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Decision Making Tree 2012 05
Decision Making Tree 2012 05
Spikers and Members of SpikeTrade.com carefully plan their trades. Most are discretionary
traders who have written down their trading plans, which we call decision-making trees.
Here are a few quotes about such trees from the book Come into My Trading Room by Dr.
Alexander Elder:
A beginner never writes down a plan because he has nothing to write. He is having too much fun
chasing hot tips and trying to make a quick killing. Even if he wanted to write, he wouldnt know
where to begin. A serious amateur or a semipro who writes down a plan, including money
management rules, is on his way towards the expert level.
What is the difference between a decision-making tree and a mechanical trading system?
The main difference between a trading plan and a mechanical system is the degree of freedom
it allows traders. Trading systems are rigid, while plans lay down the main rules but leave you
free to use your judgment.
A trading plan includes a few unbreakable rules along with more flexible recommendations
which call for an exercise of judgment. Your judgment grows with experience. A trading plan
includes the principles for selecting markets, defines the types of trades, generates buy and sell
signals, and allocates trading capital. When you write a plan, avoid the temptation to make it
allencompassing. Know when to stop. Write down your rules but indicate where you will use
your judgment at the moment of decision.
Today we share with you the specific decision-making trees developed in recent Traders Camps.
Please read them to see what they have in common and how they differ and then start developing
your own decision-making tree.
You can see Spikers decision-making reflected in How I Got My Gold on the main page of
SpikeTrade. If you become a Member, you will also receive access to Spikers profiles, telling you
how they plan their trades.
Thank you for joining us as a Guest.
Please consider joining us as a Member to enjoy greater resources!
Dr. Alexander Elder & Kerry Lovvorn
SpikeTrade.com
Decision-Making Tree
2008
PART ONE: INTRODUCTION
1
A personal mission statement including goals Decide what markets to trade and decide
general view of where we are. (In this plan we will focus on stocks) Why am I trading? Improving
psychology, knowledge, how will I know when I accomplish this? One option to focus, establish a
personal dividend paid out of super profits. Set performance goals.
2
Select the strategy that appeals to you personally (Are you a long, short, value, momentum
trader?) (In this plan we will focus on swing trading; you can modify for other types of trading.)
3
Define the characteristics of the market you want to swing (this plan will apply to long
trades only). These conditions will serve as flags that a potential trade exists.
Short term oversold (near the lower channel line) MACD divergence False downside
breakout Kangaroo tails Force Index down spike
Pullback to value in an uptrend
Weekly EMA rising, Daily EMA rising, price below fast EMA
We need to
of these
1
Define
target and stop
ENTRY TRIGGER:
red line PROFIT
channel line
history of
line and put a stop
level below the
conditional orders to place target and stop after your trade is executed.
2
Money Management % Risk per trade, will it be the same for every trade? Trade Sizing:
small (.5%), medium (1%) or large (2%) based on how confident we feel. As beginners, stay small.
The 6% Rule: stop trading for the rest of the month after hitting a 6% limit of drawdown
plus open risk.
PART TWO: THE ACTUAL TRADE
1. Screen the markets to find the condition we seek
a. Write down a Market view for next week that will have impact on our trade sizing.
b. Narrow down on the best stocks that meet our condition. Option: Do industry group review
Option: Look at your favorite 50 trading stocks Consider filtering out stocks in advance of earnings,
Fed reports, option expiration week, stock splits, and do not short into dividends.
Find two to four stocks you like best. **Avoid the delusion that you will find the best stock
one of the best is enough!
1
Compare Reward to Risk parameters for our best stocks. Make the final selection (preferably
more than one)
2
Ask: Do I have available risk based on the 6% Rule? If not, consider whether you want to free
up capital by closing other positions or moving stops. If yes, how much will you risk on this trade?
Use the Iron Triangle to size the trade. (Divide total risk per trade by the distance from the entry
to the stop.) If the stock is not yet ready for a trade, put it on your Watch list.
3
5
Document your fills. Track slippage and commissions. Consider writing psychological notes.
Update diary. Consider canceling orders for runaway stocks.
6
Monitor your trade, adjusting both targets and stops, as MA and envelopes keep changing
7
Once the trade is completed, update the diary and create a reminder to return in two
months
END OF MONTH
update equity curve Consider separate equity curves for different tactics, along with a combined
curve Recalculate 6% and 0.5 2% size
9. Manage trade
a. Daily marketwatch updates
b. Buy slow, sell fast
c. Pull up stops (remember to contact broker)
d. Reevaluate targets
e. Add to positions?
10. Exit trade
a. Update spreadsheet and diary
b. Rate and analyze performance (incl entry and exit)