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Why Is it So Important to Have a Trade Plan?

Schwab trading specialists discuss the importance of having a trade plan and sticking to it.

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Welcome back, traders. I'm here with Kevin Horner, senior manager of trading education, and Julie Strippoli, financial consultant in our downtown Austin branch. And we're going to be discussing trade plans. Julie, can you talk a little bit about why it's so important to have a trade plan as you sit in our Austin, Texas Schwab branch?

Julie Strippoli:  Sure, Lou. I think the bottom line here is that planning leads to better outcomes. So in the branches, we talk with our clients a lot on a ongoing basis about generating good long term plans for your long term investment strategies and accomplishing your goals. Comprehensive planning is really important to that. So I want to get some data up.

This is one of the – one of the sources that we use a lot in the branch, and it comes from a third party researcher, where a segment of the population that's already retired was asked how the retirement is compared to the years just prior to retirement. Those respondents were segmented out and compartmentalized by those who thought a lot about retirement beforehand and then those who had hardly thought about it at all.

And you can see the attitudinal difference in the responses. I mean, those who planned in advance of their retirement had significantly better outcomes, and those who thought hardly about it at all more overwhelmingly responded that their retirement was not as good as the years prior to retirement. So that – I like this data, and will relate it to trade planning specifically, because it – what it does is it relates the attitudinal or psychological aspect associated with – whether it's planning financially for the long term or planning your trade in the short term.

Lou Mercer:  So there's always something to panic about, right? So actually by having it on paper, it makes you really go back to your roadmap and say, okay, why am I in this? And in your case, you're generally talking to people that are a little bit longer term than Kevin and I might talk to.

Julie Strippoli:  Mm-hmm.

Lou Mercer:   But really, the principles hold up.

Julie Strippoli:   Yeah. I mean, really, at the end of the day, this is – planning offers you a blueprint for what you're trying to do, and it's something that you can come back to as a baseline. So something else that I brought that I wanted to show, because I think it's important to have the numbers behind the facts as to why this is a good thing, average total net worth of planners is significantly higher, the more planning that someone has done, and the more that someone has stuck to their plan. And that's not only relevant for long term plans and investment strategies. This is definitely extremely relevant to the short term.

So being able to say, hey, quantified – you know, the numbers don't lie. You know, planning is extremely important, because it's going to lead to a better long term outcome.

Lou Mercer:  So Kevin, I'm going to get to you in a second. Let's take a look at my screen here, and we have, what, 300 financial – excuse me, 300 branches, 13 financial consultants across the country, and generally, the financial consultants are talking about that longer term plan that Julie was talking about. But traders might want to say, okay, well, what can I do?

So I drew a pie chart here of all of our investable assets. The biggest piece of that is that investment piece, right? And that's where Julie will talk to the clients and say, okay, well, how much risk do you want to take? What's your time horizon like? And they'll come up with a mix between equities, bonds, and cash.

Now you might carve off a portion of that that you want to trade with, and Kevin, what might be some ways to manage risk in that trading portion?

Kevin Horner: Well, I think, first of all, having the plan from the broader side of things really helps to – or really work the muscles that you need for planning, right? You're starting out broadly and carrying that consistency into your trade approach. For me, it's establishing a comfort zone of risk. I like to encourage a small percentage of what you consider to be your tradeable assets – a lot of traders like something between one and three percent. Now that sounds pretty small risk amounts, but if you think about it, if you're comfortable risking 2 percent on a $100,000.00 portfolio, that means that your worst case scenario on a trade to trade basis might be losing $2,000.00.

And if you're taking an approach like this, and that consistency is there with percentage of tradeable assets, what you'll find is that as you are improving and growing that balance, 2 percent of $150,000.00 is a little bit more risk, of course. But 2 percent of only $75,000.00 is a little less risk.

Well, as you are struggling, you're tightening the purse strings a little bit, as you're benefiting, as you're producing and being successful, you can afford to take on just a slight bit more risk, but risk commensurate with what the rest of your portfolio should be offering you.

So again, planning it out, having that consistency, really rewards the trader as well as the long term planner. There's no doubt.

Lou Mercer: Yeah, you got – we actually broke down those components into four steps, so the four important aspects of trading, analyze the market. Right? Are you trying to buy what's going up or avoid what's going down? Take a look at what the markets are doing. This is where you host Charting the Markets while Lee was gone, and you also have other webinars that you put on daily, if not weekly.

