Components Of A Trading Plan – A

This is the first in a series on trading plans. In this article, I shall be looking at the elements of a discretionary plan. But before I do that, let’s look at the different types of traders and plans:

  • Subjective: There is no plan as such. The traders use kinesthetic information to enter and exit trades. Subjective traders trade solely (or mainly) by intuition. Successful subjective traders with whom I am acquainted are ex-floor traders (locals). Most locals have had a difficult time making the transition to the screen. Perhaps the scalping screen traders will replace the locals – we’ll see.
  • Mechanical: On the other side of the spectrum lies the Mechanical Trader. The Mechanical Trader has a set of rules to which he always adheres. “See a signal, take a trade” is his mantra.

  • Discretionary: Between the two is the Discretionary Trader. The Discretionary Trader has a set of rules but reserves the right not to follow them. In this way, he makes room for his intuition. Newbies need to understand that intuition is the result of experience and is not to be confused with ‘into-wishing’. ‘Intuition’ in this context is the subconscious recognition of patterns. For the subconscious to amass the patterns, we must first have had the experience of consciously identifying them. Newbies are unlikely to have this experience and more often than not, call label ‘into-wishing’, intuition.

Discretionary plans have either a fundamental or a technical base or have a combination of the two. The better discretionary plan reflects some fundamental idea of the nature of markets. For example, Buffett believes that companies have an intrinsic value and that this value is assessable. The Market Profile believes that the nature of markets is fractal and is best observed via the bell curve with present tense information.

The better technical analysis based plans have certain, specific components:

  • Identification of a Trend of a Timeframe
  • Low Risk Entry

Zone

Setup, Entry and Initial Stop (or initial exit strategy)

  • Trade Management

I am heavily influenced by Pete Steidlmayer’s approach to the markets. Pete used to say that ‘traders succeed, not because of their tools but in spite of them’. I believe that his words are particularly applicable in this area of trend definition of a timeframe.

Most traditional trend definition tools rely on some form of moving average. The tools are great if a market is trending but do a poor job when the market is in a transitional phase. The reason is as a rule markets move from Bull to Sideway to Bear or Bear to Sideways to Bull. Moving Averages do a poor job in sideways markets.

Is there an alternative to moving averages?

I thought so: swing charts. But the traditional swing charts were almost as unsatisfactory as moving averages so I developed my own: a swing chart that had a time component (unlike percentage charts that only have a price component) and a price component (unlike Gann Swing Charts that have only a price component). I called the swing chart Barros Swings.

My book the Nature of Trends (available from Amazon) describes how the swings are drawn. I use on Daily Bars:

  • A 5-period swing to define a weekly trend (5-d)
  • An 18-period swing to define the monthly trend (18-d).

I also use the 13-period swing on Weekly Bars (13-w) to define the quarterly trends and the 12-period swing (12-m) to define the yearly trend.

I call the timeframe that defines our trading strategy the Trader’s Timeframe Trend. The trend of the Trader’s Timeframe is impacted by the trend status of the First and Second Higher Timeframe.

For example, if the Trader’s Timeframe is the 18-d, then the First Higher Timeframe is the 13-w and the Second Higher Timeframe is the 12-m. To know when the 18-d has a high probability to change its trend we need to know the likelihood of the 13-w changing its line direction or trend. The 12-m provides further perspective.

The swings make it easy to define the trend of a timeframe:

  • Uptrend: higher swing highs and higher swing lows
  • Downtrend: lower swing highs and lower swing lows
  • Sideways: almost equal swing highs and almost equal swing lows

Once we have assessed the Trader’s Timeframe trend, we need to ask: continuation or change? Once we answer that question, we have our trading strategy: be a buyer or seller or stand aside. I will trade against the trend only if there is a change in trend pattern. More on that in tomorrow’s post.

2 thoughts on “Components Of A Trading Plan – A”

  1. I just ordered your book and look forward to reading it. Based on the review comments, looks like a good rejuvenation of back to the basics of trends. We often get lost in the myriad choices of lines of technical analysis.

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