probability, I can go up to 20% per position and up to 100% per side (a rare occurrence). For people that are starting out, I'd say start with 5% per position, and move up as you build a tolerance. There are many ways to allocate capital.

8) What is your pre-market trading preparation process? This is your plan of action in the morning. You definitely want to check the futures in the morning for any gaps and their implications and location vs. the previous day's close. I like to check different news outlets/sites (there are hundreds of links on the sidebar for you to explore). I also check analyst upgrades/downgrades, economic reports, and earnings reports that may move the market. Be aware of what's happening.

9) What is your after-hours review process? Besides taking a nap sometimes, your end-of-day routine is key. Use this time to think about what happened during the day and what you did. It's good to keep a journal or blog to record your thoughts and observations. Keep a daily log.

10) How many positions are you able to focus on at once? I personally do not like to have many positions open. 10 is the limit for me. Having a portfolio with dozens and dozens of positions will create a distraction and you may miss exit points. The good thing is that the more positions you have and capital allocated per position, then the risk level per position is minuscule. I prefer larger, concentrated positions initiated through directional timing.

11) What type of trader are you (day, swing, position, etc.)? If you don't know this yet, then you shouldn't even be trading at all. Know yourself. Figure out what style suits you the best. What is your psyche most comfortable with and able to tolerate. Just because I do "X" doesn't mean X is appropriate for you. This is also why many people to follow other people become losers automatically by default.

12) Are you purely fundamental, technical or a hybrid of both? There is no wrong answer to this. It all depends on what you like and it's your choice. I am 100% technical and could care less about fundamentals (except earnings).

13) What will you use (exch-listed, OTC, futures, options, etc.)? Again, your choice.

14) When will you trade (all day, set time, every few days, etc.)? This depends on your available time, schedule, strategy, and personal preference. If you set a certain time, don't violate it. Commit to your scheduled and allotted time, or risk impulse trading.

15) What are your guidelines for using stops? This is your choice, but you have to adapt to market conditions when making your decision. Presently, wider stops are the norm due to high volatility constantly triggering tighter stops resulting in many losses. I personally do not use a hard stop unless I have to step out. I can use a mental stop and monitor the situation throughout the day. If you have a 9-5 full-time job, then you should use stops. Stop use is on a case-by-case basis.

16) What are your guidelines on losing positions? Specifically, how will you identify a serious loss vs. a temporary drawdown? How will you deal with the loss. Some traders simply stop trading for a few days to screw their head back on straight. This accompanies your strategy for exiting trades, but on the losing side. If you have 3 consecutive losses, seriously, take a break. Go ride some horses.

17) How much will you risk on every trade? Typically, a common rule is to risk no more than 2% per trade. Your risk depends on your allocation, exposure, and your loss limit. If you allocate 20% per position, you may risk up to 10% per position using th 2% rule. If you allocate 10% per position, you may risk up to 20% per position using the same rule.

18) Will you go both long and short? You should learn both skills. If you do not know how to short in a bear market, you will left with a severe disadvantage. Learn to take profits on both sides of the market. I recommend 4 main books on short selling (the first 2 are fundamental and the last 2 are technical): The Art of Short Selling by Kathryn Staley, Sold Short by Manuel Asensio, How to Make Money Selling Stocks Short by William O'Neil, and Sell & Sell Short by Dr. Alexander Elder. Get reading.

19) Are you going to trade the open? If the gap exceeds the high of the previous day after a day long consolidation, then the gap will run in the direction of the gap's open. An area gap that opens within the previous day's range is subject to fading/filling. What is your gap strategy? What is your strategy if the market opens unchanged?

20) Do you have a list of sites to visit, resources to read on a daily basis? If not, then check the sidebar for hundreds of links to every resource you need as a trader.

There are many more questions to ask yourself, but here are basics. Meditate on them.


As for the rules, there are plenty of them. We all forget about them once in a while. In fact, I always catch myself in the act of breaking them. The key is to be aware of your mistake and to get out of it as quickly as possible. Right the wrong. If you are not aware, then you won't know, and then you will be finished. Here are some rules, or little tidbits, that should aid you as a short-term trader. Some are obvious, some are not, just mind them all.

1) Buy on the 1st pullback from a new high & sell the first pullback from a new low. The first pullback and subsequent continuation move will confirm the strength of the rally or sell-off. Don't be the trader they buys right before an upside pullback and shorts right before a downside pullback.

2) Enter during quiet times & exit during crazy times. Then the markets are quiet, or trading in a tight range, that indicates that an explosive move is imminent. Use the chart to determine if it will most likely be a breakout or breakdown. Get out when everyone in the world is trying to get in at the same time, usually indicating a blow off exhaustion top.