Kevin Horner: Yep.

Lou Mercer:  And you look at where support is, where is resistance, which way is the market going.

Kevin Horner:  Absolutely. You know, the broader part of the market, you know, the idea that we're in a bull market for eight years, should lead us to considering bullish opportunities, but it doesn't mean that there's not other opportunities that are bearish in the marketplace. There are those opportunities. It's about, as I see it, utilizing the broad side of things, the broad market, and filtering in – I know our last conversation was a little bit different, but, you know, on Mondays, for example, when Lee and I talk about trades for the existing market, that's a fully top down approach, broad market, what's moving and what's shaking, and where do we find opportunity?

Lee and I both like to find those trending opportunities with limited downside, and an opportunity that is at least three times what our downside is.

Lou Mercer:  So there's different ways to filter for them, and then we're going to talk about the trade plan in a second. But Julie, I want to go back to you. I'm often asked, Lou, what portion of my portfolio should I trade compared to long term invest? Is there any rule of thumb that you use, or is it case by case?

Julie Strippoli: Well, I always say that having a trading portfolio is a way to add your unique fingerprint to your longer term portfolio. So, you know, average annualized returns, expectations over the course of the next several decades, are going to be lower in the current economic climate, if things don't change, than they have been historically. So there's a natural inclination to want to add some to the top of that.

But managing your risk is an extremely important part of that process. And so I would say that if, you know, depending on the person, I don't really see a whole lot of clients that we work with that are putting more than say 10 to 15 percent of their portfolio to work in a short term portfolio. And that just really helps to add an accent to a broader kind of longer term engine that's running.

Lou Mercer:  Yeah. Kevin and I love talking to shorter term traders, and when we sit down with them, we say, "Okay, well, what are you doing?" And we want to make sure that they have a portion of their assets that are long term, what we call boring, buy and hold, and that's working with someone like Julie, and really figuring out how much risk you're willing to take.

But let's carve off a piece that we're going to trade. That could be 50 percent of your portfolio. It might only be ten percent of your portfolio. Or guess what? My mom, zero percent of her portfolio. You're only going to carve off that trading portion if you're someone that's high strung like Kevin or I that are micro-managing our position, and we always want to prove that we're right. And by carving off a piece of those trading assets, it allows us to let the long term boring buy and hold stuff just kind of do its thing.

Julie Strippoli: Yeah.

Lou Mercer:   And I encourage that to people all the time, is, look, you should have buy and hold. Quit looking at it. That will do the best in the long term. But if you're constantly trying to time when to get in and when to get out, that's where you're going to carve off a portion and maybe trade. But you're managing risk completely different on those trades.

So Kevin, can you go ahead and show us a trade plan?

Kevin Horner:  Sure.

Lou Mercer:  And as we talk about assessing your trade, my favorite part there, number three, that trade plan.

Kevin Horner:  Yeah. So assessing the trade, developing an initial stop, your initial profit target. You know, I'm a fan of profit target for scaling out, giving me my first real exit, and then a subsequent level at which I will raise my stop on remaining shares. So I take that approach consistently.

The other thing that I don't think we involve in our trade plan, but I want to bring up briefly, is just the idea that there probably should be a maximum dollar amount associated with the trading account. And what I'm getting at is if you get through a wonderful period where you've turned a $10,000.00 account into a $15,000.00 or $20,000.00, that's an ample opportunity to take that additional money that you've just earned and move it to your broader long term plan. Get that money out of your hands, because invariably, you feel as though you're playing on house money, so to speak.

Every dollar earned is a dollar that should be worked to be kept, in my book. And so working to pull that money out of your hands at some point can be a real benefit for you as well.

Lou Mercer:  Julie, if there's a fire in this room, which exit are you running to?

Julie Strippoli: That one.

Lou Mercer: Right? You need to figure it out –

Julie Strippoli:  The closest one.

Lou Mercer:  – before you get in the position. Right? So any time you walk in a room, movie theater, room like this, you want to look to the exit, and that's the biggest part of having this trade plan, is assess your trade, know where you're willing to take that emergency exit, know where you're willing to admit you're wrong.

