In order to fully plan a trade, the trader should be aware of what they will do if the price rises quickly or slowly, doesn’t move, or falls quickly or slowly. Without considering all these possibilities, a trader is more likely to make mistakes or have a harder time sticking to their strategies.
Traders start out by learning a strategy and then setting off to try it out. Possibly it is a simple strategy, where we enter a trade and then set a stop loss and a profit target and stick to them. In this type of strategy, there is nothing to do once in a trade, except wait until the market moves enough to get us out of the trade for a profit or loss. And yet, this is one of the toughest things for many new traders to do!
The reason is that most of us are optimistic when we place a trade. Most new traders would never put out a trade if they thought they would lose on it. Yet, the truth is, most of us, even professionals, will lose between 40% and 60% of our trades, maybe even more! Yet we can still profitable if our winning trades are bigger than our losers.
Most people don’t like to think about this though. They try to avoid losers (which is impossible) and assume that every trade they take will be a winner.
If the trader is smart they will put out a stop loss order just in case the trade doesn’t go their way. But most new traders aren’t really expecting the price to reach their stop loss. Instead, they’re expecting the price to fly quickly to their profit target.
When a trader only has one expectation—for the price to take off toward their profit target or in their favor—the trader is mentally setting themself up to be disappointed or become anxious when that one expectation doesn’t play out. And it is quite rare for the price to surge in our direction immediately after taking a trade…which means if we are constantly expecting that to happen, we are going to be anxious and disappointed a lot.
When a trader becomes anxious or disappointed, it becomes much harder to stick to the original plan. The trader starts to think things like:
“The trade didn’t do what I expected, maybe I should just get out!”
“The price moved a little bit in my favor, maybe I will just take my profit now.”
“The price is moving against me, maybe I will get out now for a small loss instead of waiting for my stop loss to be hit.”
Ever thought those things after getting into a trade? I have! We all have!
The difference between a professional and novice is that they know how to handle those thoughts because everything is planned out before the trade is ever placed.
Fully Planning Trades
Knowing where you will enter and exit a trade is only part of planning. FULLY planning means you mentally prepare yourself to stick to your plan no matter happens.
That may seem daunting, but it really isn’t. I have found that there are only a handful of things that can happen once you get into a trade. The trade moves in your favor slowly or quickly, the price doesn’t move much at all, or the price moves against you slowly or quickly.
Some advanced traders and strategies may adjust how they proceed based on which one of these circumstances develops. But most traders who use simple strategies and are just trying to stick to that strategy, mentally rehearsing how you will handle each of these circumstances is still critical.
Before each trade, I make sure the trade meets all my criteria, and then I tell myself that the trade may not launch in my favor right away. That is why I give the trade some room by placing my stop loss at my desired location. I tell myself that the price may fall a little first, or may oscillate around, or it may launch in my favor but then pullback, or it may take quite a while for the price to reach my target if the price moves slowly.
The point is, I mentally prepare myself for what might happen. That preparation includes imagining the price falling all the way to my stop loss. Ultimately, if the trade setup is good, I need to respect it enough to give it room to move in my favor.
How many times have you set a stop loss, but then wanted to cut your loss early for no real good reason? In hindsight, you think…”Why the hell did I get out of that trade!?”
You need to evaluate your expectations. It is quite likely you didn’t even consider the possibility of losing (you may have set a stop loss yet you didn’t really think it would get hit…but 40%+ of the time it will), so when it happens it makes you uncomfortable and causes you to make a rash decision.
Prepare yourself mentally for anything that price might do (there aren’t many possibilities) and you will be much better equipped to stick to your strategy even if your trades don’t immediately shoot in your favor. By going through this process you will also likely find ways to improve your strategy.
Final Word On Fully Planning Trades
Get into the practice of fully planning trades. That means mentally rehearsing all the possibilities that could happen, and telling yourself what your plan is for each. For most of that will just mean letting the price oscillate until it reaches our target or stop loss. More advanced traders may want to make little adjustments to their strategy based on which circumstances develop after getting into the trade (see the Trading Beyond the Hard Right Edge section in How to Day Trade).
If you go through this process it will be much easier to stick to your strategy. Your expectations will be aligned with the market, and not based on fanciful notions.