Thursday, December 25, 2008

Trading With A Plan: The Importance of Intentionality

A planned trade is one that is guided consciously, filtered according to a variety of criteria that are designed to provide a positive expectancy. The opposite of a planned trade is an impulsive one, in which traders enter markets before explicitly identifying what they are doing and why. The difference between planned and unplanned trading is one of intentionality: being proactive in taking controlled risks vs. being reactive to what has already occurred in markets. Even the most intuitive and active trader can trade in a planned manner, if many of the elements of planning are achieved prior to entering positions.

So what are these elements of planning? The ideal trade identifies:

1) What you're trading - Why are you selecting one instrument to trade (one stock, one index) versus others? Which instruments maximize reward relative to risk?

2) How much you're trading - How much of your capital are you going to allocate to the trade idea versus other ideas?

3) Why you're trading - What is the rationale for the trade? Why does the trade idea provide you with an "edge"?

4) What will take you out of the trade - What would lead you to determine that your trade idea is wrong? What would tell you that the trade has reached its profit potential?

5) Where you will enter the trade - Given the criteria that would take you out of the trade, where will you execute your idea to maximize the reward you'll obtain relative to the risk you'll be taking?

6) How you will manage the trade - What would have to happen to convince you to add to the trade, scale out of it, and/or tighten your stop loss?

A beginning trader will take time to answer these questions, much as a new driver will need time to properly steer and brake a car. With experience, however, planning can occur very quickly, as much of a trader's homework is accomplished before the market opens. For instance, before the open, I already have identified the short- and intermediate-term trend of the market; pivot points that will serve as profit targets; and volatility that will guide my position sizing. From there, much of the trade is a function of pattern recognition and execution--seeing selling or buying dry up in a rising or falling market and entering the trade at a level in which I'll make more by hitting my target than by hitting my stop.

A good trade is not necessarily a profitable one: even the best planning is fallible. Rather, good trading is defined in terms of intentionality: having a constructive, valid purpose and sticking to it. When emotional and physical factors--anxiety, frustration, fatigue--affect decision making, they generally do so by impairing intentionality. Under the sway of an altered cognitive, emotional, or physical state, we become more reactive, less intentional. One of the most effective steps we can take when we're no longer in the "zone" of immersed concentration is to double down on trade planning, taking the next few trades only after writing down or talking aloud the elements listed above.

Training yourself to become more intentional during periods of heightened arousal or fatigue is an excellent strategy for building emotional resilience--and preventing trading losses from becoming trading slumps.

RELATED POST:

Gurdjieff, Intentionality, and Turtles
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4 comments:

Sami said...

Thank you, Dr. Steenbarger. You've maintained a wonderful blog over the years that is so helpful to so many people.
Happy Holidays,
Sami

IDkit said...

Brett

Your post today is a good revision for even seasoned traders, more so for newbies.

It is trying to internalize all the steps in preparation for a high probability trade to its exit, which will make planning easy and quick.

Thanks for the reminders.

Counting down ...6 days to 2009!

Bill said...

Dr. Brett,

Thanks for your diligent work this year. I'm looking forward to the new book.

This post struck a cord with me as it became my year end measure of the progress I have made by being able to answer each point in the affirmative. Evidence once again your work is equally useful to intermediate term traders.

Happy New Year,
Bear

Brett Steenbarger, Ph.D. said...

Much thanks for the comments and support--

Brett