What a stock trader can learn from aviation sector

Vikas SinghaniaTrade Smart Online Data collected by National Transportation Safety Board, USA shows that the accident rate in the world compared as a ratio of fatalities per 100 million miles travelled is the highest for cars followed by bicycles, pedestrian, motorcycles covering almost all form of transportation. The lowest in the category, which is near zero based strictly on the ratio, is airline travel. There is only one reason that airlines fatality rates are the lowest, though they get the highest media coverage, is because airlines learn from their mistakes. More importantly there is a pattern in their learning which is shared across airlines. The lessons learnt from each crash is added to a checklist which then forms part of the procedure of testing before an plane is cleared for flying. It’s this strict following of rules that has resulted in airlines having one of the lowest fatality rates. The same rule based system can be used in trading and investing. A checklist, if followed helps a trader/investor to stay on track and stick to his strategy. Almost all successful traders and investors follow a checklist. Over time the checklist becomes second nature and they do not need to physically maintain one. However, for a novice trader/investor it is necessary to physically maintain a checklist in his initial days. So, what should the checklist comprise of? A checklist can be as detailed as possible as well as it can be a simple pointers based highlighting the main points. Depending on the trader’s nature one can choose the checklist as per his convenience. The important thing to note is that the checklist should be such that one can follow on a regular basis. An overenthusiastic lengthy checklist might work for a few days but the trader might find it as too much work and stop following it. It needs to be kept in mind that the job of a trader is to trade, checklists are like road signs to keep investors from getting distracted. Before making a checklist the trader needs to have his strategy back-tested and tested on paper (at least a few trades). Its only when the trader wants to start his trading that a checklist is needed. We shall now look at the ingredients by considering an example. Let’s assume that someone trades a very simple moving average crossover strategy. In this case, work on the checklist will start after the previous day’s close. A simple checklist in an excel sheet or on paper can be kept with main heads and sub-heads as per convenience. List of stocks to trade: A query based search on the stocks should be under taken to shortlist the stocks to be traded the next day. Here care should be taken that if the query is run; it is on the desired group of stocks, say liquid stocks, or stocks in a particular sector. The moving average selected are of the same time frame as the trade wants to work in. In case someone is physically testing each stock in the group, care should be taken that none of the stocks are left behind and each stock is carefully studied. Pre-market checks: Equipped with the stocks to trade the next step will be to determine the levels to trade. Entry level, exit level and most importantly stop losses are to be clearly written down, so when the market opens the next day, the trader is ready with a clear plan of entry and exit. He acts as per our plan rather than react to market. As part of the pre-market test it is also important to check the equipment’s used for trading, like the computer, internet connections and charting software. A contingency plan in case something does not work should be in place, in order to avoid getting irritated and take a wrong trade. Orders: After the market has opened the trader needs to check if his orders are placed correctly, if he is trading on his own. If he calls his broker to trade he needs to double check his order by calling his broker. The moment his trade is executed he needs to keep his stop losses. Most softwares these days allow simultaneously putting a normal order and a stop loss order. If it does not, placing the stop loss order should be instant. Similarly, ones the trade is executed, if an exit level is identified beforehand (some traders take a percentage exit over entry price) it should be kept. In other cases where traders use a trail exit, the levels should be identified and order placed. Contingencies: Chances are in many orders there are slippages. Entry would be above one’s desired level if the market moves sharply. Rather than panicking, a corrective course should be in hand. Stop losses needs to be revised and so does exit levels. In case the entry price is substantially over the desired price, one might even consider exiting with either a small profit or loss as the risk reward in this case would have changed substantially. Exits: In case the stop loss is triggered or profit is booked, the other leg of the trade needs to be cancelled. In case of partial exits, where only some shares were exited as the stock again moved in the direction contrary to expectations, one needs to keep a contingency plan of where to exit the remaining portion. Logs: The most important part of trading and least understood and followed is maintaining a trading log. A detailed log goes a long way in a trader’s success. Every aspect of the trade, including charts and the psychological state of mind when the trade was executed or missed needs to be noted down. Reading of this log will probably be the most important learning. As in the case of airlines, its learning from the mistakes is what prevents future mistakes. The checklist will naturally change for a day-trader and an investor. Time of entering and exiting a trade should also be included in a day-trading logs. While for an investor it would be a checklist of all fundamental parameters.With practice, maintaining a physical checklist will not be needed. But after every major loss or a series of small loses, professional traders have gone back to using the checklist to get in the groove. A professional trader has the following quote stuck on a corner of his trading screen; it is valid for all traders and possibly for every profession:•         A dream written down with a date becomes a GOAL. •         A goal broken down into STEPS becomes a PLAN.•         A plan backed by ACTION makes your dream comes true.