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Why Traders Plan Trades

As traders we constantly hear the advice that we should develop and stick to a trading plan. For some of us this is easy to adhere to, whilst others struggle with the concept and the reality of sticking meticulously to the rules they have defined in a strict trading plan. One of the main reasons some traders and investors are unable to stick to the rules of their trading plan, is a lack of confidence in the plan. This lack of confidence causes them to exit trades at a price other than that indicated in their trading plan. That is, instead of exiting at a pre-defined price generated by a system, stop loss point, or profit objective, they will jump out of a trade somewhere in between based on news (noise) or an emotional response to the current price action.

So here’s a question for you: If you really do have a trading plan, what percentage of your exits and entries have you correctly followed? I am a big believer that we all need an unambiguous decision support system that helps us stay objective and unemotional about when to buy and sell. However, as unambiguous as any good system might be, how are you following it?

You can measure this by the way. Come up with some Key Performance Indicators (KPI) and measure how close you are sticking to your rules and trading plan. Count any errors by comparing when your system generated the buy or sell and when you actually executed it.

If a large proportion of your trades are not executed in line with your system or rules, then there is a good likelihood that you’re managing trades by feel and not by the rules of your trading plan.

While there are occasions when emotion based trading will minimize losses and lock in gains, only an elite few have mastered this ability on a continuous basis. For the remainder of us, over time, emotion based trading does not work because it is not repeatable, and it creates inconsistency and frustration. What may work today won’t always work tomorrow.

If your trading plan is solid, it should be worth following more often than not.

Traders often bail out of plans when they have not had sufficient first-hand experience with those plans and thus naturally lack confidence. The best way to determine if a trading plan suits you is to trade it with very small position sizes, or at the very least in simulation or “paper-trading” mode. Follow the rules of the plan religiously for a given number of trades. That will tell you if the plan truly suits you and it will also give you the first hand realization that the plan is worth following. You can’t expect yourself to tune out noise on a short timeframe unless you have a high degree of conviction in what you see and plan in the larger picture.

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