How to be a Successful Trader with Trade Plans

Why a Trade Plan?
You want to enjoy the benefits of being a successful trader. However, you don't exactly know where to start. A Trade Plan can put you on the right track.

Think of your trade plan as a road map. It helps you reach an unfamiliar destination successfully and safely, and identify the basics of just where you fit into the trading world.

Just as a map would help you experiment getting to a location in a variety of ways, a trade plan helps you reach your goals and get you back on track if you should make an error.

Just as a road map may be as general as a world atlas, or as detailed as a road map of your local neighborhood, a Trade Plan offers you the means to find your location in the span of world markets, and help you be successful in reaching your trading goals (or setting up shop and growing your business).

None of these concepts are meant to deter or intimidate you, whether you want to earn a little on the side as a 'hobby trader' or you have a greater goal of being a larger trading firm some day, all marketing guru's have the same theory: Business is all about location, location, location. Determining your location (your niche) in any industry means proper placement of advertising, matching your products to your customer's needs - regardless, this will involve using a 'map' (your personalized business plan).

Do you often go traveling without a map? How often to you hear a couple having issues because they head off to a location (which could be dinner or an event such as a wedding) only to turn around because they never brought directions? As we all know, heading into unknown areas requires direction (or maps). Maps (directions) are essential in ensuring we reach our final destinations! Trade Plans are essential for the same reason, so we know where we're headed when we begin our trading (or journey).

Would you ever consider traveling to Paris France without doing research? Not only is it across the ocean, but their primary language is predominately French. So there are certain questions you'll instinctively know to ask:
How much will it cost to get there, what documents do I need
Where will I stay and do I know enough about the language to stay safe in the country?

Do I know anyone who can help or do I have to do this on my own?
You can relate this to someone who is considering trading for the first time, there are many questions that might come up:
How much will it cost me to trade?
Where will I find a broker?
Is there special language that applies to trading that I need to know?
Can I do this myself or can I find someone to help?

The first steps you must take in learning to trade, are not all that different than they would be traveling to France for the first time. You will do research - this will uncover a group of plans (maps) that begin with your own desire to trade.

Like the 'micro-maps' that your research on France (such as maps of Paris, tourist locations, etc), a trader will have a set of 'micro-maps' of various trade variations. The next step in both cases will require you to do more search.
Initially, you may think that some of these steps are trivial and little more than common sense, but they can be much more significant than that. These are fundamental steps that if you skip over them, you may find yourself skipping your 'journey' altogether. Don't rely on instinct, research and plan your basic steps. This concept will serve you well wither you are traveling to a foreign country or developing your own personal Trade Plan.

As you gain experience (as with travel) in the world markets, you will begin to expand not only the number of trades you make, but the types of trades that you make within the world markets. Each step will require another set of maps to allow you to navigate those markets as informed and educated as well as safely as possible.

Whether you're considering 'bounce trading', 'short trading', 'option trading', 'penny stock trading' 'index trading' or 'futures trading' you will find a map that can help you to determine what research you need to do to research and execute your trades successfully.

Once you determine what type of trading you'd like to experiment with first, and to develop your trade plan further, you will want to look at the variety of maps that are available to your area of interest.

Essential Elements of a Trade Plan%u2028

As you begin to prepare for trading and setting up your trade plan, there are some elements that you will need to have a firm grasp on before you get started.

These are:
What are your goals?
Are you going to be a long-term investor or a short-term trader?
How much money are you planning to invest?
Do you have the necessary resources to invest?
What is your risk threshold?
Do you have the base of knowledge you need for the investments you've chosen?
Will you invest in stocks, bonds, or options or other markets?

Initially we'll take each of these topics individually to help you create your own personalized trading plan.

A) What are your goals?
Before you can begin setting up your trading plan you will need to make sure you have a clear understanding of the goals you are setting for yourself. Keep your goals realistic, investing/trading is a business. You should establish long and term goals and you should revisit your goals often to see if they have changed and if they have what you need to do to meet your new goals.

B) Are you going to be a long-term investor or a short-term trader?
The answer to this question will be one that you must answer before you begin your investment model. You may find that a combination of the two will be the most suitable for your long term goals. Long-Term investors may find it easier to invest in stocks and bonds, while a short-term trader may opt for either lower priced (higher risk) stocks or options or even futures trading. You must evaluate the risk/reward of each investment you choose. Remember that setting these expectations early is fine, but you must always go back and review/revise if something isn't working the way you originally anticipated.