3) Equalize time to opportunity. You must know how long you're going to hold the stock before you enter the trade. If you have to keep asking me or anyone else, "Are you still in?", "When are you getting out?" (of such and such stock), then clearly, you have no idea WTF you are doing. My timeframe may or may not be the same as yours.

4) Sell the 2nd high, buy the 2nd low. By default, the 1st high becomes resistance and the 1st low becomes support after major pullbacks. When a high or low gets tested more than 2x, then the likelihood of a break is extremely high.

5) Don't trade the exact open (in most cases). I like to wait a full 30-mins prior to pulling the rigger, unless #19 shows up (in the Trading Plan section above).

6) Short the weak rallies and not the sell-off (in most cases). Shorts are looking to cover since they are finally making money on the breakdown. There are times where the market just sells, sells, and sells, however, I'm talking about the majority of times when it doesn't cascade.

7) Do not short strong rallies & do not buy strong weakness. If a rally continues, corrects, continues, corrects, etc., then the rally is strong and sustained for whatever reason. Shorts will continue to cover in the face of it, adding fuel to the fire. Likewise, don't buy when a stock is selling off like there is no tomorrow. Something is terribly wrong and traders, for whatever reason, are willing to sell at any price they can get. Just remember why you are buying or shorting.

8) Keep the charts in mind & ditch the news. News moves the markets, but news is immediately priced in, and it shows in the chart immediately. First, determine if the news item is valid, trustworthy, relevant, and important. Second, measure the impact of the item. New items of all sorts are responsible for the vast majority of the breakouts and breakdowns that occur, but charts already tell you that.

9) Keep support & resistance and MA's in mind. Prices have memory, because humans have memory. People buy at support and sell at resistance. That's how it is. Use trend lines, channels, and moving averages to guide you. They are NOT just some stupid lines on a chart.

10) Trends test the last point of support or resistance (in most cases). Combine this with #9 above.

11) Use the TICK, VWAP and/or VIX, and other indicators to verify moves. They are your friends.

12) Stop chasing stocks, long or short, if you don't have a valid reason to do so. Don't be a sucker. Stop wondering why the market reverses everytime you buy or short. It's probably because you were chasing whatever you were chasing and that's your fault, not the market's. Afraid of "missing out"? Too bad, wait for the next opportunity.

13) The 200-day MA is the strongest MA, followed by the 50-day MA. The 200-day MA is not only the strongest, but the most important long-term MA. These MA's guide the trend of the market for years, and even decades. The 50-day MA is the strongest and most important intermediate-term MA, guiding the market for months to years. Always know where they are located in relation to the market.

14) Therefore, don't be buying toward or short into an MA. (includes the 20/30-day MAs). They are strong and reliable points of support or resistance. For the short-term, you want to focus on the 20 and 30-day MA's. Additionally, add the 10 and 15-day MA's if you are long and the 5-day MA if you are short. Many stocks use their own "custom" MA's, but many stocks follow the ones listed here.

15) Track the pivot points. Make note of prior highs and lows because there is a force at these points that caused at least a short-term reversal against the prevailing trend. If you are constantly wondering why a stock bounces at a certain point and pulls back at another, then you might want to note the pivot points. Pivots don't happen just because a stock "feels like doing it".

16) Make note of every gap and identify them (area, breakaway, continuation, exhaustion, etc.). Learn what all the gaps are, how to identify them, how to trade them. Gaps also mark major support and resistance levels, especially force gaps on Spikers™.

17) Massive volume at a pivot will kill the existing trend...and it will start a completely new one. Volume shows conviction, enthusiasm, and in most cases, institutional support. Don't trade against money that immediately stopped the existing trend and broke away to form a new one.

18) Bottoms take longer to form than tops because accumulation takes long than distribution. Classic greed vs. fear. People have a tendency to sell out of fear faster than buy into greed. This is why shorting stock yields profits 40-70% faster than if you were going long.

19) Stop rapidly trading during consolidation periods. What is the hell is the matter with you? The "Chop Zone" is specifically designed to chop up suckers.

20) Use multiple time frames for entry & exit signals. I like to use the 1-min, 5-min, 1-day, 5 day, 10-day, 1-month, and 4-6-month time frames on a single stock. Your reason for entering and staying in a trade will be confirmed on all time frames if the trade is still working.

MARKET COMMENTARY (02-19-09)

First, I'd like to bring your attention a scary scheme going on. It involves a piece of paper being placed on the back window of your car by someone who wants to jack your car. Apparently, the car thief will pick out cars that are backed into the spot so you don't see the paper when you walk over. Once you get in the car, you slowly get out of your spot, but put the car in park and get out to remove the paper. Your car will likely still be running. The thief will jack your car and everything that's in it the moment you step out. Don't fall for this bullshit.

