Tuesday, March 03, 2015

Best Practices in Trading: Planning Your Trading Business

A little while ago, I met with some traders and asked them to bring in everything they had prepared for the new year of trading.  All of them brought a list of goals for the new year.  Most of them brought lists of what they had done right and wrong during the previous year.  None of them laid out concrete plans that detailed how they would take the learning from the previous year and use it to work toward their new year's goals.

In other words, they took the time to set goals, but didn't drill down to create plans for achieving those goals.  How likely do you think they were to achieve their ideals for the new year?  Yet all of them felt that they were working on their trading.

Today's best practice comes from an experienced observer of both markets and traders, Tadas Viskanta, author of the well-known Abnormal Returns blog.  In this excerpt from his Abnormal Returns book, he emphasizes the importance of planning in trading and highlights the use of checklists in the planning process:

"One of the problems novice traders have is that they don't treat their trading with the same rigor and seriousness that they do with any other sort of business endeavor.  However, trading is just like any other business in that it has revenues, overhead, variable expenses, etc.  Trying to trade off the cuff without a plan or a means for measuring your performance is a recipe for disappointment.

Many traders balk at the idea of formulating a trading plan because they feel it might stifle their creativity or ability to react to rapidly changing market conditions.  As well, in the wider world of startups, the detailed business plan seems to have gone into disfavor.  In the world of trading, it never really seemed to catch fire.  However, traders are well served to think about how they plan to go about generating profits.  A trading plan that lays out the instruments they will trade, when they will trade them, and the methodology they will use to enter and exit trades is essential.  Maybe even more important is a strategy to limit losses both on individual trades and in an overall portfolio.  And as important as an overall trading plan might be, a trade-by-trade plan might be even more important.

Some traders find it useful to have a checklist they consult on an ongoing basis when they trade to ensure they are not missing anything along the way.  As Atul Gawande, author of The Checklist Manifesto, writes: 'In aviation, everyone wants to land safely.  In the money business, everyone looks for an edge.  If someone is doing well, people pounce like starved hyenas to find out how.  Almost every idea for making slightly more money--investing in internet companies, buying tranches of sliced up mortgages--gets sucked up by the giant maw almost instantly.  Every idea, that is, except one:  checklists.'  Checklists don't dictate what a trader does; rather they ensure that what a trader is supposed to do actually gets done.

The hallmark of a well-designed trading system may be the actuality that a checklist can be created.  The more experienced and successful the trader, the simpler his or her trading system becomes over time...Experienced traders have spent a lifetime whittling down ideas into a plan that works for them--and maybe nobody else."

Tadas makes a key point here:  You don't have a robust trading process unless it can be captured via checklists--and you can't truly claim to be process-driven if you have not codified those checklists and used them to guide decision making.  Airline pilots check all systems before taking off and follow a well laid out flight plan.  Physicians check their patients' systems before developing and following an evidence-based treatment plan.  In both cases, winging it with unstructured decisions would lead to catastrophic consequences.  The best trading plans are grounded in best trading practices--and those become a template for best performance.

Further Reading:  A Psychological Checklist for Traders