A Trading Plan Equals Your Business Plan

08/15/2012 1:45 pm EST

Focus: STRATEGIES

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

There was a very popular game show in the 1980s called Press Your Luck. The rules of the game were simple―answer trivia questions and then spin the 18-space “Big Board” to win cash or prizes. Within the “Big Board” were a number of “Whammies”―if the contestant landed on them all the money gained up to that point would disappear.

In 1984, a man named Michael Larson won US$110,237 in cash and prizes on the show, making him the biggest game show contestant winner of his time. Contrary to popular belief, Michael did not win because the “Big Board” never landed on a “Whammy.” He won because he was well prepared―Michael spent six months studying the movement of the light used for the “Big Board” and learned how to consistently hit the squares containing bonuses.

He used a VCR to record every episode of the game and then proceeded to look for patterns, frame-by-frame. Then he used what he learned and practiced “stopping” the board on his VCR at the exact places he wanted. Since Larson did not break any rules, and the game show let him walk away with all his winnings. What separated Larson from the other contestants was that he went on the game show with a clear plan that he spent months practicing. He knew that he had only one chance to be on the show and had to make it work.  Regardless of whether it’s a game show or trading, what separates professionals from novices is that professionals always come prepared.

The same is true for trading because professionals always have trading plan and this plan that is their business plan.

Too many traders watch their profits disappear like ice cubes melting in their hand due to lack of proper planning. In order to avoid this, here are five things that you should know about every trade you take.

1. Know the rationale
Don't just buy a currency pair because your friend recommended it. Make sure you have a fundamental and technical reason for taking every trade.

2. Know the event risk
Economic data is released on a 24-hour basis. How could upcoming economic data affect your trade? Will it hurt or help?

3. Exits are just as important as entries
Most traders focus on finding the perfect entry but if you have ever watched a trade move in your favour, only to reverse and stop out, you know that exits are just as important.

4. Know the characteristics of your market
Not all markets are created equal. Some pairs have narrower trading ranges while others have wider ones. Make sure your stops are appropriate for the market you are trading.

5. Know the key levels
Are significant support and resistance levels far enough away to give your trade breathing room? You don't want to be selling into support. Professional traders and people like Michael Larson look at trading more like a science than an art, because emotions can kill profits. It is important to realize that you are the most rational before you place your trade and the most irrational once the trade is placed.

Answering these five questions are the first step to developing a trading plan. If you are serious about trading a long-term endeavor, you should approach it like a business and not a recreational hobby.

Related Articles on STRATEGIES