Plan Your Discretion in Trading

In Blog by Michael Arnold

“Plan your trade and trade your plan” is one of those trading clichés that everyone knows but few people follow. Often times people think a trading plan needs to be so rigid, that they are discouraged from writing one. Studies into this type of behavior have shown this to come from the same place in the mind a fear of failure and embarrassment. If one does not write down direction and goals, then one can adjust those directions and goals on the fly and not feels the sting of not following their own direction or reaching  their goals.

Another excuse often given is the need for discretion in a trading strategy. A firm trading plan does not disqualify the use of discretion. On the contrary, if included in your plan it actually filters good, sound discretion from the almost always negative use of “gut” instinct. There is no gut instinct in trading, because trading behavior goes completely against human instinct. Our instinct tells us to survive and survival would have us avoid risk ENTIRELY. Trading is about taking pre-planned and controlled risks, not avoiding or eliminating risk.

To plan your discretionary rules, you must define situations which may occur and call for the use of discretion. Recently we had a target of $51.68 in the WTI crude oil futures contract. Last week’s  high was $51.67, so it would seem that a rigid rule of “wait for our target before exiting a long” would have resulted in a frustrating stop out of our trade on the pullback. Our discretion, however calls for a certain range of prices around a target, depending on the production we are dealing in, where it is allowable to exit a trade. The rule could be written like this: (example only, not a recommendation) “If price movement causes a market to come within 3% of the projected target, and then pulls back past a 75% retrace of the entire move, we will exit the trade”. This is no longer looks like discretion, you say? Well maybe, but what it definitely does look like is professional trading.