Lesson 10: Thinking In Probabilities

The critical lesson chess players learn is that a bad plan is better than no plan.

In trading, failing to plan equates to planning to fail. So in this short lesson, we will look at developing a sound, profitable trading plan.

A trading plan has several components. Each component covers different elements of trading. We are going to break down these components;

1. Executive Summary – Vision, Goals, Objectives
2. Research and Idea generation
3. Execution and trade management
4. Risk and money management
5. Trading Psychology

Executive Summary

Without a vision, my people perish!

Goal setting is critical for high performance. Setting realistic goals can help us sustain focus, a prerequisite for high performance.

A vision is a big picture perspective of what we aim to achieve in the markets. So, for example, we could have the idea to trade a seven-figure account. But, on the other hand, goals are tangible targets that can guide us on our path to attain our visions.

Among the most crucial process goals in trading include;

Risk management goals

What plans have you developed to help in managing drawdowns and maximizing returns?

Developing low-risk ideas

Goals pertaining the process of generating low-risk trading ideas. A sound trade idea has an asymmetric risk to reward ratios.

Trade execution goals

Goals of implementing trade ideas to maximize reward and minimize risk;

Self-management goals

Goals of maintaining a constructive mindset for optimal decision-making;

Objectives

Are you aiming to preserve capital or to multiply money? Depending on your objective, you must think hard about how to organize yourself to attain profitability. A balance between the two is what we should aim for in our trading.

What are your objectives for the next six months of trading? Deliberate practice can only happen from this perspective.

Research and Idea Generation

The goal of proper research is to develop low-risk ideas in the markets. Therefore, depending on your trading style, you must create different frameworks or perspectives that we can use in our research.

A trader focused on Fundamental analysis must research data releases, central themes in the markets, and critical data points that can act as an edge.

In technical analysis, we can use the top-down approach to look at markets. Here are some questions that can help in research;

1. What are the primary setups and patterns I will be looking for in my trading?
2. How can I ensure I get the best entry zones?
3. What markets are you going to trade?
4. How often will you analyze markets? Too much screen time is harmful.
5. How will you handle backtesting?

Execution and Trade management

In this section, it’s all about pulling the trigger and managing ourselves.

Mental rehearsals are essential in this section of our trading.

The following data points can help us think through our trade executions;

1. What time frames will I use for trade implementation?
2. How will I set targets and stop losses?
3. How will you scale into winners?
4. How do I ensure I retain my objectivity when trades are running?
5. How many trade setups can I execute at a go? Multiple executions can be challenging to manage in markets.

Risk and Money management

“The Dead can’t be brought back to life.”

Risk management is the holy grail of trading. To make money, we need to be alive.

Avoiding the risk of ruin needs strategic decision-making. But, unfortunately, most traders settle on simple risk management rules, which don’t help prevent catastrophic events.

Discipline to follow trading rules is a must.

We will look at key data points that we must consider when planning how to manage our risk.

1. How will you avoid the risk of ruin? Chances of losing money in the market are higher than winning. Coming up with effective strategies to prevent the risk of ruin will prove to be valuable.
2. How do you plan to position size to attain your objectives? Think hard about the plan you will use to position size your trades in the market?
3. What’s your attitude toward risk? What is your risk profile? Traders have different risk appetites. Finding your niche and capitalizing on it is a good edge.
4. What strategies will you use to manage risk? How do you plan to handle hazards like a change in market conditions or black swan events
5. How will you handle winning streaks and losing streaks? The use of threshold limits should help us understand how to manage streaks in trading. A decision to cease trading after losing 10% in the markets could be precious.
6. How will you cover transaction costs? Traders hardly think of how much it costs to trade. Commissions and spreads can be expensive. We must come up with good filters to prevent losing.

Managing ourselves

Traders are part of the trading system. All styles of trading are discretionary. We make decisions daily on how to position size, which markets to trade, and how to mitigate losses.

We, therefore, need to plan how to manage ourselves in the markets. Lack of mastery over ourselves only results in losses in trading.

Here are points to help you think through how to manage yourself in trading;

1. What are your cognitive strengths? Are you good at processing information fast or thinking deeply? Deep thinkers tend to do well in long-term trading strategies, while fast thinkers do well in short-term trading.
2. What are your personality weaknesses? What traits are likely to lead to bad decision-making. Sloppy trading often starts with flaws in our decision-making.
3. How do you plan to handles losses? Newbies often go into a cascade of self-doubt after losses in markets. We need to think hard about how to manage our losses. An effective strategy would be a focus on the process.
4. What are your core beliefs in the market? Adopting the right ideas is the secret to success in trading. List down your trading beliefs and think hard about whether they lead to profitable trading patterns.
5. Daily self-analysis plan – Examine your state of mind and think hard about if you should be taking risks in the market in that mental state. Success starts in our minds. The world is a reflection of what we think about daily.

Reading this course and failing to take action marks the beginning of failure. So don’t jump into live trading without thinking through everything outlined in this lesson. All the best!