C) How much are you planning to invest?
The amount you plan to invest at any one time will significantly impact your trading plan. As a general rule of thumb, regardless of how solid your trading plan is (or will develop to be) you should never plan to invest more than you can comfortably lose. The stock market (like many other things) is not a guarantee of a profit and from time to time it is possible to lose 100% of your investment.

D) Do you have the necessary resources to invest?
This goes back to the above statement of not investing more than you can afford to lose. It would never be recommended that you invest all of your savings into the stock market (unless you were investing in 100% guaranteed investment return things like a money market account), so that if you lose your investment you will have no reserves. Carefully plan your investment amount and ensure that you will not suffer irreparable financial problems if you should lose your investment.

E) What is your risk threshold?
Our ability to tolerate risk varies at different points in our lives. Those in their 20's to 30's with a long way to go until retirement and sufficient financial means may have more free cash to invest than the investor in their 40's to 50's with a home, children headed for college, and closer to retirement. Your individual tolerance to risk will dictate what your threshold will be. Pure growth stocks offer individuals a higher risk for a potentially higher reward, while purely income investments will offer a lower risk but potentially a lower reward as well.

F) Do you have the base of knowledge you need for the investments you've chosen?
Before you consider investment in any type of vehicle you will want to fully research what you've selected whether that is a stock, bond, annuity, option or future. It is critical that you gain a base understanding of the trading cycles, dividends (where applicable) and what the tax ramifications of your investment(s) will be. You may want to start off with a combined portfolio of investments and you will need basic knowledge of each component of your investment portfolio before you begin so that you will understand the variations as they occur in your portfolio to assist you in changing your strategies in your trade plan.

G) Will you invest in stocks, bonds, or options or other markets?

Whichever investment vehicle you've selected, you will want to build your trade plan around that investment. If you are considering a variety of investments, you will want to identify each of them in your trade plan and identify what your goals are for each of them, how much you want to invest in each and what you are looking for in terms of growth.
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I am ready to begin - Part 1

My Short Term Goals

You've reviewed the outline of how your trade plan should start and you're now ready to begin the initial stages of your trade plan. We'll step through each piece in this series, and we will walk through the process of each step so that you can establish your trade plan and provide for contingencies.

As you recall, our first step was establishing your goals so now we need to determine exactly what are your goals?

In order to fully establish your goals you'll need to look at both short and long term goals. For the short term, you will want to establish attainable goals that can be adjusted for long term prospects.

So for the short term we'll look at what your goals are over the next 30 days and we'll talk about the steps to achieve them.

Short Term Goals:

A) Determine investment objectives
Everyone has a different set of investment objectives. There are those of us who trade for the sheer enjoyment of it and those of us who trade for tax reasons. If you're trading for enjoyment, you'll get far more enjoyment out of investing with a specified profit in mind, and for tax purposes you'll be looking for both short and longer term investments.

For short term investing, you've decided that equity options are your investment of choice. Initially, you'll want to take a look at the group of equities that most interest you, whether it's a specific company or it's a specific industry group. For instance, you may find that IBM doesn't really appeal to you, but DELL does. In this case, you'll want to focus your market research on DELL and find out the short and long term trading patterns that have been established.

B) Researching trading patterns
So you're not quite sure where to start!! Your options for beginning research are as numerous as the number of companies that are out there. You can contact the company directly and ask for company reports, you can go to the companies website and review annual reports online, search out rating services (such as Morningstar, Zach's or even the SEC website where you can find reports in Edgar), or you can do your own market research right online with various quoting services that can offer you unbiased information. You also can seek out an investment advisor who can help you through this process.

C) Understanding what you're reading
It's important that with the maze of information that you are researching that you find a way to comprehend what you're reviewing. There are many resources available to you to make sense of all of the numbers and you should avail yourself of them. Simple searches on the internet can help de-mystify all of this data.

D) Setting your investment accounts up
You've figured out that you wish to invest in DELL options and you've done all of your research but you're not quite clear on how to invest in the options. The first thing you will need to do is to find a broker to help you with these transactions. There are disclosures to be made by the broker to you, including their fees when you invest in a trade. Don't forget to ask the right questions of your broker, including minimum investments (some brokers will charge a fee unless you guarantee a certain dollar amount in trades), fees for buying and selling (some companies charge different fees for purchase and sales especially with options trading), and you'll also want to find out about settlement dates.

