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"Losers who suffer from the 'brain myth' will tell you, 'I lost because I didn't know trading secrets.' Many losers have a fantasy that successful traders have some secret knowledge. This fantasy helps support a lively market in advisory services and ready-made trading systems." Dr Alexander Elder, Trading for a Living, 1993. Pub: John Wiley & Sons, Inc.

Developing a trading plan

When a person decides to start a business the first thing they usually do is to draft a business plan. While most people would see this as nothing more than common sense, it seems the same logic does not always apply to new traders.

Rather than planning how and where their capital is to be allocated, some new traders launch headlong into their trading careers with scant regard as to their risk and profit objectives.

In the absence of a trading plan, traders will simply not know what to do when the market goes in their favour or worse still, when it goes against them.

Without the 'road map' that a trading plan provides, traders are at the mercy not only of changing market conditions, but also of their own conflicting emotions. This is a sure recipe for disaster.

While a trading plan may contain many elements, at minimum it should at least answer the following questions:

1. What are my expectations?

A common problem that new traders have is that they approach the market with unrealistic expectations. Rather than seeing trading as a business which requires both time and intellectual commitment, some traders see the market as nothing more than a place to make 'easy money'. Of course a few of these traders may be fortunate enough to do well over the short term however invariably their inexperience and overconfidence catches up with them. When this occurs, the losses are often so large that it prevents them from returning to the market in the future.

Success in the futures market is not impossible however prospective traders need to understand that trading requires dedication and hard work. Only when this is given, will the rewards be forthcoming.

2. What markets will I trade?

When approaching the futures market, a trader needs to establish which market or markets to trade.

The choice of which markets to trade is an individual decision that will be guided both by the trader's own trading style and by the time they have available to commit to the market. For example if a trader has a system which is based on some form of technical analysis, then the trader may be able to apply the system across a broad range of markets both domestic and international. If however the trader's decisions are guided largely by fundamental analysis then there may be only a limited number of markets where the trader will feel confident in taking a market position.

The time that a trader has available to them to study and monitor the market will be another factor which will determine the variety of markets traded. For example, if a trader has only limited time available for trading, it may be beneficial for that trader to focus on a small number of markets so that they can get a better 'feel' for the price behaviour of these markets.

3. What are my requirements?

Just like when drafting a business plan, a trader needs to consider what resources are needed to get the job done and the cost of these resources. While competition between vendors has forced the price of such services down, in the context of trading, the largest outlays are related to the costs of obtaining price data and the costs of any systems used to analyse this data. As mentioned earlier in this booklet, there are many vendors who provide live price data and market analysis tools. Many systems also include market news, risk management software and a range of popular technical analysis indicators. Other vendors, provide dedicated stand alone software packages with highly sophisticated technical analysis programs.

In addition to this expense, other expenses such as brokerage and exchange fees both of which are levied on a per trade basis, must also be considered. Finally the trader must also take into account other one off costs such as the purchase of computer hardware and software as well as ongoing cost such as electricity, rent, phone and internet provider charges.

4. What capital do I have available?

Another key question that a trader must ask before they start trading is ? how much capital do I have and how much can I afford to lose?

The principles of money management and risk control are perhaps the most important issue that any trader will face. Put simply, unless traders know how to manage their money correctly and keep their losses to a minimum, their career as traders are sure to be short lived.

In practice, sound money management means that a trader will set limits on how much of their total capital will be risked on any one trade. Though there is no industry standard on this, most experienced traders will never risk more than 5% of their total account size on any single trade. For some, this figure is even lower, being around 1%.

Whatever the percentage, all experienced traders realise that it is vital not to over commit yourself on any single trade. To do so, not only puts you at risk of making a large and often unsustainable loss, but it also, makes it much harder for you to close the position should the market go against you (i.e. the size of your loss makes you unwilling to realise it even though your trading system demands that you do so).

Another aspect of sound money management, which should be obvious, is that you should only trade with money that you can afford to lose.

Over the years it has been statistically proven that most new traders who come to the market will lose (as is the case with starting any business). Further, no matter how good a trader you are (or think you are) it is simply inevitable that at some point you will make a losing trade.

Using money you can afford to lose and knowing how to take a loss when one comes, are two of the biggest caveats in trading. Some of the world's most successful traders only make a winning trade 30 to 40% of the time which by definition means that up to 70% of the trades they make, are losing trades. The fact that these traders can be successful with such a seemingly poor win to loss ratio says much about their money management skills and the way that they are able to use these skill to their ultimate advantage.

5. When should I start trading?

Another important aspect to the trading plan is the decision of when the trader is ready to start trading.

Before they begin in the market, some traders find it helpful to 'paper trade' the market for a while. This involves taking 'hypothetical' positions in the market and then monitoring these to see what the outcome will be. To make this as realistic as possible, some traders will even use simulated trading services where they speak to a virtual futures broker and where statements are produced to evidence every trade made.

Other traders, whose systems are more technical in nature will 'back test' their system against historical market data to determine the success of the system in that particular market.

While all of these techniques are beneficial, prospective traders need to be aware that simulated trading - no matter what its form, does have its pitfalls.

Experienced traders will often say that there is no substitute for having real money in the market. Depending upon traders own discipline, the way they react in this circumstance could be very different compared to when the trade was purely hypothetical. In addition, while a market's past performance can provide some general clues as to its price behaviour, there is no guarantee that this will be repeated in the future.

Trading systems - a synopsis

A trading system can be as simple as a few rules or as complex as a Black box technical analysis package. The key is that the system matches your personal trading style. You can either create a system from scratch or buy a readymade package. Either way it is advisable to test the system with dummy trades before doing the real thing. Some experts recommend 10 years of back testing with historical data (black box systems) where as others recommend a shorter time span for the testing of a simpler system. It is very important to perform your own testing on any 'off the shelf' systems, and not rely purely on the seller's recommendations. Some publications which might be of benefit when developing a trading system include:

Trading Systems And Methods by Perry Kaufman
New Concepts In Technical Trading Systems by WelIs Wilder
Trading Systems Toolkit by Joe Krutsinger
Trading Systems: Secrets of The Masters by Joe Krutsinger
Cybemetic Trading Strategies by Murray Ruggiero

Recordkeeping

Whilst brokers will provide clients with records/statements of trading, it is recommended that the clients maintain their own records. In addition to keeping records of trade instructions given, some experts also recommend that traders keep a record of the reasons as to why they entered each trade. This can be used later to evaluate the trader's success or otherwise and to highlight potential areas that could be improved.

An example of a trading sheet is given on our web site.

Conclusion

As was highlighted at the beginning of this Handbook, trading futures and options is not for everyone. To be successful over the long term, traders need discipline, commitment, persistence as well as the humility to accept that they will not always be right. Despite the effort and sacrifice required, trading can be very satisfying, both in intellectual and financial terms. We hope that this handbook has gone some way to unlocking the mystery of futures markets and that you now have a better understanding as to the operation of futures markets and their benefits to investors worldwide.