Eliminating Mistakes With Checklists

Regardless of your trading methodology or system or general strategy, one of the key sources of losses will be mistakes.

Failing to design a wining strategy from the beginning would be a mistake.
Taking too large of a position for your goals would be a mistake.
Not having and following predefined exit and entrance strategies would be a mistake.

Missing an entry or forgetting about a setup you had identified would be a mistake.

From the most common and most damaging or potentially most damaging mistakes you can construct a checklist and develop the habit of following it to avoid those mistakes.

If improperly constructed the checklist itself can lead to other mistakes. For example, one mistake is entering a trade too late or missing a trade opportunity if the checklist itself is too long. Consider estimating how many mistakes you'll make each year with a typical years worth of trades with or without the checklist or how much you'll lose from mistakes as a result of some simulation or projection and see if there's anything you can cut out.

One of my mistakes is being over positioned during times in which I'm optimistic and under positioned when I'm pessimistic. This is partly an emotional component, but partly based upon the availability of setups. I need to regularly practice a procedure (going through a checklist) until it is almost compulsive. I need to create upper end limits on number of position or total exposure to risk and lower end limit. However, that may not necessarily work on it's own. So I may deliberately under position size when I'm excited and want to trade a lot and have created certain methods to ensure I'm never under positioned.

Say I want to put 1% at risk normally. When things are going well I may reduce that to .8%. This way I can create up to 25% more trades before I put any more at risk overall.

I've created sort of an allocation based system for reasons of balancing out under exposure. When the market has sold off and there are few setups and all the trades I have on have stopped out, expired, or are far away from the money in option trades it's hard to gain exposure for me. So instead of being a stock picker in this environment, I choose between either an inverse volatility ETF like XIV or a broad based market ETF like IWM or leveraged ETF like TNA. In these I will increase allocation as the markets get more oversold.  I will hold even as other setups become available as the market stabilizes, and only after I begin adding setups and begin getting over exposed do I begin reducing position size and possibly at some point hedging.

A checklist can be part of a trading system, but it isn't the trading system itself. Relying solely on checklists or a group of checklists is too time consuming which is why setting alerts and/or automating orders can combine with checklists to help make up the foundation of a trading system.

Up next, strategies for automating your trading.