“When you define your goals, you give your brain something new to look for and focus on. It’s as if you’re giving your mind a new set of eyes from which to see all the people, circumstances, conversations, resources, ideas, and creativity surrounding you.” Darren Hardy, author of Compound Effect
With goals, investors can create a realistic plan for achieving their investing objectives within a certain time frame. Since one of the biggest mistakes investors make is confusing investing with stock picking or trading. Ask many people how their money is invested and they might quickly jump to tell you the latest hot stock they’ve purchased and the investment thesis that explains why they think it’s going to take off.
Without an investment plan, what is the goal? Probably just to make some quick, easy money, which neuroscience has shown makes us feel good. Unfortunately, behavioral economics tells us that acting on such impulses tends not to end well. To be true to the term, investing must start with a specific goal corresponding to a set time horizon. The goal itself could be anything: buying a new car in two years; purchasing your first home in five years; or retiring in 40 years. What’s most important is to have the goal be the focus of your approach.
Once you’ve identified a goal, an investment plan can take shape. How much savings can you devote to it? How much time do you have? How realistic is the goal given the first two questions and the amount of risk you feel comfortable taking? If you choose to work with a Financial Advisor, he or she can help you find answers to these questions, and take you a long way to devising a strategy to help achieve that goal.
Know your time horizon
How long do you plan to hold a stock and what purpose will it serve in your portfolio? Your trade time frame depends on your trading strategy. Generally speaking, traders fit into one of three categories:
- Single-session traders are very active and are looking to gain from small price variations over very short periods of time.
- Swing traders target trades that can be completed in a few days to a few weeks.
- Position traders seek larger gains and recognize that it often takes longer than a few weeks to achieve them
- Determine your entry strategy Look for entry signals—for instance, divergences from trend lines and support levels—to help you place your trades. The signals you employ and the orders you use to make good on them hinge on your trading style and preferences.
Plan your exit
When it comes to an exit strategy, plan for two types of trades: those that go in your favor and those that don’t. You might be tempted to let favorable trades run, but don’t ignore opportunities to take some profits.
For example, when a trade is going your way, you could consider selling part of your position at your initial target price to make gains, while letting a portion run.
To prepare for when a trade moves against you, you can set sell stop orders underneath a stock’s support area, and if it breaks below that range, you can choose to sell.
Determine your position size
Trading is risky. A good trade plan will establish ground rules for how much you are willing to risk on any single trade. Say, for example, you don’t want to risk losing more than 2–3% of your account on a single trade, you could consider exercising portion control, or sizing positions to fit your budget.
Review your trade performance
Are you making or losing money with your trades? And importantly, do you understand why?
First, examine your trading history by calculating your theoretical “trade expectancy”—your average gain (or loss) per trade. To do this, figure out the percentage of your trades that have been profitable vs. unprofitable. This is known as your win/loss ratio. Next, compute your average gain for profitable trades and average loss for unprofitable trades. Then, subtract you average loss from your average gain to get your trade expectancy.
Profitable trades
A positive trade expectancy indicates that, overall, your trading was profitable. If your trade expectancy is negative, it’s probably time to review your exit criteria for trades.
The final step is to look at your individual trades and try to identify trends. Technical traders can review moving averages, for example, and see whether some were more profitable than others when used for setting stop orders (e.g., 20-day vs. 50-day).
Sticking to it
Even with a solid trade plan, emotions can knock you off course. This is particularly true when a trade has gone your way. Being on the winning side of a single trade is easy; it’s cultivating a continuum of winning trades that matters. Creating a trade plan is the first step in helping you think about the next trade.
Source:
- Lee Bohl, 5 Steps for a Smart Trade Plan, Fidelity Insights, November 21, 2019
https://www.schwab.com/resource-center/insights/content/5-steps-smart-trade-plan?cmp=em-QYD - www.morganstanley.com/articles/having-goal-key-to-investing