Active-Trader - My Trading Plan

Welcome back Active Traders and Wealth Builders.

After my breakout week 2 weeks back, I didn't do quite as well this past week.  In an attempt to analyze why, it occurred to me that I can't tell if I am executing according to plan, because I don't have one!  Specifically, I don't have a written trade plan which has been fully thought out and committed to paper.

Before I get to that, let me digress briefly on what trading is not.  Due to my training as an engineer, I used to think that trading could be automated.  Trading was a puzzle to be solved, and technology could help me solve that puzzle, and when I was done, all I would have to do is sit back and put up my feet and watch the money roll in.  Right?  Wrong!

Sure trading is being automated by high-speed algorithmic trading on Wall Street.  But I can't compete with those guys and there's no point in trying due to their built-in advantages.  So instead let's define what successful trading is for me:

Trading is a set of habits and behaviors, developed over time, which allow you to extract profits from the markets.

And good behaviors, when repeated faithfully over time, tend to become automatic.   So my job going forward is to develop those skills and work on my inner game.  And this trading plan should be a good step forward so let's get started.

1) Why am I still trading?

I trade mostly because I enjoy it, but also because of the chance to earn extra cash and improve the quality of my life.  Eventually, I will leave my full-time job and I plan to rely on trading to create and income to enjoy what life has to offer without having to worry about the money aspects.

2) When do I trade?

I trade between 9:30 and 10 AM and between 3 and 4PM on market days.  These times are when the best opportunities are found.  I also look at the market between those hours also and fortunately my full time job allows me to do so.

3) What do I trade?

I trade Weekly and Monthly options on stocks.  Fast moving, high priced stocks provide the best opportunity since they move around a lot and can easily move between strike prices in a single day.

My preferred strategy are options spreads where if I am bullish, I will sell a put credit spread and if I am bearish, will sell a call credit spread.

I will also occasionally buy directional puts and calls but limit losses to my risk limits described below.

I will also occasionally scalp stock and options for short, intra-day movements with very tight loss control.

4) What is my trading methodology

a)  Determine the overall market context.  Do this by first looking at the Daily, Weekly and Monthly charts of the major indices.   This will provide a backdrop for expectations for price movement

b) Determine the daily market context.  Are the Futures heading higher or lower in the Pre-Market?  Are their any important news announcements for today and when are they expected?  Are their any other calendar effects to be considered?  For example, Fed Day, End of Month, Triple Witching etc.

c) Determine the context for the tradable.  Review the charts and determine whether the tradable is expected to move higher or lower.  Extra consideration should be given to stocks with movements expected which are in confluence with the general market.

5) What are my entry signals?

I will focus primarily on the Daily charts for signals.  Entry will be daily patterns such as Key Reversal, Elephant Bars, Bounce off Support or Resistance, Close above the low of the High Bar, etc.  This mean don't just take a trade because it makes a new high or I think price is close to support or resistance.  Have an opinion on support or resistance, but don't take action until confirmed by the Daily Price action

6) What are my Risk/Reward parameters?

I will take spread trades when the credit is approximately 30% or greater the width of the spread.  Here are these values for various spread widths:

$5 - $1.80 max gain $320 max loss
$2.5 - $85 max gain, $165 max loss
$0.5 - $25 max gain, $25 max loss

Generally the higher the credit received the better, minus any amount the spread is already in the money.

7) When will I cut my losses?

I will cut losses when it become abundantly clear that my short options will expire in the money.  I will wait until the day of expiration for this to happen to give the tradable the greatest chance of recovery.  I will attempt to close the trade before noon of the day of expiry for something less than the maximum loss.  If the tradable is close to the short strike give it time to recover.

8) When will I take profits?

For scalps, I will only take the trade if there is a high probability of price movement, and I will move the stop up immediately when the trade is in the money.

For long options, I will take profits when the price of the underlying reaches its target price.

For spreads, I will take profits once the spread reaches 80% of its max profit or if the short strike is in danger of going in the money.   Generally, I will try to hang on until expiration and let each trade go to maximum profit   This sometimes leads to a situation where a profit turns into a loss (AAPL this week) but avoids taking profits too early which can result in under-performance.

9) How much will I risk on a trade

For this year, I will stick with a Max loss of about 1% of my account on any given trade.  Since my account is about 33K, that means that I will risk a maximum of about $300 on a given trade which (conveniently) is very close the Max Loss on a $5 spread trade.  As I gain additional confidence, I will increase my risk profile in double increments (2%, 4%) until I reach a maximum of 10% for trades in which I have a high degree of confidence.

10) How many trades will I put once at once?

I will keep the number of trades to a manageable level, typically in the neighborhood of 5 trades, with an upper limit of about 7 or 8 open trades for any given expiration.   Given a rule of thumb of 5 trades, that means my max loss for any given option expiration would be about 5% of the account, and maximum gain would be one third of that or about 1.8% for that week.

Clearly, I have room to increase my trades size since I'm only using about 10% of the buying power in the account.  However, as I stated previously, my primary goal in 2013 is to end the year with a solid profit and build this account.  Longer term, if I can build this 30K account up to 100K, I will be in a solid position to use that as my trading stake for full-time trading.   I am clearly taking the slow road to financial success, but slow and steady wins the race.

That's a good start for my trading plan.  Think about your plan in your time off this weekend and have a great week ahead.