We are flagging and, at this stage, it is a bull flag indicating additional upside sometime soon (I did not say tomorrow, I said soon, for those who are illiterate). I remain in all cash until we gap up/burst out to the upside or break the flag and sell-off. The market had a terrific run and it needs some time to properly consolidate those gains. As the consolidation develops, it will show appropriate entry signals.


Tomorrow, we will likely continue the flagging action. The SPX finds immediate support at 780 and 775 and very strong immediate resistance at 800. If you are going to day trade, just remember that consolidation days get choppy. Also, do not forget about quadruple witching. You might as well go take the day off and ride some horses like I did last Friday.


I suggest keeping an open mind if you are thinking in the intermediate-term. We could be forming the bullish broadening wedge pattern. This downward coil will produce a Force™ spike if/when it breaks out above the 50-day MA. If that occurs, it will furious and immediate. Likewise, if we breakdown completely, the bottom of the wedge would be at around 600. Just FYI.


You can see a various time corrections, an ascending triangle, and presently, another time correction. After a series of time corrections, you usually encounter a more deeper price correction, not to be confused with a sell-off. A possiblity is that one may occur between the 50- and 30-day MA's on the SPX. If we form a doji, it'll likely be a large time corrective flag.

MEMO TO AIG EMPLOYEES

MARKET COMMENTARY (02-18-09)

I'm in 100% cash once again, not having the courage to hold overnight positions, especially when we're at the 50-day MA. I see no reason to put my money at risk here. The 50-day MA is like a stop sign along a trend and the market has always met resistance here and has either paused and continued its uptrend or stopped completely and made a U-turn to go back to where it came from. The same applies to the market - it's one big road.

No doubt, you'll see some crazy drivers. For example, today you saw the Bernanke in the front seat of dollar destruction, driving 130 in a 65, recklessly throwing Benjamins out the window. And if you're a short-seller, you might see Congressmen tailgating your ass, shouting and shit, telling you to get off the road. You realize that they're all driving POS Ford Pintos and Chevy Cavaliers, so you just speed up while giving them the finger behind you, hoping that they don't pull out the uptick gun in their fit of rage and use it on you.

As you're cruising along, you'll encounter SEC cops sitting on their fat asses enjoying their KKD donuts and not giving a care about what happens on the road. They're only there because other drivers want them enforcing the law. You stop on the side of the road to inform them that a 70 year old man with silver, curly hair wearing a jacket with the initials "BLM" and a stupid grin on his face looked like he was robbing some bikers on the shoulder of the road. The cops go back to eating their donuts, not giving a damn. You get back in your car and drive into the sunset, giving them the finger.

As dusk approaches, you come across some highway construction workers putting up directional signs to help you navigate the road. You stop and ask the bald guy, Cramer, for some directions. After blindly following his stupid directions, your car ends up in a swamped out ditch on the side of the road in the middle of no-fucking-where. It is 3am and you're standing on the shoulder having lost your wallet, phone, and your shirt.

But good thing you had your seat belt on.


Bullish broadening wedges are only bullish if the market consolidates at the upper range and breaks out. Otherwise, there is a risk that the market can fall to the lower end of the wedge, just fyi.

Don't forget to try the Free Trend Analysis. It's FREE, so give it a shot!

MARKET COMMENTARY (02-16-09)

Yesterday was a reversal day and I am now greater than 20% short in the financials and small caps. I put equal weight on reversal candles, moving averages, trends/channels, support/resistance, and price/volume action to determine whether I scale-in more positions.

We had the rare gravestone doji yesterday and various shooting stars, that have either formed right at the 20- or 30-day MA's and have also hit resistance, with most indices at the November low retracement. The COMP has shown a divergence and it has formed a quasi evening star reversal.

The obvious question is, 'Will this be a normal pullback or is this the start of a breakdown?'. The answer is, 'I probably wouldn't get any signals until Wed'. Why? Because typically, a upside reversal candle such as doji or hammers precede the continuation of a rally. In a downside breakdown pattern, you'll see solid red candles with larger volume on the sell-off. The key here is the volume. Low volume should accompany pullbacks and the opposite is true for sell-offs (higher volume).

A great way to confirm any short-side thinking is to look at the inverse ETFs, 2x and 3x, and see if they exhibit reversal candles on support levels or moving averages and are accompanied by higher than average volume. For example, if I wanted to short financials, I would look at FAS, FAZ, UYG, SKF, XLF, and their top main components to see what the odds would be if I decided to short. In most cases, there won't be any divergences, but if there are, then I have to consider why.

I am looking to swing the shorts and then the market determines what action I take next. Below are 40-day and 5-month charts for the SPX, DJIA, COMP, and RUT.

Don't forget to try the Free Trend Analysis. It's FREE, so give it a shot!

THE TRADER'S MINDSET & COMMON PSYCHOLOGICAL ISSUES

Plutchik's Wheel of Emotions

As you know by now, psychology is a secondary interest of mine, after reading charts and tarot cards, of course. For this week, I decided to cover the "trader's mindset" and the most common psychological issues that all traders deal with.

