Lesson 10: Putting it all together

Throughout this chapter we have introduced you to the concept of Technical Analysis & Charting. The tools you have learnt in these lessons are an introduction to a larger selection of trading techniques and tools. However, they are the techniques that will form the basis for all of your future trading. As a trader, you will need to practice these techniques and begin to form your own opinions. Trading is just not a systematic approach, where certain rules must be met before entry or exit, it is also an art form that requires patience and a clear understanding of the tools you are about to use.

One of the greatest tools you have at your disposal is called a Trading Plan. Using the techniques you have learnt throughout this chapter, we can develop a trading plan to offer guidance for success.

In this lesson you will learn about trading plans. We will introduce you to management systems that professional traders adopt to become successful. We will establish entry and exit rules and we will discuss money management techniques. You will also learn about back-testing and how you can take years of data and evaluate your trading plan profitably within minutes.

Successful businesses are typically those that are managed well. They have a clear idea of what it is they intend to achieve and have clearly outlined tasks to help achieve those goals. Successful businesses have business plans that outline their product or service, competitive analysis, marketing plan, budget, staffing, etc. So it makes sense that if you want to be a successful trader, that you have a plan on how to achieve this.

So, what makes a successful trader?

The answer is a trading plan. And trading plans have 3 components:

1. Firstly, a sound Entry Criteria. More than 90% of a traders’ time is focussed on the entry component of a trading plan. While this is where you will spend a lot of time, it is not necessarily the most important factor. Each component of the trading plan is as important as each other.

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profits have dissipated, and they’re actually in a loss. Establishing your exit criteria is critical in alleviating the emotional aspect of trading.

• And finally, Money Management. Too often we come across traders who put all their eggs into one basket. They might have a few profitable trades and think “Ah, this is easy!” So they load up their trading and put all their capital on the one trade. This is why trading is viewed by many as gambling. Managing the risk of your trading sorts the professionals out from the amateurs.

Using these 3 components of a trading plan, we will now begin to discuss each of these to help you establish a trading plan of your own.

In previous lessons, we introduced you to:

• Candlestick analysis

• Trend analysis

• Support & Resistance

• Moving Averages

• RSI

• Bollinger Bands

• Stochastic Oscillators, and

• OBV

All of these techniques can be used for your entry criteria. But would we use all of these techniques at exactly the same time? In most cases, no! Loading up your entry criteria with more analysis does not make it a better trading plan. In fact, most experienced traders will advise that the KISS statement applies in this situation: Keep It Simple Stupid!

To develop a successful trading plan, you must first spend some time analysing charts, testing criteria, and choosing the indicator, or combination of indicators, that will best suit your goals. Unfortunately, with the hundreds of indicators and technical techniques available, there are literally hundreds and thousands of combinations that could make up your entry criteria. Choosing the best combination for your goals is well beyond the scope of our lesson today.

As this course is all about using the power of Options to trade the markets in any type of condition, we also have the added criteria involved with choosing the right option strategy and or options to trade. In the following chapter, we will be introducing you to the different strategies and how you would trade them.

There are numerous ways of approaching your entry criteria. Some traders would like to choose a strategy and search for stocks that meet their criteria. Other traders would like to follow specific stocks and apply a strategy when they have an alert. There is no right or wrong answer here, so you will need to choose the approach that best suits you. We have found, however, that it is easier for beginners to choose a strategy and become good at that strategy, before including any other strategies in your repertoire.

So the keys to establishing your entry criteria are:

1. To choose a strategy to suit the type of trading you wish to participate in

• Select a number of stock to analyse/trade. Or establish a system to scan a category of stocks.

• Establish entry rules using technical indicators

• Outline charting criteria to establish buyer or seller strength

• Analyse option pricing, choosing options that meet your criteria for that strategy

• Establish an entry plan for your order placement.

Throughout the next chapter, we will be outlining parameters of entry for each of the strategies. It is critical that you abide by these trading rules, and as your experience grows, test any adjustments to the trading plan before you implement the changes.

Having a tested entry criteria is only one third of your trading plan, however. To ensure you manage

your Risk and maximize your profits, you will need sound exit criteria. This is the second component of our trading plan.

Your exit criteria could include many different variables, just like our entry criteria. This is what makes the markets so volatile. Even with millions of people watching share prices on a daily basis, we’re all making decisions based on different reasons. Some of us may be using the same entry criteria, but might have variations to our entry or exit rules, that means our timing is slightly different. Whereas some traders might be trading for short-term daily movements. Or, might be trading for the long-term or even hedging their portfolio.

