Have a business plan before you trade

Vikas SinghaniaTrade Smart OnlineWay back in late nineteen century, American author Robert Collier said in his self-help book ‘Success is the sum of small efforts – repeated day in and day out.’ Though the author’s quote was meant for businesses and self-motivation the quote is very valid for trading and investing. Chipping away small profits in each trades while waiting for the big one and restricting the loss is the way a trader makes his living. If one breaks it down same is the case with any business. For instance, an automobile manufacturer makes his money by selling one car at a time; a garment manufacturer earns revenue by selling a piece of garment at a time. Most retail investors enter the game of trading and investing in the hope of making a quick buck. But before they know it they lose their capital and then blame the markets as a ‘gambling den’ or a place where only insiders make money, or the classic ‘THEY’ will not let a retail investor make money. Trading and investing is probably one of the most challenging endeavours a person can ever take in his lifetime. On the surface it may look easy, but a person has to pass every emotional and psychological test to succeed. A good trading or investment strategy is as good as the person working with it. As Warren Buffett says making money is simple but not easy. Trust in one-self and their trading or investing strategy, perseverance and discipline are the three main ingredients for success. The challenge is continuing on the defined path. Many investors or traders consider trading or investing as a part time job. This might be the case if one is dependent on someone else for giving them advice on when and what to buy and sell. But for those who do it on their own trading and investing need the same amount of respect as a full time business, if not more. In order to succeed one needs to have a long term vision and the discipline to stick to the vision. One way that most corporates and successful traders do is to make a business plan and then stick to it. A common business maxim is – ‘failing to plan is planning to fail’. There is little difference between the way a corporate goes about planning and a trader should plan. Both need to clearly mention the mission statement and goals of the plan and then go into the details for how to achieve them. In order to better understand how a trader makes a business plan let’s take an example of a trader. Assume that this trader starts with his investment capital as Rs 5 lakh and has a simple trend following strategy – which is say buy if price crosses the previous months high and sell at the lowest price of the last two week. The trader’s mission is to be a successful trader and achieve financial freedom and the goal is to have a higher win loss ratio with average win trades exceeding average loss trades by a ratio of at least two is to one. He then specifies his initial risk capital of Rs 5 lakh with clearly mentioning if he is willing to put in more money or withdraw money from this account. For argument sake let’s say he is investing only Rs 5 lakh. Then the trader needs to mention how he is going to trade – basically his trading strategy. His entry points – in this case buying if a stock crosses one month high price. His exits and stop losses – which is selling and getting out of the trade if price goes below the low price of two week. The trader mentions that he will be monitoring the price daily and shifting his stop loss position everyday if required. Note that a more refined version of this strategy was used by the famous Turtle Traders in the USA who posted record gains for many years in a row.The trader will keep a log of his entry price and where the one month high was exactly to get an idea of any slippages in execution. He would clearly mention the stop loss at this point and then on a daily basis update the log of the shifting exit point. Any deviation from the strategy is to be clearly noted and the reason for deviation needs to be mentioned clearly. The trader will then need to mention how much money is he will to lose on each trade. Ideally successful traders are willing to risk one per cent of their capital on each trade. In this case the amount would be Rs 5,000 per trade (one per cent of Rs 5 lakh). Please note this is the risk amount and not the invested amount. Suppose the one month high of a stock is Rs 100 and the lowest price of last two weeks is Rs 90. So the trader is basically risking Rs 10 on each share. Thus if he is risking Rs 5,000 on the trade he should be buying 500 shares of the stock (risk capital of Rs 5,000 divided by risk of Rs 10 in this trade). Thus the trader is actually buying Rs 50,000 worth of shares (500 * Rs 100 per share) and risking Rs 5,000 in the trade. This way the trader will have at least 100 trades to test his strategy, assuming on a worst case scenario all are loss making trades. The trader also needs to mention how many trades he will be willing to keep open at any point of time. With the strategy and money management in place, the next step is to note how the trader will carry out the analysis of finding a stock which is touching a one month high and the low price of two weeks. Each and every detail of trading needs to be documented, including the name of the broker and how to reach him, a fall back plan if the broker is not reachable. Only then would the trader be ready to deal with the uncertainties with a cool head. Finally the most important part in any business plan is to test where one is in terms of the plan. Is the trader following the plan – if not why? An old adage in the market is to plan your trade and trade your plan. Having a business plan helps in sticking to the rules and making adjustments along the way. In the present case the trader can review his plan periodically and bring it back on path. At the end of a year or say 100 trades he may revisit the strategy and decide to have a new plan. In case he is successful he may decide to increase his capital and have a new set of rules. Management Guru Peter Drucker said ‘Plans are only good intentions unless they immediately degenerate into hard work.’ The most important thing of a successful plan to put it in play is sticking to it. A goal without a plan is a wish.