Your broker should also offer you all of the available literature on options trading. This includes certain required publications. You will have forms to fill out which may be confusing. Do not hesitate to take the time to read them thoroughly before signing anything! Don't let your broker dictate what you're doing, if you're not comfortable with what they're telling you, look for someone else!
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I am ready to begin - Part II

My Long Term Goals

You've now had the opportunity to establish your short term goals and now it's time to think about your longer term goals. These can be as short a period of time as ninety-days or as long as five years.

So if we break it out into pieces, we can easily determine the proper course of action for your trade plan.

Setting up longer term goals takes much more planning than setting up your shorter term goals. We've already established our account with a broker we're comfortable with and we've prepared for some of the eventualities that can come with shorter term trading so now we are ready to begin setting our a longer term plan.

Since options trading can be done in the form of 'day trades' (i.e. trades that are liquidated at the end of the trading day they are purchased), or in incremental trades of 30, 60, or 90 days (or longer if you look at investment products such as LEAPS), it is wise to begin thinking in increments of trading.

If you're 'long term' plan is for thirty day trading then your investment strategy will be different from those who have a longer-term plan (say 90 days or more) and you will want to invest slightly differently.

So let's discuss various trading techniques that you can accomplish in 30 days.

You have invested in shares of DELL and have purchased 1,000 shares of the stock at a cost of $27.00 per share, but are concerned that the stock price could drop below that. You want to do your best to protect this asset, and because of that you decide that an option is the best way to do so. Armed with this knowledge you are prepared to make your first trade in a PUT option, and a review of the available puts helps you to determine that your best price will be at the 30.00 share level, just slightly above your original purchase price. You find that the put option is trading in the 2.60 price point and determine that you will purchase 10 put contracts which expire in 30 days, (giving you the option to sell the stock at 27.50 per share). Your total investment for the contracts will be $2600 plus broker and transaction fees (keeping in mind that each contract is for 100 shares and 10 contracts therefore is 1,000 shares). As it turns out the stock drops to 26.00 per share before your contract expires and you now decide to exercise your option to sell the stock at 30.00 per share. The seller of your contract has committed to you that they will purchase your shares for this amount so you can now sell your 1,000 shares of DELL at $30.00. What would have happened if you did not have the option? Your initial investment of $27,000 (1,000 shares of stock at 27.00 per share) would have shrunk to $26,000 resulting in a net loss of $1,000 (plus commissions and trading fees), instead you were able to realize $30,000 from the sale of the stock. Even after taking into consideration the cost of the option (and associated fees) you have realized a small gain (depending on commissions and trading costs) of approximately $400 on the sale of the stock.

Note that this example is for illustration purposes only and should not be considered investment advice.

Are you going to be a long-term investor or a short-term trader?

Short and long term investing are both valuable tools for you however, both must be used correctly to achieve maximum benefit.

When setting up your goals (as we discussed in the prior articles), you will want to have attainable goals in all phases of your trade plan.

While we will focus a great deal on shorter term trading (via options), it is practical and sensible to have a plan for your longer term investments as well.

Investments Suitable for Short Term Investments

There are a number of investment vehicles that will suit you well if you have specific short term investment goals. Some stocks that have higher volatility will offer you great 'short term' investment opportunities, as will both put and call options. Whether you choose to invest in equity options or index options, you will need to understand not only the rewards that can be a part of option trading but equally important that you understand the risks of trading in options (especially shorter term options).

With a short term stock investment, you can purchase a security and one you own it you're free to sell that stock at any time after the purchase with no deadline as to when you can sell.

When purchasing options (whether they are puts or calls) you have a limited window of opportunity that begins the day you purchase that option and continues only through the option exercise date. It is critical that you invest wisely when dealing with options (and all other securities) so that you can minimize your risk and maximize the rewards.

Investments Suitable for Long Term Investments

As with short term investments, there are several options available for long term investments depending on what your investment goals are.

If you are seeking liquidity in your investments as well as safety, you will most likely be better suited to bonds, or a bond fund (mutual fund companies offer these) or even a money market fund (with low return but guaranteed return on investment).

If you are not as concerned with liquidity but are concerned with not losing your investment, you may want to consider investments into secure stocks that you know remain in the top of their markets. While these securities may have some volatility over time they have proven to be solid market performers over time and will most likely some stability in your portfolio.

Mutual fund companies offer a wide variety of investment options that will allow you to invest in portfolios of funds that will offer longer term investments based on your particular investment objectives as well.