Your exit criteria may include some of the follow categories or a combination thereof:

1. Exit Stop based on Option pricing
2. Profit target/s based on Option pricing

• Time Decay

• Technical Exit

• The Greeks, such as a change in Vega or Volatility, for example.

An Exit Stop is the key to trading. It is one of the cardinal rules that should never be broken. Without a stop, you are leaving your losses open indefinitely, and using your “skills and experience”, or what we like to refer to as the “Hope & Pray” method, and basing your decision-making process on emotion.

Emotion has no place in trading. Because we are dealing with our hard-earned money, our initial response is that we do not want to lose any of it. Unfortunately, there is no trader out there who ha5 never made a loss. Even the best, and most wealthy traders, have made losses. It is something you have to accept as a trader, or don’t participate in the first place. We need to manage losses, and ensure they are limited.

Another method of a Stop is called a Trailing Stop. This is a stop where we establish an exit point, usually derived by percentage, and as the position shifts in our anticipated direction, the stop follows behind. If the underlying stock shifts against us, however, the trailing stop holds its position. If the stock moves significantly against us, the price will meet the trailing stop level, and close out the position, either locking in a profit along the way or limiting our loss to that stop level.

As we are option traders, our exit stop will be based on option prices. There are different

calculations for the exit stop for different strategies, which is beyond us elaborating more at this point.

Of course, we trade because we want to make money, but one of the hardest aspects of trading for beginners is retaining the profits they have made. For this reason, we will typically establish rules on when to exit with a profit.

The probability of you entering at the exact beginning of a trend and exiting at the exact end of the trend, is extremely low. The reality is that when you are trading, no matter whether you are trend trading, momentum trading, trading volatility or even option writing, our goal is for as much profit out of the movement as possible. But knowing we will never get the exact top or bottom of the movement. Therefore, our goal is to get in and out before the buyers or sellers have completely exhausted themselves and the movement reverses direction.

For each strategy, there are different criteria’s for what the profit targets may be. This may be established as:

• A percentage gain.

• Multi-level profit target (% level)

• Technical levels

These will be explored more for each specific strategy.

Options have an expiration date, which means they have Time Decay. Some strategies benefit from time decay, whereas other strategies do not. Therefore, there are situations where you may exit a position based on time factors. This is also explored further during the strategy lessons.

We’ve already mentioned that Technical Indicators can be used for entry and exit. Some strategies may use specific criteria for entry, and other criteria for the exit. But the key to establishing your entry and exit is to test the system, before implementing as your trading plan.

There are literally millions of combinations of technical criteria that could be used to exit. But to keep it simple, you start by using Price analysis with Support & Resistance and Candlestick reversal patterns. Secondly, establish simple indicator exits based on the strategy you are adopting.

A little more advanced is using the Greeks to manage the exit of your position. Such as the Vega, or Volatility. Remember we discussed the fact that when volatility increases, the cost of an option increases. For some strategies you may actually enter on high volatility and close out of that position

Having a clearly defined criteria for when to enter a

trade and when to exit a trade will cut out all of the emotion out of your decision-making process. The hardest

aspect of your trading, once you have established a trading plan you are confident in, is having the Discipline to

abide by your rules.

For some, sticking to the rules is black and white. Whereas for others, you

may come unstuck due to your own inability to be disciplined enough to follow your trading plan.

Finally, but certainly not least importantly, is Money Management. This is the glue that keeps our trading plan stuck together. You can have a great entry and exit plan, but if you do not have good money management, you are likely to self destruct.

When you establish a great trading plan, it is tempting to put all your capital down on the one trade in an effort to make hundreds of percent return. This is referred to as “Putting all your eggs in one basket”. I’ve heard of some people talking about taking $2,000 and turning that into $1million in only 9 trades by making 100% return on each trade. And doubling up each time.

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1	$2,000	$4,000	100%
2	$4,000	$8,000	300%
3	$8,000	$16,000	700%
4	$16,000	$32,000	1,500%
5	$32,000	$64,000	3,100%

6	$64,000	$128,000	6,300%
7	$128,000	$256,000	12,700%
8	$256,000	$512,000	25,500%

Now, this is absolutely ludicrous. Even if you were lucking and got your first few trades right at 100%, and turned $2000 into $4000, and then turned that into $8000. Could you imagine placing $250,000 down onto the one trade in the hope of making 100%? No-one in their right mind would do so. And in more than a decade as a professional trader, I have never seen this done.

