Developing a Small Cap Trading Plan

When you trade small cap stocks (or anything really) do you have a clear plan or are you just trading because you can? To break free from serious losses, including account destruction, and enter the realm of professionalism, you must have a clear trading plan in place before entering any position.

The Macro Small Cap Trading Plan

At the macro level, you should have a general trading concept and some practices in place. At this level, you might list what you’ll trade, some general conditions that need to be met before trading and a daylight limit.

Here’s an example of some items/topics I’d put down:

• What I’m willing to trade (small cap stocks as an example)
• My maximum asset allocation per position
• My overall daylight limit (example: 25%, so if I lose 25% of my capital, I have to walk away for a bit).
• My overall individual trade risk limits. While this could vary on the micro level, my limit might be something like 2%. This means that if I lose 2%, the trade is over.
• Going further with a daylight limit, do you reduce your risk and limits as you incur losses? For example, if you have X losing trades in a row, do you force a mandatory break in the action and reduce your risk limits to 1.5% or 1% until you’ve gained momentum?
• Will you trade on margin? If so, what are the parameters? For me, it’s no.
• What is your general trading strategy? Your answer should be very thorough and describe how you want to trade. It shouldn’t be just a simple answer like swing trading or intraday trading or something like that. Talk about what you look for, charts you look at and so on.
• What are your general goals?
• Why are you trading/investing?

There are certainly more items you could address, but this is a start.

The Micro Plan — For Every Small Cap Trade

From here, we drill down a bit and talk about more specific details on a trade by trade basis. You should keep a journal and enter everything into it.

Here are items of data you might want to put down before making each trade.

• The stock you’re looking at trading.
• Why are you thinking about trading this stock? What’s happening? Why do you think the stock is going up or down (specifically)? This portion of text will make for good reading later on.
• Include a chart if you can
• What is your ideal entry point? (For example, $10.75)
• What has to happen for you to make the trade?
• How many shares will you buy? (For example, 10,000 shares at once)
• What is your stop loss point? This goes back to your macro plan. Let’s say you risk tolerance per trade is 2%. Your stop loss, if you got in at $10.75, would be $10.965 on a short or $10.535 on a long.
• What is your ideal exit point and strategy? Example: You go long with 10,000 shares at $10.75. You decide that at $11.25, you’ll sell 2,000 shares, at $11.50 you’ll sell 5,000 shares and at $12, you’ll sell the remaining 3,000 shares. Additionally, you’ll raise your stopping point by 25 cents per share at each point. Your initial stop loss was at $10.535, so when the stock climbs to $11.25, your new stop loss is at $10.785.

Do you have a trading plan? If you trade at home, are you running your investments like a business or just playing it like a video game? Do you know what percentage of your trades work out and why? If you’re following a stock picker or have someone managing your money, do you know why they do what they do? Can you find out?

I welcome your comments. And feel free to share any planning ideas and tips you have.