Now that I have defined my investment philosophy and style, let us talk about the trading plan. First of all, I do think that all investors, especially investors who trade frequently, need to have a trading plan. It is one way to keep emotions out of the equation. That is the most important reason for actually having a trading plan.
I do have a trading plan that, at a high level, is quite simple:
For every 10 trades that I make, I aim to get at least 5 of them right.
What that means is that my trading plan caters for 5 of my trades to be wrong and still come out positive. How can I say that? It is use of Math. The idea is to get higher profits on the winning trades and lower losses on the loosing trades.
Let me explain further. I always trade with options, very rarely with the underlying stocks. The reason for this is to maximize leverage and reduce risks. So, typically I aim for a 40-50% gain on invested capital per trade. On the loosing side I usually get out if I incur a 25% loss on the trade. Both these percentages are high because when I am working with options, those are usually the percentages that are workable. So, making more gain on my winners and less loss on my losers ends up me being in the positive.
As an example, consider an investment account of $10,000. Consider, in a given month, I used this amount to make 10 equal investments of $1,000 each. If I can make an average of 40% gains on 5 trades, I will end up making $400 times 5, which is $2,000 on the gain side. If I keep my average loses on the losers to 25%, then I will loose $250 times 5, which is $1,250 on the loss side. The net gain is $750 (without considering brokerage costs), which is a return of 7.5% in that month.
Is it possible to do exactly as above month after month? Probably not, but with due diligence and sticking with the trading plan, at an average it will work out.
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