Trading Plan
(www.sumitkgupta.com)

By now, I believe we are a bit comfortable with bar and swing charts construction and trend determination. We also understand few important stock market terms like support and resistance (or glass floors and ceilings J), bull and bear market, long and short trades, STOP LOSS etc.

When you are an investor, you need to have an investment plan. Similarly, traders need to have a trading plan. We need to remember that our aim in this journey is to become an advanced trader with an ability to forecast the movement of stock or markets. There are few differences in investor and trader.

An investor seeks returns from the financial instruments of a company, primarily dividend and capital appreciation. A trader is interested in making profits from price movements (either side, UP or DOWN).

An investor has a longer term time frame (more than 6 month) and a trader has a short term time frame of upto 3 months.

An investor generally takes a lower risk, and hence his returns are lower. A trader takes a higher risk (though calculated and limited) looking for higher returns. My target from my trading is generally to get at least 5%-7% returns per month on the capital that I trade with. I also look at a Reward : Risk ratio of minimum 2 : 1. The higher, the better. In other words, if I am risking Rs. 10 on a share, my reward or profit on that trade should be minimum Rs. 20 per share. This was explained in an earlier post http://sumitkgupta.com/2010/05/05/risk-vs-risky

Whenever you are going to take a trade, on either side, Long or Short, a trading plan is a must. A trading plan has 4 essential components which are:

Entry Price – price at which you will get in the trade
Exit Price – target price or price at which you will exit making a profit
STOP LOSS – your life jacket – a price at which you will exit if the stock / market goes against you
Maximum risk that you will take – we will cover this later when we review the money management rules to keep alive in the market. As of now, let’s understand, mathematically it is :
(Entry Price – STOP LOSS Price) X Number of shares traded

Your maximum risk should not exceed 5% – 10% of your trading capital, depending upon your risk appetite.

The benefits of trading plan are that before you take the trade, you know how much amount you would lose if stock / market moves against you i.e. you were wrong in selecting the trade. You would also know your target when to take profits. Prices can go beyond your target price, but that’s the price point where you take your profits.

Remember, in stock markets, the profit is not yours unless you have booked it. It’s only a notional profit.

We will review few trading plans to increase our understanding of the trading plan over next couple of days.

Till then,……. keep determining the trend

www.sumitkgupta.com