Create a Winning Trading Plan
The next lesson in our free online swing trading course is critical to your success: its a lesson about having a detailed trading plan.
Having a trading plan written out is one of the things that separates those who make money long-term and those who lose. So the following concepts are important to understand.
A lot of traders fly by the seat of their pants and have no clear plan of attack when they swing trade. So they end up chasing stocks just before they pull back with no idea where to stop out on the swing trade or when to sell for a profit.
Or they buy on a sharp pullback with no idea where the ideal stop-loss point is on the trade and any idea how to know when the trend is changing back to the upside.
Winging it is not a recipe for success long-term. If you sit on a loss and it turns into a 30% loss, you need to now make nearly 50% on your next trade just to break even. A 50% loss requires a 100% profit on your next trade. Just one big loss per quarter can have a major impact on your profitability over time.
Meanwhile, a 7% stop-loss, below a strong support, requires just an 8% profit on your next trade to recover. Meanwhile, the strong support just below your entry increases you likelihood of success which is critical.
So its extremely important to have a good trading plan based on extensive research and experience. Its difficult to succeed without one when swing trading.
A trading plan is a very broad concept and can include many of the facets of a trading business plan. A business plan includes the actual strategies you use and when, risk management, the types of stocks you trade, equipment, etc…
Understanding and utilizing sound risk management in a trading business plan is critical and I cover some of the basics in the following video. If you have not watched it yet or do not have a definite written plan to manage risk, this video is a great starting point.
But today I want to focus on the part of your overall trading plan that involves when to enter and when to exit a trade.
Before entering a trade you have to know your entry point, stop-loss strategy and exit strategy for the winning trades.
The ratio of the potential profit to the potential loss on a trade is known as the risk/reward ratio.
To illustrate a sound swing trading plan, lets look at a recent example from a stock I traded in my own account.
ALGN is one of the best growth stocks in the market that was setting up a bullish chart pattern within a strong long-term uptrend. The price had pulled back to its long-term uptrend support when we featured it in December.
In a trading plan, you need to identify the entry, stop-loss, reasonable target based on fundamental and/or technical analysis and the risk/reward ratio you are willing to accept.
I like to have a very reasonable target if it gets off to a slow start and more aggressive target if it gets off to a strong start and/or I really love the fundamentals and valuation.
In this case I was playing a bottoming pattern very similar to an explosive bottoming pattern on a great growth stock. The entry point was a move above around $230.
Now through extensive research and back-testing I know this technical setup has a very high win rate.
A high win rate even while using a tight 3.5% stop-loss when its found above the 200 day moving average. And I also knew the stock had a good chance of retesting the highs – about 15% above the entry point.
15% upside with 3.5% downside is a more than 4 to 1 risk/reward ratio on a top growth stock which is hard to pass up. Of course, we need a firm support just below the entry point which is what the strong bottoming pattern gives us.
ALGN hit the entry point and got off to a very strong start so I kept nearly all my shares until it broke into new highs. Once it broke the highs and then a prior days low I sold half my shares for about a 15% profit in about 2 weeks.
One of the rules in our trading plan is take some off at a 4% to 10% profit which usually comes quickly with the explosive bottoming pattern.
In this case, since its a terrific growth stock with rising estimates and a tendency to crush these expectations, I sold just a small portion at that point and stopped it around the entry point.
I plan to sell more before earnings (another rule in our trading plan) when another daily candle is broken and the remainder after the report most likely unless it sets up another earnings eruptions pattern in which case I will play that strategy. Currently, its up about 20% or so from the ideal technical entry point in just over 2 weeks.
I only keep a portion of my shares through the earnings release if they crush earnings expectations consistently. Another rule in my trading plan.
Again, after hitting my first target I stop the trade around the ideal technical entry point. From my experience, I know its critical to get in at this ideal window of opportunity.
Another exit strategy for your final shares may be just waiting until the price closes below the 9 EMA (exponential moving average). A strategy that works well with this stock.
Your trading plan could also include a position size for the very best setups and another for the good but not great ones. Something else you should add to your plan.
But once you identify a winning strategy, a written trading plan becomes invaluable. Another part of our trading plan includes getting out of a trade on any significant negative news event for the stock.
You need a trading plan to deal with all the eventualities so you can maximize your potential and cut losses short. As you practice trade on a simulator, you can fine-tune your trading plan after dozens of trades. One thing to keep in mind is that different strategies generally call for different trading plans.
For instance, an earnings eruptions trade behaves different than an explosive bottoming pattern on a top stock. So each has a different trading plan based on extensive research and experience. However, both are very successful while using a tight stop-loss.
So be sure you have a written trading plan to guide your own trading. You have to at least know your target entry point, target sell price and stop-loss point. Its very important to your success in the long-term.