Q) I love your newsletter, keep up the good work! Everyone keeps talking about having a trading plan, but as a newbie it is hard to know what items should be included in a trading plan. Do you know of any good guidelines for creating a trading plan?

Ed Ponsi) Thank you for your kind comments and your question. In his classic work "The Art of War", author Sun Tzu is credited with the following quote: "The victorious strategist only seeks battle after the victory has been won, whereas he who is destined to defeat first fights and afterward looks for victory". What this means to me is, do your work before you place the trade. Once you enter the trade, your work is essentially over - now all that the trader needs to do is follow the plan, and cut off all other possible avenues of action. This removes much of the stress from trading, and makes it easier to take an objective approach.

Here is what having a trading plan means to me: Before I enter the trade, I know exactly where I am going to enter, where I am going to place my stop, and where I am going to exit. I also need to know when I am going to raise my stop, if I am long (or lower my stop if I am short). I need to know the criteria for each of these, and there should be nothing left to interpretation.

Q) What is your opinion on trading the news, and getting in before the spikes or even getting into a trade on the retracement?

Ed Ponsi) Trading the news can be a risky proposition, and is usually only done well by traders who have spent years watching the markets react to economic reports. This is because it is often what is beneath the surface that creates movement, as opposed to the more obvious "headline number". For example, the Chicago Purchasing Manager Index (PMI) report contains the headline number, which garners most of the attention, but also contains sub-numbers (known as "components") which deal with employment, inflation, and other sub-sectors. There are also revisions of last month's headline and component numbers.

Suppose that the Chicago PMI number is released, and the headline number is mildly positive, but the employment component is disappointing and last month's headline number is revised lower. Traders who pay attention only to this month's headline number would expect the U.S. dollar to strengthen slightly, while those who give more attention to detail might expect the USD to weaken. In a situation such as this, I would expect the U.S. dollar to slide - especially if the markets are particularly focused on employment. Meanwhile, traders who only follow the headline number complain that the market's reaction to news "doesn't make sense". The truth is, the market's reaction to news usually does make sense, but only if you are looking at the big picture and paying attention to the details of the news.