Tuesday, October 31, 2006

Business Plans for Traders and Investors

I teach seminars on stock and option trading and in the basic class, I always begin with the necessity of having a business plan. Trading and investing are businesses. We need to treat them that way. If you were going to open a retail store or a medical practice or an oil exploration company you'd certainly have a business plan, wouldn't you? So why wouldn't you have a trading or investing plan? Clearly, each of us who trades and/or invests should have a plan, but many don't. In all the seminars I've taught, I'd guess that less than 1% of the attendees had a business plan before they came. Now, I hope they all do.

Emotion is the enemy of the trader and the investor. If that investor doesn't have and abide by a plan, don't you think the chances are high that his trading will be controlled by emotion? Fear and greed take over and generally seem to lead to poor decision making. The undisciplined often enter at exactly the wrong place and exit just as badly. One of the ways to avoid the dangerously undisciplined approach is to have a plan. I remember being on the trading floor of a large brokerage house in New York when I first began trading for my living. I was fortunate enough to meet the head trader and he asked me what I was doing and I excitedly expounded the trading plan I was following. I hoped he would acknowledge the obvious brilliance of my plan. He didn't. What he said, however, has stuck with me for many years. He said it wasn't so important what my plan was; it was important that I had a plan. He told me that most of the retail traders and investors he knew had no plan and that almost any plan was better than having no plan.

As I began to teach trading, I tried to incorporate that message to my students. Generally they would glaze over when I went into my sermon on having a business plan. They were waiting for the "good stuff" about how to make money. Well having and making a business plan is definitely a huge part of that "good stuff." Without it, making money is infinitely more difficult. One of the perks of our basic trading class is that everyone is entitled to a free retake and many of the students wisely avail themselves of that opportunity. We throw an awful lot at them in the initial two day class and repetition helps them finally own the knowledge. Anyway, I began asking the retake students whether they had completed a business plan and they never had. When I asked why, I learned that they had no clue how to formulate the plan. Now, in class, I take some time and go over some detailed suggestions as to what the business plan should include.

While the following is not intended to be complete or exhaustive, it is intended to give the reader a starting point in formulating their own personal business plan for investing or trading. Here are some of the elements of a business plan that I suggest to my students:

1. Will I trade full or part time?

2. How much risk money will I assign to the business? (I define risk money as money you can lose that will not affect your life or lifestyle. It does NOT include mortgage payment money, rent money, grocery money, car payments, insurance premiums, clothing money, or any other money you absolutely can't afford to lose).

3. What will be the size of my trades? (Equal dollar amounts, or equal percentage amounts).

4. How will I make my trading decisions?

5. When will I make my trading decisions? (In the evening? Only on weekends? Once a month? It depends on what is going on in your own life).

6. How will I enter?

7. How and when will I exit?

8. What strategies will I employ?

9. What are my business hours? (In my view, this is very important. If we had a store, we would be open certain hours. If we assign business hours to ourselves, they should be treated as exactly that -- business hours. It is not a time to play with the dog or have non-essential interruptions. The business needs to be treated like a business).

10. What is the maximum number of trades I'll have in place at any one time?

11. What type of stops or alerts will I use?

12. What are my specific trading expectations?

13. What will I do to increase my trading knowledge? (Reading, seminars, paper trading, DVD's, etc.).

Again, these questions are intended as a starting point only. Other questions will occur to you as you develop your plan. Remember, the business plan is always a work in progress. It is expected to change over time. You may start trading part time and ultimately go full time. You may learn new strategies over time and that could change the strategies you are going to employ. You may begin with only a small amount of risk money and not have enough money to make equal 5% percentage trades at first so you may decide to trade equal dollar amounts. Later, when your account grows, you may switch from equal dollar amounts to equal percentage amounts.

The critical point is that you do develop a business plan of your own for your own trading and investing. The act of devising the plan will require some thought and will reveal important information to yourself about yourself. Completing the plan will give you a foundation for better trading. Abiding by the plan once you have completed it will put you in a rare class of trader and investor.

Bill Kraft, Editor
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