Editor’s Note: This popular article was previously published in Tharp’s Thoughts Weekly Newsletter.
When people choose to trade the markets, they always want to rush in and get started right away. They foolishly think that they are going to miss the next big wave. But the market doesn’t know when you get in or when you get out. So don’t be foolish, take the time to plan. ~Mel
The entry price to be a trader or investor has always been pretty low. All you need is enough money to open an account – which these days is remarkably low. In fact, you can open a stock trading account now without any money (heard of Robinhood?). Maybe that low of a bar expresses some realities new entrants to the market don’t realize –
- Your broker doesn’t care whether you understand expectancy or objectives.*
- Your broker doesn’t care whether you understand that position sizing strategies are the key to meeting your objectives.*
- Your broker certainly doesn’t care that you must have your personal psychology in order for any of the other factors to matter.*
* In fact, the staff at your brokerage is unlikely to know the real nuances and fundamentals of safe and profitable trading themselves.
Day in, day out, year after year, people jump into the markets recklessly: without experience, without training, and most definitely without any type of formal plan. Far more often than not, people who open a brokerage account lose money – but your broker doesn’t care about that.
Your broker cares about two things:
- That you have enough money to open an account, and,
- That you don’t lose many times the value of your account so that the broker gets in trouble.
You can easily open an account and start trading without knowing the first thing about trading.
Is this true of other professions? Could you engineer a building or a bridge without understanding calculus? Can you become a doctor without understanding biology, chemistry, and anatomy? Can you practice law without passing the bar to demonstrate your understanding and ability to interpret the law? Of course not, there are all kinds of rules that regulate these areas.
Or, in the world of sports, would you play golf against a pro the first time you stepped on a golf course? Would you enter a chess tournament against master players if you’d never played before? Probably not but if you did, the worst that could happen is you lose a few games or hurt your pride.
But what do people lose in the markets when they face the top human and algorithmic traders in the world? Anything from a few dollars to their life savings; yet there are no rules about who should or shouldn’t be in the markets.
If you are serious about being a good trader, then you need to approach the practice of trading with the same level of rigor in which you would approach any high-level professional endeavor. The market does not owe you or anyone great riches. The market does, however, occasionally fool a large number of people with seemingly easy gains during bubbles and other manias – only to take them back again shortly thereafter.
Trading Is A Business
Have you been treating it that way or have you been trading more as a hobby? One answer will tell you a lot – have you written a business plan? Most businesses fail because they fail to plan.
Business planning is the backbone of success. It shows you where you’re coming from and helps you to organize your thoughts and your objectives. A good plan can keep you trading successfully and in the markets for the long term.
Therefore, I recommend that every trader and investor develop a thorough business plan to guide their trading. Even if you are trading well now, I still recommend developing one as a planning tool. Those who are trading well already will just have a little less work to do!
Your business plan should cover all of the following areas:
- Your vision.
- Your purpose.
- Your objectives.
- A thorough self-assessment of your strengths and weaknesses based upon real trading logs.
- A thorough assessment of the big picture and the fundamentals that might be behind any trend.
- A complete understanding of your beliefs about the market.
- Procedures for getting empowering beliefs and mental states behind you.
- A market type classification process.
- Documentation of your research procedure for developing new systems and determining how to analyze their effectiveness.
- Your procedures for developing and maintaining discipline.
- Your budget and cash flow systems.
- Other necessary systems such as marketing, back-office record-keeping, etc.
- Your worst-case contingency plan.
- System 1, which is aligned with a particular market type.
- System 2, which is also aligned with a particular market type.
- System 3, which might come into play should the market type change.
If you have all of those things in a written plan, then you have a chance of doing well. And you won’t just write the plan once and set it on a shelf. Incorporate regular updates and refinements to your business plan to create a process of continually improving yourself and your trading.
What happens when someone gives you a tip or idea about a trade or investment? Do you get very excited and want to act? (An improper response is to buy some sector ETF just because a colleague or talking head recommended it.) Or, does a hot tip make you skeptical and suddenly distrust the person giving you the tip? Or, do you assess whether or not the tip fits into your game plan?
The only correct response to any “hot tip” is to see if it fits into your plan. If it fits your plan, you need to do more evaluation according to the criteria in your plan. If it does not fit, then you simply discard the idea saying that’s not something you know much about.
How you react to hot tips is a good test in several ways. First and foremost, it tests whether or not you even have a plan. Do you have a written plan that helps you deal with the learning of a “new sure-fire can’t lose” trade/investment? If not, then it’s time you developed one.
Do whatever it takes to develop a thorough business plan to cover your trading or investing. It’s important enough that I won’t let Super Traders even start trading until they have written a full business plan.