Here I would to share with you the Q&A exercise (“Trade Your Way to Financial Freedom” by Tharp, 1998) in setting my own trading objectives and expectations. I hope that you can use these questions to help in setting your own objectives and expectations.
Q: How much capital do you have?
A: I currently have about $25000 in my account.
Q: How much money do you need to live on each year?
A: About $30,000.
Q: How much of that must come out of your trading profits?
A: Currently, none of it. I earned a salary from my current job.
Q: How much time during the day do you have to devote to trading?
A: I allocated 2-3 hours daily.
Q: When you are trading, how many distractions can you expect to have?
A: A lot of distractions.
Q: So obviously, you need a trading methodology that allows you to deal with those distractions.
Q: How much time do you expect to devote to developing your trading system?
A: Currently, I spent approximately 5-8 hours during weekend and 1-2 hours during weekdays in planning and doing research.
Q: How would you rate your market knowledge?
A: I have extensive experience in stock investment and Forex trading.
Q: What are your psychological strengths and weaknesses, especially in terms of trading system development?
A: I am a strategic and patience trader, which I believe are the qualities needed in developing long-term strategies for trading. I’m also self-confident, which gives me a lot of psychological strength in trusting the systems I develop. In terms of weaknesses, I am always striving for perfection therefore sometimes this distract me from my primary mission as a trader.
Q: How about your strengths and weaknesses in terms of personal discipline?
A: I am fairly good at discipline. I have no problems following a system.
Q: Do you tend to get compulsive (i.e., get caught up in the excitement of trading), have personal conflicts (i.e., have a history of conflicts with your family, at your job, or during past trading experience),-or have any emotional issues that constantly crop up, such as fear or anger?
A: I certainly don’t think of myself as compulsive. I do find trading exciting but I am not addicted to it. I don’t think I have any conflicts. My family life is reasonably stable. Moreover, I rarely get angry or frustrated but once a while I do tense up. Whenever I feel tense, I will practice the breathing method that I learnt from Anthony Robbins to relax myself, and convert my state to positive.
Q: Based upon your personal inventory, what did you need to learn, accomplish, or solve prior to beginning trading? How did you do that?
A: I think my personal inventory was and is quite strong. I’m able to trade well.
Q: What is your advantage or edge in trading? What is the particular concept that you are trading that gives you an advantage?
A: I would consider myself a man with quite a number of skill sets that allows me to take advantage of in order to become successful in trading. My number 1 advantage is that I possess strategic thinking due to my high analytical skill set in Computer programming. In fact, I had programmed quite a number of indicators to mechanically identify potential support and resistance levels, and identify price action patterns. While most people don’t take it to the level that I do. I also have the higher advantage in terms of patience and detachment. For example, I am able to sit back and do nothing while waiting for the right opportunities to come along, even if that means not making a trade all day or few days.
Q: Do you have the time to trade short term?
A: As of now, I only trade short-term during holidays.
Q: What do you expect to make each year as a percentage of your trading capital?
A: About 20 percent to 40 percent.
Q: How much money do you need to make each year? Do you need to live off that money? What if you don’t make enough to live off? Can you make more than you need to live off so that your trading capital can grow? Can you stand regular withdrawals from your trading capital to pay your monthly bills?
A: I make it a habit to only spend my living expenses from my current salary, so I won’t need anything additional from my trading income. As of now and until I decided to do full time trading, trading income will simply be a second income for me.
Q: Are you being realistic, or are you expecting to trade like the best trader in the world?
A: I want to achieve financial freedom via investment and trading. I am learning from Market Wizards and trying to emulate them by achieving their standards. However, I am taking one step at a time and will not force myself.
Q: What risk level are you willing to tolerate in order to achieve that?
A: About half the potential gain, so the maximum loss would be 20 percent in a year.
Q: What is the largest peak-to-trough drawdown you are willing to tolerate?
A: About 6 percent. I will commence System Stop if my methodology experience 6% drawdown in a particular month.
Q: How will you know your plan is working, and how will you know when it’s not working? What do you expect from your system in various kinds of markets? Trending? Consolidating? Highly volatile?
A: I plan everything after taking into consideration of all aspects. I set up worst-case scenarios, and I run through them just as an exercise. I have specifications on the best case and the worst case for each scenario. Thus, when something comes along, I have usually planned for it and have a range of expectancy. Therefore, if the results fall within that range, then I know everything is as per plan. However, if the results fall outside that range, then I know that I will need to study what went wrong and get it fixed. Generally, I expect a 40 percent return at the best and a 10 percent return at the worst, with average returns of 15 to 25 percent. We can also conclude that the expected worst-case drawdown will be 6 percent per month.
Q: How much capital will be at risk?
A: I’ve got around $25,000 to trade with, so I will only use $15,000 as at-risk capital, and the remaining $10,000 I will keep in a money market account in case I burn the first $15,000.
Q: How much risk can you afford to take on a given trade?
A: This depends on trading methods use at that time. I will just use 1% risk for short term trading, and 2% for medium term trading.
Q: How much to risk on all open positions?
A: I will not have more than ten open positions at any time and/or will not have more than 20 percent of my capital at risk on open positions. I applied the rule that limits the number of open position size at any given time.
Q: How do you determine position size?
A: I practice different money management strategies – Fixed-Volatility and Fixed-Percentage – respectively for different trading methods.
Q: What is you acceptable risk/reward ratio?
A: I will only make trades that have a risk/reward ratio of 1:3 or higher. No matter how beautiful the outlook may be, but if I can lose more than I can make due to wrong judgment then I will not make the trade.
Q: Will you lower risk parameters?
A: If I lose more than 6 percent of my capital, I will then lower my risk accordingly.
Q: What is your cutoff point before questioning trading plan?
A: If I’m down 35 percent of my capital since I started, I will stop trading until I review my system, risk parameters, and trading plan to determine the root cause.
Q: What kind of markets do you want to trade? Do you want to trade only liquid markets, or are there some illiquid markets you’d like to trade?
A: Currently, I am trading Forex and Gold spot which are the most liquidity market in the world.
Q: What beliefs do you have about entering the markets? How important do you believe entry to be?
A: Entries are very important as it directly define our stop placement, initial risk, and potential loss. The size of our losses, compared to our wins, directly affects our expectancy! When we enter a trade, we have no idea whether the trade will enjoy a strong trend as we do not have the crystal ball to visualize the future. We only have present and it is all about controlling risk and trading for the opportunity to earn expectancy. Well since entries define initial risk, it also directly affects the position sizing in money management strategy.
Q: Given your goals in terms of returns and drawdowns, what kind of initial stop loss do you want?
A: My initial stop loss is defined by using volatility measurement (ATR) or the support level.
Q: How do you plan to take profits? Reversal stops? Trailing stops? Technical stops? Price objectives?
A: I am more comfortable in using trailing stops as an effective way to exit profitable positions. I am wary of profit targets as it generally reduces profitability.