10. October 2016
How to make your trading checklist work for you (and not the other way around)
Make yourself a practical checklist that ensures a great trade
If you want to trade, you need a good checklist. A pilot uses a thorough checklist before take-off, and so should you. Especially if you want to survive the flight - which is more or less the idea of it.
You already have a checklist, even if you don't know it. It might be unwritten, but you do have some kind of "thing I need to check before I plunge in". You don't walk out on a 5 meter high diving board and then jump blindfolded into the pool. You always look before you jump. So your short list can look like this:
That is a simple list and easy to remember, so it is all "basic and common logic". We need the same thing in trading.
You and I are not the only one who has experienced this: We are serious in our approach to the market and we want to trade in the best way possible. So we make a checklist. And then the checklist gets bigger and bigger, and it consumes so much time that in a short while we start to trade without using the checklist – but we still feel guilty for trading without it. Sounds familiar? Checklists have a way of growing and devouring their makers. That is why I offer "2 rights and 1 wrong" in how to make checklists work for you – and not make you work for the checklist.
Two right things and a wrong
There are two things about a good check list that I'm pretty sure about, and there's one thing where I know I'm wrong. Let's go through them:
So here goes the two checklists you must have
Checklist A - Dipping your toes
You have several reasons for entering a trade. Some times you simply have a good hunch that this can develop into a really good trade, but all the setup and signals are not in place. So I enter a trade with a very small amount of money, and that way I’m "in" and follow the development more keenly. I call this "dipping your toes". The amount is so small that it doesn't matter, but it keeps the trade in my view. And here I don't need a big, comprehensive check list because I already know that it doesn't have all the signals for a real, substantial trade. That was the whole point of it. It's a curiosity, a gut feeling trade, and you just test the waters without jumping full in. Of course your checklist should be small and very basic for such a trade.
It was a revelation for me when I developed this short version. It gave me permission to be faster on the trigger and test more freely without a dinosaur checklist looming over me.
Checklist B - The real jump in the pool
Here you commit more serious money and so you want a more comprehensive checklist. This is business.
A checklist is only good to the extent that it is practical to execute. Many lists are simply too long. Either you follow them meticulously and get analysis paralysis (and the train has left the platform before you board), or you simply make the trade and then afterwards glance cursorily at the check list. Neither is good. So I think that your checklist should be fashioned in steps.
In this template I'll focus on "my" time frame and my tools, but you can easily adjust it to your time frame and tools.
I like to start with the technical check-list first. This is easy and quick. If the answer is "no", then I don't bother looking at the next checklist (the fundamentals).
These 9 points must give either a yes or no to a trade.
If the technical analysis says "yes", then I need to continue the check-list with some fundamental data. Otherwise I'm flying with radar only (technical), without seeing the ground (fundamentals).
These 5 points either confirm the "technical yes" or it makes you more hesitant.
The technical list is more quick, and the fundamental list is more slow. I know that you can easily get "analysis paralysis" if the list is too long and slow. And maybe you are just a technical trader, so you don't want the fundamentals. Anything's fine. It is your edge. But making a habit out of asking the fundamental questions will make you grow, so try it.
If the fundamental analysis also says "yes", then I cross reference with the macro check list.
This is not something you have to analyze at every trade. I update the macro economy once every month - after hours - and this serves as background information. But when trading, I just double check to see if it is in alignment or is giving warning signals.
Fusion + patience
Now you fuse Technical + Fundamental + Macro into a coherent list. 9+5+2 = 16 points.
They don't all have to agree, but you must see a story that makes sense for you. Learn to distinguish what factors are important. It is - despite all my effort - still somewhat of a long list, but try to keep it simple.
Rule: Is the trade evident - or do you have to "squeeze" meaning into it? If you have to "squint" your eyes to figure it out, then it's likely too complicated. Sometimes we just "want to trade" and jump on anything without discipline. So ask yourself the question whether you are seeing something real (based on your above mentioned "edge"), or whether you are "trigger happy". Understanding your own state of psychology is often the key root to good trading.
The checklist can perhaps be added with single thing, patience, as Jim Rogers put it: "By forcing myself to wait until there was a trade that appeared so compelling that I could not stand the thought of not taking it, I had vastly improved my odds.”
There is a ton of things I didn't put in my checklist. You can be big on calculating the risk/reward ratio. That is fine, so put it in your list. Just resist the temptation to make the check lists longer and longer. If you are new you need to expand your check list somewhat but really seasoned traders keep pruning the lists to more and more basic elements without overcomplicating things. For each item on your check list you should ask: "Is this information really useful in my trading decision? If the answer is not a resounding yes, then it will only distract you. Don't confuse information with decision.
Not a word about this
There are other things I deliberately don't write about here because it doesn't relate to a checklist:
All of this is worth several blog posts, and is essential. You can say that all these things needs to be in place first, as foundation, before you can write a good checklist.
A final note to when you make your own check list. Ponder this question: Are you too quick with the trigger finger, or are you too “gun shy”, slow and want endless confirmation signals? The answer to this question should have a big impact on your check list. There is no shame in being either type, you just need to compensate. If you are too slow, then don't build a very long list that will then act as a very good excuse to keep you away from any trade. If you are too quick and impatient, then make a commitment to an "absolutely essential list" before you trade. In the end it is about understanding yourself and compensate for your bias. Know yourself.
So here we are, journeying from a checklist to the psychology of the age-old "Know thyself". Trading is not just trading. It is expanding your view of the world. And at the same time it is a pressure test of your own psychological core. A journey outward and a journey inward. That's why it's so worthwhile. Check your checklist before flying. Have a good flight!!