How to Invest with a Plan

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Narrator: An investing plan is a set of rules and guidelines that defines how you invest.

An investing plan helps you decide in advance what you'll do and how you'll do it. This creates a repeatable process that can take the guesswork out of investing and make the investing process much easier.

Each plan includes six important components: the investment's objective, watch list criteria, entry rules, money management rules, exit rules, and routines. In this video, we'll briefly examine each component.

Let's begin with objective, which represents the specific goal of your investing plan. Once you have this in place, you'll set rules based on your desired outcome.

An objective can vary from the goal of an individual trade to the goal of your entire portfolio.

Because each objective has a different scope, investors may implement multiple objectives simultaneously.

For example, you may use one investing plan with an objective that concerns your overall portfolio, such as asset allocation among stocks, bonds, options, and cash.

And then you could have another investing plan for a specific asset class, like stocks. This plan could help you decide which stocks to buy, when to buy them, how many shares to buy, and when to sell them.

Now on to the next component—the watch list criteria. This section details what specific qualities you're looking for in an investment. Any investment that meets these criteria will be added to your watch list.

Watch list criteria will differ for each investor. Some investors might create a watch list based on a company's financial statement, which is known as fundamental analysis. Other investors might use price and volume movements to determine whether a stock fits their watch list criteria; this is technical analysis.

Many investors combine elements of fundamental and technical analysis into their watch list criteria because both can help determine which securities to watch.

Once you've created your watch list, you need to determine when to buy. These are known as entry rules, guidelines that dictate when you'll purchase a security on your watch list.

Determining your entry rules before you buy reduces the guesswork when deciding when to enter a trade. Entry rules may be different depending on the investor, but here's one simplified example.

Let's say you have company stock XYZ on your watch list and are waiting for the correct time to buy.

Your rules dictate that you'll invest in a stock. For example, you might choose to invest when the stock's price breaks resistance with high volume—say, 150% of the daily average.

With this rule in place, you keep an eye on the chart.

But when this happens, it begs the question, "How much do I buy?" This is when you consult the money management rules component of your investing plan.

Your money management rules define your position sizing guidelines.

To put it another way, this is where you weigh your portfolio size and your risk tolerance to figure out how many shares to buy.

When it's time to buy, you should first look at your portfolio to determine how your transaction will fit in the big picture.

For example, you may have a rule that you won't invest more than 10% of your portfolio in any one security. If you have a $100,000 portfolio, you wouldn't invest more than $10,000 in a single security.

Now that you know what to invest in and when to buy, let's move on to the next investing plan component: your exit rules.

Exit rules are important because you've already determined the acceptable profit or loss before entering a trade.

For example, one investor might have an exit rule to place a stop order at 3% below recent support levels. If the price hits this level, it will trigger the order and the security will automatically be sold.

Creating these rules in advance removes emotion and uncertainty from your trading exits. You'll know what to do no matter which direction the market goes.

Now, all you have left to do is create a routine and follow it. This will help you make sure everything is in its right place.

Often, a routine consists of quarterly, weekly, and possibly daily actions.

Your routine can involve everything we've mentioned so far: maintaining your objective, creating and updating a watch list, buying and selling assets in line with your entry and exit rules, and balancing your portfolio according to your money management rules.

With an investing plan by your side, you'll soon feel confident every step of the way.

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