What is contingency plan and why every trader should have one?
What is contingency plan and why every trader should have one? How a trader should build their contingency plan?
- If you want to be a successful trader, you should have contingency plans in place. You should use a “what if” process every time there is an issue and update the contingency plan as and when you encounter new scenarios and build your contingency rule book. For example: all the financial firms decentralized operational teams and have multiple data centres and backups after 9/11 attack.
- Your goal as a trader is preparedness to handle any surprises markets throw at you. To do so, you need to develop a dependable way to handle virtually every situation that may occur. Having events and circumstances thought out in advance is the key to manage risk effectively and build your capital.
- The mark of a professional trader is proper preparation. Before you make a trade, you should write down your responses to meet virtually any unexpected movement that may take place in the market. And whenever any new unexpected issues present itself, you should add them to your contingency plans/rules. By implementing contingency planning, you can take swift, decisive action the instance one of your positions changes its behavior or is hit with an unexpected event.
- Let’s take a Simple example of a contingency situation: “Consider you are positional trader: what would you do if price gaps down below your SL?”. If you don’t have a plan in place, you would do something in panic and it might end in disaster. Also, you would behave differently every time this happens, so you won’t have any approach to deal with this systematically. You will just be following random thing every time this happens, which won’t get you anywhere.
- Having a contingency plan will help you to approach this issue systematically. You won’t do anything in panic and you will be able to follow a rule based approach. So every time you face a gap down situation, you will stick to pre-defined rules, which will guide you on “how to approach this scenario”.
- So here is the contingency plan: “In a positional Long Trade, if the market gaps down below my SL, I’ll wait for 30 minutes after market opens. If CMP is above open price of the day, I’ll wait and exit near my entry/SL based on market structure. If CMP is below open price of the day, I’ll exit at CMP. But in any case, I won’t exit before 9.45 (i.e) 30 minute from market opening.”
- The important role contingency planning plays is that it enables you to make good decisions when you’re under fire—when you need it the most. Contingency planning allows you to have a psychological strategy that is as robust as your trading strategy, as well as a trading strategy that has built-in responses to potential situations that could, if not prepared for, lead to competing thoughts at the precise time you need to implement instant, unbiased action.
- Contingency planning is an on-going process. As you experience new problems, a procedure should be created to deal with them, which then becomes part of your contingency plans. You’re never going to have all the answers, but you can cover most of the bases to the point where your reward outweighs your risk, and that’s the key.
For more details and examples, checkout the video: