Routine and Habits IV (B): The Trading Plan

Today I am going to write about aspects of a discretionary plan. Discretionary plan are first and foremost a reflection of our beliefs about the nature and structure of markets. Someone who believes in the market efficiency theory will use a different plan to someone who believes they are chaotic.

I believe that markets are chaotic. Consequently, I believe:

  • Markets have a discernable structure
  • They rhyme rather than repeat i.e. there are patterns we can exploit but these patterns are repeated’ similarly rather than exactly’.
  • The market rhymes because the patterns are a reflection of the emotional tug-of-war between the buyer and the seller.
  • The context in which the patterns occur are critical to the plan.

A discretionary plan is also a reflection of our psychology including our appetite for risk; this refection is articulated in our trading philosophy. In Trader Vic–Methods of a Wall Street Master by Victor Sperandeo, I found a statement that mirrored my values:

  1. Preservation of Capital – this is the overriding principle
  2. Consistency of Returns – this goes hand-in-hand with (1)
  3. Superior Returns – only when (1) and (2) have been secured

My plan and results reflect the three characteristics; for example I use the Rule of 3 not because it increases my bottom line. Indeed, in a strongly trending market, the rule reduces my profits. I use the rule because it smooths my equity curve.

I believe a discretionary plan has certain critical elements:

  • A way of identifying the trend of a timeframe and when the trend changes or is likely to change. Once we identify that a trend is likely to continue, or that it is likely to change, we have our strategy. That strategy is rooted in the timeframe we are trading and includes the effects on our the trend by higher time frames.
  • Tools to identify price levels where a trade may take place (zones) . As my nature favours a responsive trade, I look to buy support in an uptrend and sell resistance in a downtrend. I very seldom buy/sell breakouts of my timeframe.
  • Chart patterns that indicate a zone has held (setups) and entry patterns that tell me ‘now is the time to take a trade’ (triggers). The setup and trigger define the price stop placement. In addition to the price stop, I look to define the qualitative conditions that will cause me to exit a trade.
  • Chart patterns that define the core profit target in the Rule of 3. This core profit target versus the stop defines the Risk:Reward expectancy: I need to see around 2:1 or better to take a trade.
  • The relationship between the price stop, my risk assessment of the trade, and money management plan govern my position size. I have three sizes: normal, 1/2 above normal and above normal (usually 1.5 or 2.0 times normal).
  • A set of rules (Rule of 3) that govern my subsequent trade management i.e. the management of the trade once it starts to move in my favour.

What tools do I use?

  • TREND: Barros Swings and the Ray Wave
  • ZONES: Statistics of waves, MIDAS (see free section’ for Paul Levine’s lectures on this tool), and various ratios.
  • SETUPS: Negative Development and Contraction
  • TRIGGERS: Intra-day volume on Market Delta software
  • INITIAL QUALITATIVE EXIT STRATEGIES: Based on Market Profile and Wyckoff
  • INITIAL PRICE STOPS: Barros Swings and The Ray Wave

Once you have your tools, you need to create a plan. I have found that classifying the rules under ‘Buy & Sell’ and giving a setup and trigger a separate rule number, is the best way of creating a data base to assess the efficacy of the rule. I’ll discuss this farther in the blog on ‘Stats to Keep’.

A couple of final comments. I believe all traders should have a passing acquaintance with statistical and probability theory. This comes from someone who was mathematically a complete dunce until well into his mid-30s. “Salvation” was found in two books by Derek Rowntree:

  1. Statistics Without Tears
  2. Probability Without Tears

Finally if you see yourself as a serious trader (as against someone having a ‘flutter’ i.e. a gamble for pleasure), you owe to yourself to back test your setups and triggers. Generally because a discretionary trader relies so much on context, it is difficult for most back testing programs to test the trading rules. However, you can certainly test the setups and triggers. In back testing, you are looking for evidence of robustness and if you lack the skills to do it yourself (like me), then find someone who’ll do it for you.

4 thoughts on “Routine and Habits IV (B): The Trading Plan”

  1. Ray

    I find your concluding line provocative:

    “if you lack the skills to do it yourself (like me), then find someone who’ll do it for you.”

    Which means you pay some brilliant mathematician or egg-head to crunch the figures and back-test for you. Unless you have a sibling of such calibre who will do it for you for free!

    Just kidding, as I am still suffering from boredom of the way the markets behave from year end to the New Year.

  2. Well Ana, though you may be kidding, you do raise a good point. Nothing in life is free, so paying for service is the final resort.

    On the other hand, nothing stops a bunch of guys & gals getting together to share skills.

  3. Your blog is a must read for me everyday!! Love it!

    I’m backtesting manually but finds it too time consuming. Any recommendations or ideas to shorten it?

    Who is this guy or company that does this testing for you?

  4. Hi Sito

    Thanks for your kind words

    I am sorry for the late reply. I am attending a seminar that runs 9:00 am to 11:00 PM for two days. I took an early mark today because of the Non-Farm Payrolls.

    My brother does most of my backtesting. A friend Howard Elliott also assists. My brother won’t do it commercially but Howard will consider it depending on what you want.

    Howard’s e-mail:

    In addition, Dr. Brett Steenbarger this year ran a series on putting traders and testers together. You can contact him at his blog:

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