If you're not as concerned with safety of an investment, there are many long term trading opportunities in options including LEAPS and other longer term options.

How much money are you planning to Invest?

Planning on your total investment ability is crucial to setting up your trading plan. It is impossible to design a trading strategy without knowing the amount of your investment.

A careful look at your overall financial picture is critical in determining your ability to invest in both short and long term trading.

You will need to answer the following questions to determine your financial ability to trade:

A) Is my job stable?

While you may have been with your company for 10 years (or more) there is no guarantee of job stability. Many companies go through downsizing and while you can look at how stable your job is today, you must be aware that there is no guarantee that you will still have your position a year from now.

In looking at the stability of your job, take into consideration how many 'new' people have been hired, what their qualifications are, and where your particular job fits into the 'big' picture in your particular company.

Today, none of us are guaranteed to be employed by the same employer for our entire careers like our parents may have been. Oftentimes company policies change resulting in changes to your career which you have no control over.

B) What are my savings?

Taking into consideration your current level of income, your savings should be substantial enough to carry you through any 'difficult' periods, including job loss, uninsured medical costs, and other unexpected expenses.

It is never a good plan to invest all of your savings into trading. While you do your best to minimize your risk, there will always be a risk to trading and that could result in substantial loss of your initial investments.

Have I planned for emergencies?

You must always have a back up plan. For those of us who own homes, we know that furnaces break down, roofs need repair and other unexpected things come up all the time. It is crucial to your overall financial health to have contingencies in place for these types of emergencies.

While the overall goal in trading is always to show a profit, it is critical that you not depend on these profits to handle emergency situations that come up. If you were to lose your job tomorrow would you be able to continue to maintain the lifestyle you are leading today for a period of time (six months is typically a good rule of thumb).

Do I have sufficient insurance, medical, life, homeowners, auto?

It is never recommended that you begin a trading plan without assuring that you have sufficient other assets that your family can depend on. You certainly would not consider investing your last $1,000 in the stock market with the expectation of doubling or tripling your investment in a short term trade, and investing in any type of stock market trading should never be considered good financial planning.

What is my other household debt?

Credit cards, auto loans, student loans, etc., all take their toll on your income, your savings and your overall financial health. Be sure that you have sufficient savings to accommodate all of these financial needs for a period of time that you determine to be safe in the event that you should lose your initial investment in any stock or option trade.

When setting out your trade plan, you should take all of your financial obligations, savings, and the overall financial health of your family as a whole before you determine the level of investing that you are prepared to do. It would also be beneficial to you to discuss your intentions with your tax preparer and see what tax concerns trading will create for you, as capital gains and other considerations will impact your trading patterns and abilities.

Do you have the necessary resources to invest?

In the last part of our series on developing a trade plan, we asked you to consider how much you were going to invest. It is time to assess your resources and evaluate not only your financial resources, but your time resources and other resources that you will need to invest wisely.

Financial Resources
As we previously stated your financial resources will play a significant role in determining your overall trade plan. If you have $5,000 to invest your trading plan will be very different from someone who has $50,000 to invest, and your plan should reflect this.

Time Resources
You must consider the time that it is going to take you to implement your trading plan. If you plan to spend only one hour per day monitoring your investments, then your trading plan should reflect this time, whereas if you can devote 3-5 hours per day, you can trade slightly differently.

Clearly if your job takes you to very long and lengthy meetings and you hit a period of high market volatility you run the risk of losing out on beneficial trades (or run the risk of substantial loss) if you are not able to monitor what is going on with your investments.

Other Resources
Do you have subscriptions to financial newspapers, access to a broker who is readily available to discuss various trading ideas, regular access to the internet, regular access to updated stock prices? These important resources can help you plan your next steps, update your trading plan (when necessary) and provide you with an ongoing education into various types of trading.

It is critical if you are going to be doing short term trading that you are constantly abreast of what the changes in the stock market are. If you do not have the time to do this yourself and are depending on a broker to do that for you, then you must have the ability to talk with them on a regular basis.

However, if your trade plan lays out mainly longer term goals, then you should have no problem monitoring your portfolio's progress. However, if you have established a lot of short term trades, you will need to monitor the market activity much more closely and more often.

What is your risk threshold?

All of us are willing to accept different levels of risk. This is true whether it's buying a home, a pet, having children, developing a relationship, or on the job.

