Clare White, CMT, Optionetics.com
December 23, 2010
Possibly the heart of the trading plan are the preferred trading plan components which consist of markets traded, strategies used, and systems implemented. The trader’s knowledge, experience, and preferences impact decisions on markets traded, as well as those used for analysis purposes. In all cases the trader’s style should exert strong influence on the plan components they select.
Preferred trading plan components in Cornerstone, and covered here, include:
These components are considered in light of the work already completed by the trader to address the trader’s style. As mentioned last week, the trader's style is broken down into four categories [MATA]. These include:
1)Method: Systems (Rules or Guidelines) or Discretionary
2)Analysis: Technical, Fundamental, or Blended
3) Time Frame: Short-, Intermediate- or Long-Term
4) Approach: Directional, Non-Directional or Volatility
When approaching this portion of the plan preparation, a plan of attack is helpful. A comprehensive plan considers each area from three different focuses; 1) an active trading area, 2) an analysis area, or 3) a new area for exploration. A trader will also want to consider whether the plan components include synergies or conflicts—such as insufficient time to assess multiple markets and strategies—and how to blend or separate tasks for best implementation.
Cornerstone used the following standardized, liquid financial markets within the course:
1) Equities (stocks, indices, ETF’s, and options)
2) Futures & Commodities (options)
4) Currencies & Forex Pairs
Your plan should be best suited to you, so if including less liquid markets or separating ETF's as a unique asset class from equities is best, do what works.
In each case, a trader must understand both rules and regulations for the market, as well as its characteristics. These areas include margin requirements and the effect of leverage, along with liquidity and risks associated with the particular market. It's critical for the trader to appreciate that success in one market does not instantly translate to success in another.
When assessing preferred markets a trader should consider such things as:
- Market hours and access,
- All trading cost for that market,
- Unique contract specifications, as applicable,
- Liquidity for the market,
- Security fungibility,
- Margin rules,
- Market risks such as interest rate changes for the bond market, and
- Economic factors impacting the market.
When accessing multiple markets for trading, the individual may want to identify a primary and secondary market as a starting point. The plan should identify the maximum number of markets traded as well as other markets that will be assessed for analysis purposes. From a trading standpoint the individual should also identify conditions that would make them transition from one primary market to another.
If this is your first crack at creating a trading plan, make a quick assessment of your situation as it pertains to preferred markets, then dig deeper into the topic. Consider taking the markets list from this article and prioritizing them by a) trading interest, b) analysis interest, and c) further investigation interest. You may even want to start out by identifying those markets in which you've experienced success.
The preferred market review should include a style check list. Is the primary market you identified one that best suits your trading methods, analysis form, preferred timeframe, and your approach to the markets? The same question needs to be asked of the secondary market. If your checklist has been satisfied, you should also identify the tools you use to be successful in your preferred market.
In terms of analysis, many traders believe that markets don't move in isolation, but rather are impacted by the flows from one market to the other. Inter-market analysis is one tool that can be applied to assess these flows. A second comment analysis team is the impact from the home country's economy as well as international economies.
When considering new markets be sure to have a very clear reason for expanding into that area. It may also be better to have proven proficiency in a single market prior to simply moving on. However, it is quite possible the market you where trading was unique enough and not suited to your current situation to create obstacles that may not exist in another market.
Strategies include the security combinations you use to take advantage of different market conditions. The strategy section is most closely related to the approach aspect of your trading style. It also clearly touches on analysis since the strategies you implement are a function of current market conditions and what you expect for the future.
Table 1 provides a limited sampling of strategies that may be considered by the trader. It follows the style categories of Method, Analysis, Time & Approach [MATA], with strategies listed by approach.
Rules, Guidelines, or Discretionary
Technical, Fundamental, or Blended
Short, Intermediate, or Long Term OR Day, Swing, or Position
Long or Short Security
Long or Short Security
Long Call on FX Pairs
Table 1 Sample Strategies
This table originally appeared in the Cornerstone course and is included here to bridge the approach-strategies connection. Learning about market approaches and strategies is something completed outside of your plan, while being very specific about the ones you choose to implement during the plan period is completed within it. Given a trading style that includes directional non-directional or volatility approaches, your market analysis will address bullish, bearish, or flat conditions, as well as quiet or explosive volatility, as appropriate.
At this point in the trading plan preparation process, you may find that a single strategy can work in multiple markets or that you can use multiple strategies for different market conditions. Having a clear understanding of your trading style and preferred markets, the preferred strategies section can be more focused.
As with the preferred markets section, be sure to also identify strategies that you want to understand better. Ideally, new strategies would fill in gaps, allowing you to be a more effective trader under a variety of different market conditions. Virtual trading platforms are well suited to exploring new strategies. Don't forget to apply fundamental tools you used when initiating your current strategies, such as risk graphs and paper trades. Be specific about the tools you will implement for existing strategies and those you wish to explore.
Identifying preferred systems is the next step in the progression, with the trader’s style elements addressed in each system. System is the general term used to describe various methods ranging from a purely mechanical system to one that is discretionary and guidelines based. The trading plan should define different systems by preferred markets and strategies.
Table 2, also taken from Cornerstone, provides a basic framework for the different types of methods considered for the systems portion of your plan:
You do your best thinking and research up front, then build automatic rules into a system. From there the system automatically generates buy and sell signals.
You set up a system so that it alerts you when certain guidelines are activated. Then you make the final decision regarding when to buy and sell on a case-by-case basis.
You make all trading decisions based on what you see happening in the market place and on what you expect will happen next. Virtually all trading decisions are based on experience and instinct.
Table 2 Summary of Trading Style Methods
In the systems section traders need to identify the specific edge in which the system is based. An edge is the advantage you seek to exploit and can be as straightforward as persistent trends or calendar seasonality. The advantage should be measurable via back-testing or forward-testing of the method.
As with the strategies section, there is a reasonable amount of learning that occurs prior to clarifying systems included with your plan. Cornerstone provides system references from courses, articles and books available from Optionetics, as well as those popular with a wide variety of traders. There are similarly tools and resources to assist with the testing process. One goal of the course was to simply remind traders of the different materials they can access prior to plan prep and as part of the plan creation process.
Identifying specifics for how the trader will establish positions certainly seem to be the heart of the trading; however, a well-defined system that does not suit the trader’s style can drain all sorts of resources. As part of the Preferred Systems process, be sure to honestly assess system suitability. The plan preparation process should help new traders recognize which existing systems may conflict with their style while experienced traders—and more importantly, plan preparers—have likely built up a variety of style appropriate systems that can be used under a variety of conditions.
I’ll be completing some pro-active posts on the discussions boards geared towards questions to consider as you go through the plan creation process.
Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site