Creating a Trading Plan (Part 3)

Risk Management and Market Direction

Welcome to week 3 of my series on creating a trading plan. If you’ve been following along you should have now created rules for your trading plan that cover what your goals are, what investment instruments you will trade and your entry and exit rules. We’ll continue building this week with two very important topics: risk management and market timing.

Trading legend Mark Minervini has always preached to think risk first, and the is reason he pounds the table on that that is because the asymmetry of losses. Looking at the following chart you can see how the math works against you the larger your losses become.

This asymmetry of losses is one of the reasons why risk management is so important. By setting clear risk management rules and following them, you can help to minimize losses and protect your capital.

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Before we dive into risk management and market timing rules make sure you are subscribed so you can follow along week to week.

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When it comes to risk management rules, we want to define the following criteria:

• Position size & max number of holdings

• Exposure limits

• Losing streaks

• Max percentage loss of capital

Example:

• Position size & max number of holdings: A full position will represent 15% of account value. Without using margin this makes my maximum number of holdings 6

• Exposure limits: Do not add more than 30% exposure in one day or hold more than 30% of account value in a single sector

• Losing streaks: If 4 losing trades in a row, complete a post trade analysis on those trades and review current state of the market before placing a new trade

• Max percentage loss of capital: Do not risk more than .75% of account value on any single trade

Like risk management rules, market timing rules can help you navigate the markets more effectively. Recognizing the state of the market as a whole is a crucial part of any trading plan, as the market trend will have a big impact on your performance. It is important to have rules to tell you when it is safe to be in the market and when it is not.

Example:

Do not initiate any new trades while the price of the Nasdaq is below the 21 exponential moving average.

You’re rule can be as simple as that or you could make it more complex having to do with follow through days or net highs and lows. The key is to find a balance that works for you and your investment goals we laid out in the beginning of your trading plan.

By establishing a clear set of guidelines for managing risk and staying on the right side of the market, you can better navigate the market.

Next week we will wrap up our trading plan by laying out the framework for our daily and weekly routines, clarifying what resources you will use and any miscellaneous rules that didn’t fall into one of the previous sections.

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Creating a Trading Plan (Part 1)

Creating a Trading Plan (Part 2)

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The content presented is for informational and educational purposes only. Nothing contained in this newsletter should be construed as financial advice or a recommendation to buy or sell any security. Please do your own due diligence or contact a licensed financial advisor as participating in the financial markets involves risk.