Let's say you have made a detailed trading plan. You know the exact
criteria or "rules" you will use to place a trade. You have a
checklist to make sure you follow each of these rules. You have a
money management strategy so you know how much you will risk on each
trade, and you know what your risk:reward ratio must be. You know what
time of day you will trade, what time frames you want to look at, and
what currency pairs you want to look at. You have a spreadsheet ready
to track each trade for further analysis.
The reality, is that this is the easy part. To give an analogy,
there are many people who could learn an NFL offense. They could watch
film, go to meetings, and learn which route each receiver will be
running on each play. However, there are only a handful of people in
the world who can execute these plays with a blitzing linebacker
bearing down on them in a game situation. In other words, very few
quarterbacks have the ability to execute.
Of course, the gap between learning plays and playing quarterback in
the NFL is much larger than the gap between making a trading plan and
following it. But the point remains that if we can't execute the plan,
then it doesn't matter how great the plan is. It may seem easy to
follow a trading plan, specifically if it incorporates all of the
points I listed in the first paragraph. For those of you who have
traded with real money, you know that this is not the case.
There are many obstacles that prevent most traders that have an
excellent trading plan from following it properly. Almost all of these
factors are psychological. The other factors are problems such as the
internet going out right before a trade. Events like that are rare,
and should be accounted for in the trading plan anyway. These
psychological roadblocks can take a serious toll on trading
performance. For those of you who have experience trading, I am sure
you have had many moments where you wondered why you are not making as
much money as you should be based on your trading plan. The answer, of
course, is that you are human, and humans have emotions.
There are three primary mistakes that derail even the best trading
plan. The first is taking a trade that is not part of the plan. The
second is not taking a trade that is part of the plan. The third
mistake is changing the rules of the trading plan based on a
statistically insignificant event.
Taking a trade that is not part of the plan is extremely tempting.
There are any number of reasons that a trader would take a trade that
is not part of the plan. You could be having a losing streak and
desperate for a win. You could be having a winning streak and think
they are invincible. You could receive a tip that a large bank is
buying Yen (keep in mind this tip could be from a bank trying to sell
Yen and looking for suckers to buy their Yen). You could see something
that was part of an old strategy they heard about. You could even
straight up gamble just to get in the market. All of these scenarios
are dangerous. If you lose, you feel miserable because you know you
violated your rules and it cost you. That can lead to even more
psychological damage. If you win the trade, that only encourages you
to continue a behavior that will not be profitable in the long run.
Passing on a trade that is part of the plan is the second most
common error. This happens for a variety of reasons. Maybe you have
lost two and a row and are scared of taking another trade, only to see
the trade you passed on become the big winner. Or you have won three
in a row and think the streak can't last forever. Regardless of the
cause, this is also very dangerous. It is not uncommon for an
emotional trader to pass on a trade that fit their rules and ends up
winning, only to place a trade that doesn't conform to their rules and
ends up losing. These errors are why most traders do not maximize the
results of their trading plan.
Changing your rules bases on a small sample size of trades might be
the worst thing you can do. Let's say you have placed 300 trades with
your current rules. Although you have had your ups and downs, this has
been a profitable strategy. Then let's say you lose 5 trades in a row,
which can happen. All of the sudden you change your time tested rules
that have withstood hundreds of trades based on this sample size.
Overreacting to a small sample of trades can lead you go down a
dangerous path. If you change your rules to accommodate those 5
losers, you may wind up losing far more than if you stayed on course.
Naturally, it is wise to reevaluate your rules from time to time. But
do not make major changes based off of 5 trades.
Hopefully these examples will help you stay the course and follow
your trading plan. If you have ever asked yourself why you are not as
profitable as your plan indicated you should be, check to see if one of
these stories applies. Better yet, learn from these examples and stay
disciplined right from the start.
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