How does someone know that they reached the trader's mindset? Here are a few characteristics:

1. No anger whatsoever.
2. Confidence and being in control of the self
3. A sense of not forcing the markets
4. An absence of feeling victimized by the markets
5. Trading with money you can afford to risk
6. Trading using a chosen approach or system
7. Not influenced by others
8. Trading is enjoyable
9. Accepting both winning and losing trades equally
10. An open mind approach at all times
11. Equity curve grows as skills improve
12. Constantly learning on a daily basis
13. Consistently aligning trades with the market's direction
14. Ability to focus on the present reality
15. Taking full responsibility for your actions

Developing the trader's mindset takes time. It usually takes traders 2-5 years before they can read through the above list and honestly say that it describes themselves.

Let's take 100 traders using the same trading system or approach. It is highly likely that no two of them will trade it exactly the same way in all aspects. Why is this? Because our mindsets, beliefs, and understandings are unique. It is no surprise that most traders fail and the reason why is because they lack the trader's mindset. This article covers those in Stage III and IV within the 4 Stages of Learning. More importantly, it applies to those that survived Stage II.

There are two parts to fixing any psychological problems:

1. Recognizing that it exists
2. Accepting it so you can move on

In trading, this is where it's so crucial to take responsibility for your own actions because it induces change and you can start making improvements. If you don't recognize and accept a problem, then you won't get anywhere!

What are some of these issues that I speak of? Here are a few along with their causes and/or effects:

1. Anger over a losing trade - Traders usually feel as if they are victims of the market. This is usually because they either 1) care too much about the trade and/or 2) have unrealistic expectations. They seek approval from the markets, something the markets cannot provide.

2. Trading too much - Traders that do this have some personal need to "conquer" the market. The sole motivation here is greed and about "getting even" with the market. It is impossible to get "even" with the market.

3. Trading the wrong size - Traders ignore or don't recognize the risk of each trade or do not understand money management. There is no personal responsibility here.

4. PMSing after the day is over - Traders are on a wild emotional roller coaster that is fueled by a plethora of emotions ranging throughout the spectrum. Focus is taken off of the process and is placed too heavily on the money. These people are very irritable akin to the symptoms of premenstrual syndrome.

5. Using money you can't afford to lose - Usually, a trader is pinning his/her last hopes to make money. Traders fear "losing" the "last best opportunity". Self-discipline is quickly forgotten but the power of greed drives them, usually over a cliff.

6. Wishing, hoping, or praying - Do this in church, but leave this out of the market. Traders do not take control of their trades and cannot accept the present reality of what's happening in the market.

7. Getting high after a huge win - These traders tie their self-worth to their success in the markets or by the value of their account. Usually, these folks have an unrealistic feeling of being "in control" of the markets. A huge loss usually sobers them up pretty quickly.

8. Adding to a losing position - Also known as doubling, tripling, quadrupling down, typically, this means that the trader does not want to admit the trade is wrong. The trader's ego is at stake and #6 comes into effect as the trader is hoping the markets will "work in their favor".

9. Compulsive trading - Similar to #2, except these traders have an addiction to trading and quite possibly gambling issues. They need to constantly be trading, even if there is no rational reason to do so. They are always excited whether they win or lose.

10. Afraid of "pulling the trigger" - This usually means that the trader does not have a system or approach already in place. They have not calculated risk/reward and many times, these trades are unplanned. This also comes after a string of losses. They don't want to be "wrong again". There is no trust from within.

11. Over-thinking or second guessing - Similar to #10, but these people are usually looking for a "sure thing", when they clearly don't exist. Losing is not recognized a normal part of trading and the risks and unknowns of trading are not fully accepted.

12. Limiting profit or getting out too early - These traders have poor self-esteem. This is a direct effect of believing that the profits were undeserved. Usually a trader is stressed over a trade for some reason and closing the position quickly eliminates the anxiety. Usually, there is a fear of "giving back" those gains.

13. Fear of being stopped out - Traders fear failure and the pain from taking losses is great. Here is another instance where the ego is at risk. They must always be correct or suffer a feeling of "let down".

14. Not following your system - This is a trust and follow-through issue. Perhaps the trader didn't test it enough, or it recently produced a string of losses, casing some doubt. Your faith in the system is broken. Not only do you not trust the system, you can't even trust yourself with picking one that works for you.

15. Following other traders (indiscriminately) - These traders do not have a system. They are also limited in trading knowledge. They feel that they will become winners if they simply "follow" someone. These trades are usually impulsive.

The key to all things is creating balance. This means that if you are winning or losing, you should not care. When you finally recognize and accept each of these common pitfalls, you'll be well on your way to acquiring the trader's mindset. Good luck.