07:43 AM, 02 Mar 2024 (AUS EST)   The market is currently closed       

How to Treat Trading Like a Business

Before a bank will lend you money for a business venture, they often want to see some level of due diligence in the form of a business plan. They may look over your forecast projections for revenue, profit and growth to decide whether to fund you or not.

As we enter into the world of stock trading, we need to be our own bankers making sure that we have a sound plan with many checks and balances. An old proverb says, ‘what you sow is what you will reap’; this suggests that our reward is partially based on our preparatory work. If we put no forethought into our trading system we should expect little out in the way of gain – except by accident. If, on the other hand, we are diligent and every adapting to new circumstances – we are more likely to succeed.

What does a good trading plan include? How is trading like running a business?

Targeting Clientele. When you start up a business, one of the first things you need to focus on is who your target customer will be. Understanding your typical customer will directly translate into regular revenue and profit.

In trading you need to decide which market you will be trading in – which is your clientele. Each market is like a different set of customers. Do you plan to trade bonds, equity or publicly traded stocks, leveraged instruments such as options or CFDs? Perhaps the futures market or the currency trading such as the FOREX is what appeals to you. How do you decide on which capital market, or customer, to target? Much depends on you, your personality, your interests, and the degree of risk you are willing to assume.

If you are most interested in interest rates and credit ratings, then bonds might be what you are suited for. For most, the stock market is the starting point. From there, many venture out into the leveraged markets to gear their gains…and their losses. The FOREX market requires solid technical analysis skills and often a broad understanding of global markets and what affects currency values of individual countries.

Capital. A startup business requires money, and trading is no different. How much do you need to start? That really depends on which market you choose to trade in. You should not let your capital dictate your preferred market, which is why I have listed this second. For instance, if you only have $100 in your savings account, do not assume that you must trade the most risky and leveraged markets because you cannot afford anything else. As the Titanic was sinking I am sure you could rent a room really cheap– but this didn’t make it a good investment.

How much capital do you need to start? If you are buying publicly traded shares and holding for long periods of time, you can start with very little – perhaps only a couple thousand dollars with regular additions of investment capital. Remember that transaction fees will cut into your profits so trading in very small amounts may not be a sound in all instances. As you gravitate toward the highly leveraged instruments you may need less per trade. Other leveraged instruments may not need as much per trade, but the skill level required goes way up.

As well, you need to define the difference between total capital and trading capital (or capital at risk). As a trader, you should never put all your money in one trade. Possibly, you will only be using 2 – 5% of your total capital per trade, which means that if you use $2,000 per trade, you may need $40,000 - $100,000 total to begin.

Plan to Make Money. Every business plan must include the methodology to make money. How will you drive customers through the front door of your business? Advertising, signage, or newspaper ads? How will you close the deal once the customer is in your store?

With trading, you also need a strategy that includes when to buy and when to sell your investments. There are many types of strategies so you need to consider a few items.

  • How long is each typical trade? Some last minutes and others last years, with everything in between.
  • What is the guiding principle behind the strategy? Am I following the pack with trend or momentum trading or am I taking up a highly contrarian position that needs to be held for a long period of time?
  • Is my position based on fundamental or technical analysis?

You may start with a commonly used trading strategy or system but it may need some adaption to suit your personal needs.

Assessing Your Skill Level. You may have the money and the strategy, but do you have the skills? If you are starting a restaurant, you may need to know how to manage people and food. A cleaning company will require skill in window washing, mopping, and waxing. Trading requires a certain level of skill matched by the right personality type.

Some of this you can determine by asking someone that knows your personality very well – perhaps your mate. If you detest risk and make slow calculated decisions, then making lightning quick trades on the leveraged and volatile FOREX market may not be your best bet. Another way to determine if you have the necessary trading skills for a certain strategy is to use a simulated trading platform. Paper trading is no substitute for real trading but it will give broad indications whether you are ready or not – or if you are well suited for this trading style.

Goals. Every business plan needs to have goals: how much profit do you expect to make in your first month, quarter, and year? This is also true when trading financial markets. You have a strategy and a plan, but how much do you expect to make…realistically?

You should have clear goals in mind. These can range from dollar amounts to winning trades and everything in between. Below are just a few goals:

  • Average profit per trade
  • Average profit per month, quarter, year
  • Average amount of winning trades
  • Average loss per trade

Risk Management. How will you manage risk? Will you limit the amount of capital put into each trade? Or will you pre-determine what the maximum amount of loss is per trade thus setting a stop-loss exit in advance? Have you decided when to take a profit or will you let gains slip away?

Your risk controls will be dictated by the markets you trade and your risk tolerance. It is vital that you have a clear plan to limit risk so that you do not start doubling-down on losing trades to quickly lose all of your trading capital.

Daily or Weekly Routines. Every business has a certain routine or process that needs to be adhered to. What process do you need to go through to trade? One routine might be as follows:

  1. Get a good night’s sleep.
  2. Drink a pot of coffee two hours before the market opens.
  3. Read any macro-environment business items that will affect the market as a whole such as war, rating downgrades, interest rate changes.
  4. Study a chart of the market for 10 minutes getting a feel for what the day might bring.
  5. Look at the futures market to see which direction traders are already leaning.
  6. Fire up your screening software and isolate the stocks that are hitting your fundamental buying criteria.
  7. Look at each stock on a chart individually to determine which the strongest candidates are.
  8. Predetermine when you will buy and when you will sell based on your strategy.
  9. Fire up your trading platform and wait for the signals in real-time.

Tools of the Trade. A plumber needs his wrenches, and artist his easel, and a trader his hardware and software. What specific tools will a trader need?

  • Hardware setup. This will include a computer, dual-monitors or more, and a quick high-speed internet connection.
  • Broker. Which online discount broker gives you the best rates, the right investment products, and accompanying software that you need?
  • Data feed. Your online broker may provide you with a data feed that can be used with 3rd party software or you may need to buy this from a provider.
  • Charting software. Typically, the charting software that comes free with your online broker is not robust enough for complex trading strategies. You will need a quick charting package with a variety of indicators and customizations. If it includes technical back-testing and optimization – all the better.
  • Other software and feeds. In addition to charting you may also want to subscribe to some information feeds such as live traders on the exchange floor telling you the general feeling there, various screening tools, or research packages.

Evaluation of Success. A periodic review of your entire trading strategy is one way to ensure you are heading in the right direction. Businesses report earnings every quarter and year – your trading business should be no different.

  • Every three months you should target your losing trades – particularly if the average losing trade percent is above your original estimated parameters. What is causing the higher percent of losing trades? If it is your emotions – why is that so? Has the market changed becoming more volatile? Perhaps you need to wait for a specific condition to resume trading.
  • Is your strategy mismatched for your personality? You may need to pick one that is better suited for your trading style.
  • Are emotions getting in the way of sound trading? You may need to find a way to enforce self-discipline.
  • Do you need to adjust your entry and exit signals to current conditions?

From big to small you should review the success of your trading system. Sometimes the problem is a small technical matter such as intermittent broadband or latency issues, and other times it is major such as a strategy that quit working or an emotional makeup that is ill-suited for the type of trading you are employing. Be honest and review your plan like a banker would a balance sheet.

Many people try their hand and self-investing with big hopes and aspirations but with little forethought. As the saying goes, if you ‘fail to plan – you plan to fail’. Perform due diligence, make a plan, prepare for the worst, and work towards the best. If you treat trading like a banker – you have better odds of being a successful trader with a rewarding career.