Now Kevin, would you put a stop loss order on a long term buy and hold position?

Kevin Horner:  Probably not, for myself, because my long term positions are built on a very different approach. From a trading standpoint, I pay a lot more attention to technicals, and of course, on a broader level, I'm not paying nearly as much attention to technicals. I mean, they're there, and I'd pay a little bit of attention, but what it comes down to is the longer term positions, I try not to – as you like to say, try not to micromanage them. The less I have my hands on it, the better off I am, probably. So it's more of an accumulate and manage longer term.

Julie Strippoli:  Yeah, I would say that the fundamentals are going to drive those longer term positions a lot more strongly than the technicals, because you don't want to risk getting whip-sawed out of a position –

Kevin Horner:  Because you need to be right twice.

Julie Strippoli:  – that's a really good one for the long term.

Lou Mercer:  Right. The people that got out in October of 2008, wow, they were jumping for joy by March of 2009, but guess what? The market rallied so fast that they couldn’t get back in. They were stuck in too much cash. And I still see that today. The market's going higher. People say, "Look, I can't get in now. I don't want to be the fool that buys at a high." Guess what? As long as people have that position or that perspective, as the market is making higher highs and higher lows, I believe we can continue to go higher.

Kevin Horner:  Yeah.

Lou Mercer:  Joanna and I, we put this deck together, and Lee, on Stock Market Manias and Crashes. And the common characteristic that bubbles have or heights of market is overly optimistic people. And we just don't see that today.

Julie Strippoli:  Yeah.

Lou Mercer:   Right? So be careful with the stop orders, because you need to be right twice, not only when to get out, but when to get back in. So what am I saying? Don't place a stop order on your long term assets, but yes, make sure you have it on your trades. On your long term assets, you're going to manage risk through diversification.

Julie Strippoli:  Right. And that's what I was going to say. Having that core portfolio does lend to having more diversification in your trading portfolio overall, because sometimes in those shorter term trade portfolios, you can end up with concentrations that would definitely overweight you.

Lou Mercer: Is there a certain general rule of thumb on what percent of your portfolio should be in individual stocks? In other words, if I want to buy XYZ company, should I not own more than a certain percent of it?

Julie Strippoli:  We consider a concentrated position. When we talk with clients in the branch, we consider a concentrated position to be a position that's greater than ten percent of your portfolio. That's a position that typically needs to be dealt with. Not to – not to say that we haven't seen 50 percent concentrations or 75 percent concentrations, but those are – those are times we really have to assess what it is that you're going to do. And a lot of times, clients get locked up in the capital gains situation, not wanting to pay taxes.

But it's just something you can't avoid. The risk metric is significantly higher once you start to get above that 10 to 15 percent threshold and into those higher double digits.

Lou Mercer:  Kevin, do you want to continue to go through that trade plan? What else do you like to point out when you're talking to investors?

Kevin Horner:  Without a doubt, review your performance. You have to know how you are actually doing, not how you feel you're doing. You know, not based on what you recall from the last three days. Go back and look at your history. More importantly, go back to the gain/loss analyzer available in Trade Source. You know, Joanna's tool there that has been implemented has been a wonderful tool for me to rely on as the accountability factor for my approach.

So I reference that weekly to check out what's working and what's not, make sure that my risk/reward ratios are in place. I'm not perfect by any stretch. I'm certainly not where I want to be, a three to one ratio, right now. But if I can get to that point, because my success ratio is pretty high right now, thanks, bull market, the – as Lee likes to say, the bull market makes us all feel very smart.

But yeah, but better on the numbers, but not as good on my ratios. So as soon as I can kick those ratios the right direction, I'm going to see a better result. So relying on that tool has really given me a stronger level of accountability and diagnosis of what's working and what's not.

Julie Strippoli:  I think one other thing to mention is part of – one of the reasons why the trade plan is so impactful is that it gives you a barometer through which you can actually use that feedback much more valuably. If you've got a consistent regimen, then when you get positive or negative feedback, you're analyzing it against a real strategy.

Lou Mercer: And you're accountable, right?

Julie Strippoli: Yeah.

Lou Mercer:  You could actually go back and say, oh, yeah, I did make a mistake, because I had an idea, and it did or didn't work.

Julie Strippoli: Mm-hmm. Yeah.

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