Money Management is all about managing risk. We are all aware that there are Risks involved in the markets. But we also know the opportunity that exists. If we can manage the risks, then we can profitably participate in the greatest opportunity we’ll ever experience.

There are different approaches to money management. The most common is to diversify your trading capital. Simply put, if we had say $10,000 to trade with, we could split this into a number of trading packets. For example, let’s say 5. So we would have 5x $2,000 trading packets.

Let’s say we were able to achieve 2 average profitable trades, 2 loss trades at a set stop level, and 1 very profitable trade. Our account should be able to achieve positive growth. Trading is all about averages, making good average trades that exceed an average loss.

For those traders using larger amounts of capital, there is a point where you could diversify just too far. Splitting, say, $100,000 across 20 stocks would be a great deal to manage, and would begin to incur a substantial amount of brokerage fees.

And for those traders who are beginning with a small amount of capital, say $1,000, it may not be beneficial to be diversifying across too many stocks. We have to make a substantial return on each trade just to cover the brokerage. For this reason, the risk of a trader with a small amount of capital is higher than a trader with a larger amount of capital. You need to find the balance that best suits your situation.

Another method of money management is to only risk so much capital into the markets at any one time. For example, let’s say you had a trading account of $5,000. You only want to risk $500 at any one time, and your trading plan has an exit stop of 50%. Therefore, if you placed a trade of $1,000 into the markets, if it was stopped out, you would make an estimated loss of $500. So your goal is to risk only $500 at any one time.

Let’s say you placed a $1,000 trade into the markets and we are currently at a 50% profit. That is, we have a profit of $500. This means you could afford to place another $1,000 into the markets with a 50% stop. If both trades were in a profitable situation, you could place another $1,000 position into the markets, and so forth.

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Starting Capital = $5,000

3 $1,000 $500 +50% In profit, place next trade

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Alternatively, instead of a dollar amount at Risk, like $500, you may actually stipulate a percentage of your account. Let’s say 5%. If you had $5,000 you wanted to trade with, and only wanted to Risk 5% of your account, then you would be using a trading packet of $500. Therefore, we would only have $250 at risk at any one time.

This type of money management helps you to increase your trading packet as your account grows and decrease your trading size if you have made a number of losses. Remember, you want to be trading for the long-term. We’re not into “Get Rich Quick Schemes”. Consistency and the effect of compounding over time, will help you become a successful trader.

I would like to now talk to you about Backtesting.

Back-testing is one of the chores of becoming a successful trader. Whilst it may sound boring, if you

take on your back-testing with enthusiasm and an open mind, you will become a very successful trader.

Back-testing is the process of taking your trading plan or concept, evaluating historical data and evaluating the results. To back-test you will need to:

1. Establish your trading plan: your entry, exit and money management criteria

• Select a range of stocks that have different market activity

• Choose a time-frame to test. Typically market conditions that reflect Bullish, Bearish and Sideways markets.
• Identify the entry and exit points and tabulate the results
• Evaluate results and identify strengths and weaknesses

• And re-evaluate with adjustments to your trading plan.

ensure you remain true to your trading plan. I’ve seen many students attempt to “fit results” to what they want to see. And they then wonder why their trading plan does not work in real trading time.

The types of results you want to tabulate include:

1. Number of trad alerts due to entry

• Number of winning trades
• Number of loss trades
• Average win return (%)
• Average Loss (%)

• Investment return for duration of test period.

There is additional information you make like to correlate, if you’d like to spend more time. The data is gathered requiring more interpretation than the above results, which can be black and white. These include:

1. The number of trades that were “whipped out” and the direction continued in the original trend

• Number of alerts against the trend. For example, a Bearish alert during a medium upwards trend.

• Correlation of entry/exit to Support & Resistance levels

• Correlation of entry/exit to major announcements or earnings releases etc.

By studying these types of results, you can gain a better insight into how your trading plan reacts to market activity. This will help you establish a better trading plan for better profitability.

In this lesson you have learnt about trading plans. We have introduced you to the management systems that professional traders adopt to become successful. We’ve also established entry and exit rules and money management techniques. Finally, you have learnt about back testing and how it can

help you take years of data, and evaluate your trading plan profitably within minutes.

This concludes the chapter on TA and charting. We recommend that you watch these lessons over to help establish a solid knowledge in this topic. The next Chapter to this course, focuses on Option

strategies.