Risk becomes a much different thing when we are considering trading in the stock market. Market changes happen not just daily, but often there are significant market fluctuations during any single trading day.

A well thought out and implemented trade plan, while it will help minimize risk, there is no such thing as a stock market trade that lacks any risk at all. The following scenarios are possible when trading in the stock market:

Make a profit on purchase/sale
Break even on purchase/sale
Lose fees and charges from broker on purchase/sale
Lose part of investment on purchase/sale
Lose all of investment on purchase/sale

A) Make a profit on purchase/sale
In order to secure a profit on the purchase and sale of any stock market investment (or other investments) you must sell at a higher price (including fees) than you purchased the investment for.

B) Break even on purchase/sale
You purchase a stock at 12.75 per share and the fees you incur from your broker add up to about 1.25 more per share and you sell your shares at 14.00 per share resulting in a break-even trade.

C) Lose fees and charges from broker on purchase/sale
You purchase a stock at 12.75 per share and the fees you incur from your broker add up to about 1.25 more per share and you sell your shares at 12.75 per share resulting in a loss of fees and charges on the trade.

D) Lose part of investment on purchase/sale
You purchase a stock at 12.75 per share and the fees you incur from your broker add up to about 1.25 more per share and you sell your shares at 12.00 per share resulting in a loss of fees and charges as well as .75 per share on the trade.

E) Lose all of investment on purchase/sale
This is a scenario that many traders will not have to deal with, although many options traders face this scenario on a regular basis. In a stock (equity) trade, this would occur only if you owned shares and a company went bankrupt, but in an option trade, you may purchase an option which may expire with no value (and unable to be exercised) resulting in a complete loss of your investment.

When determining your risk threshold, you will want to take into consideration the following;

how much am I willing to invest per trade
am I willing to risk losing 100% of my investment
can I afford to take the risk of losing 100% of my investment

How much am I willing to invest per trade?
Clearly the more you are willing to invest, combined with the risk you are willing to take will have an impact on potential profit. As a rule of thumb, the higher the risk the higher the reward, and therefore the more you're able (or willing) to invest the more you are likely to gain (or lose). When determining how much you are planning to invest in a single trade sees how it first fits into your overall trade plan and carefully weigh the risk and the benefits of that trade.

Am I willing to risk losing 100% of my investment?
If you are unwilling to risk a 100% loss on a single trade, then you should not be considering an option trade. Since options pose specific risks, there is always the possibility of losing 100% of the investment in that instrument.

Can I afford to take the risk of losing 100% of my investment?
It is critical when you are setting out your preliminary trade plan that you carefully evaluate your personal financial situation. It is not a good plan if you are risking funds that you cannot afford to risk.

Clearly, those investors in their 20-30's have a 'higher' risk tolerance than an investor in their 50's or 60's. However, a good trade plan (designed by you with advice from your financial advisor if needed) should take into consideration not only your risk, but should also take into consideration your age. Lowering risk as we near retirement is simply smart investing.

Do you have the base of knowledge you need for the investments you've chosen?

Before you begin trading, you must have the basic knowledge of the types of investments you have opted to trade. The stock market overall has a language that is foreign to those of us who are not familiar with the everyday jargon.
Be sure you have a solid understanding of the instruments that you will be trading and that you take advantage of reading our 'client education' series where you will find topics such as:

What is an Option?
What are Options?
Stock Vs Options
Call Options
Put Options
What are Candlesticks?
Defining Put Options

As we progress we will discuss things as annuities, bonds, bear markets, bull markets, etc... In the meantime, you should feel free to review this material:

http://www.sec.gov/investor.shtml- Securities & Exchange Commission Investor Information
The SEC's Office of Investor Education and Advocacy provides a variety of services to address the problems and questions you may face as an investor

http://www.cboe.com/LearnCenter/RCTools.aspx - Chicago Board of Options Exchange Investor Information
The Definitive Source for Options Trading Information%u2122

http://www.cbot.com/cbot/pub/page/0,3181,1058,00.html = Chicago Board of Trade Investor Information
The Chicago Board of Trade (CBOT®), established in 1848, is a leading futures and futures-options exchange

http://www.nasdaq.com/aspx/ResearchAndToolsHub.aspx - NASDAQ Investor Information
NASDAQ is the primary market for trading NASDAQ-listed stocks

The better informed you are as an investor; the more likely you will be to structure your trade plan in the way that is most beneficial to you. If you have specific questions we are here to help you develop your plan and work with you to ensure its success.