How to Design a Decision-Making Tree

Spikers and Members of SpikeTrade.com are serious people who plan their trades in
advance. Many of them are discretionary traders who have written down their trading
plans, which we call ‘decision-making trees.’

Here are a few quotes about such ‘trees’ from the book Come into My Trading Room by
Alexander Elder:

A beginner never writes down a plan because he has nothing to write.  He is having too 
much fun chasing hot tips and trying to make a quick killing.  Even if he wanted to write, 
he wouldn’t know where to begin.  A serious amateur or a semi‐pro who writes down a 
plan, including money management rules, is on his way towards the expert level. 

What is the difference between a decision-making tree and a mechanical trading system?

The main difference between a trading plan and a mechanical system is the degree of 
freedom it allows traders.  Trading systems are rigid, while plans lay down the main 
rules but leave you free to use your judgment. 
 
A trading plan includes a few unbreakable rules along with more flexible 
recommendations which call for an exercise of judgment.  Your judgment grows with 
experience.  A trading plan includes the principles for selecting markets, defines the 
types of trades, generates buy and sell signals, and allocates trading capital.  When you 
write a plan, avoid the temptation to make it all‐encompassing.  Know when to stop.  
Write down your rules but indicate where you will use your judgment at the moment of 
decision. 

Today we share with you the specific decision-making trees developed in recent Traders’
Camps. Please read them to see what they have in common and how they differ – and
then start developing your own decision-making tree.

Decision‐Making Tree Copyright 2009 Alexander Elder  Page 1 
You can see Spikers’ decision-making reflected in How I Got My Gold on the main page
of SpikeTrade. If you become a Member, you will also receive access to Spikers’
profiles. Most of them give you an indication of how they go about their trade planning.

Thank you for joining us as a Guest.

Please consider joining us as a Member to receive access to even greater resources!

Alexander Elder & Kerry Lovvorn

SpikeTrade.com co-directors

There is a chapter on Decision-Making Trees in Come into My

Trading Room. If you have not read this book, you can order it from www.elder.com,
and if you mention SpikeTrade, they will give you free shipping.

Decision‐Making Tree Copyright 2009 Alexander Elder  Page 2 
Decision-Making Tree
2008

PART ONE:  INTRODUCTION 

1. A personal  mission statement including goals 
Decide what markets to trade and decide general view of where we are.    (In this 
plan we will focus on stocks) 
Why am I trading?   Improving psychology, knowledge, how will I know when I 
accomplish this?  One option to focus, establish a personal dividend paid out of 
super profits.    Set performance goals. 
 
2.  Select the strategy that appeals to you personally (Are you a long, short, value, 
momentum trader?)  (In this plan we will focus on swing trading; you can modify 
for other types of trading.)   
 
3.  Define the characteristics of the market you want to swing (this plan will apply 
to long trades only).  These conditions will serve as flags that a potential trade 
exists. 
 
‐ Short term oversold (near the lower channel line) 
‐ MACD divergence 
‐ False downside breakout 
‐ Kangaroo tails 
‐ Force Index down spike 
‐ Pullback to value in an uptrend 
Weekly EMA rising, Daily EMA rising, price below fast EMA 
 

Decision‐Making Tree Copyright 2009 Alexander Elder  Page 3 
    
We need to write definitions for each of these conditions. 
 
4.  Define entry trigger, profit target and stop for any type trade 
‐ENTRY TRIGGER: Place a buy order at the red line 
‐PROFIT TARGET:  At the upper channel line 
‐STOP:  Measure the history of penetrations of the red line and put a stop at or 
below the deepest level below the EMA. 
Consider using conditional orders to place target and stop after your trade is 
executed. 
 
5.  Money Management 
% Risk per trade, will it be the same for every trade? 
Trade Sizing:  small (.5%), medium (1%) or large (2%) based on how confident we 
feel.  As beginners, stay small. 
 
The 6% Rule: stop trading for the rest of the month after hitting a 6% limit of 
drawdown plus open risk. 
 
PART TWO:  THE ACTUAL TRADE 
 
1.  Screen the markets to find the condition we seek 
a. Write down a Market view for next week that will have impact on our 
trade sizing. 
b. Narrow down on the best stocks that meet our condition. 
Option:  Do industry group review  
Option:  Look at your favorite 50 trading stocks 
Consider filtering out stocks in advance of earnings, Fed reports, option 
expiration week, stock splits, and do not short into dividends. 
Decision‐Making Tree Copyright 2009 Alexander Elder  Page 4 
 Find two to four stocks you like best.  **Avoid the delusion that you will 
find the best stock – ‘one of the best’ is enough! 
 
2. Compare Reward to Risk parameters for our best stocks.  Make the final 
selection (preferably more than one) 
 
3. Ask:  Do I have available risk based on the 6% Rule? 
If not, consider whether you want to free up capital by closing other 
positions or moving stops. 
If yes, how much will you risk on this trade? 
Use the “Iron Triangle” to size the trade. (Divide total risk per trade by the 
distance from the entry to the stop.) 
If the stock is not yet ready for a trade, put it on your Watch list. 
 
4. Create a Diary Entry  
 
5. Place your orders (Entry plus conditional target and stop.) 
 
6. Document your fills.  Track slippage and commissions.  Consider writing 
psychological notes. Update diary.  Consider canceling orders for runaway 
stocks. 
 
7. Monitor your trade, adjusting both targets and stops, as MA and envelopes 
keep changing 
 
8. Once the trade is completed, update the diary and create a reminder to 
return in two months 
 
END OF MONTH 
‐ update equity curve 
‐Consider separate equity curves for different tactics, along with a combined 
curve 
‐Recalculate 6% and 0.5 – 2% size

Decision‐Making Tree Copyright 2009 Alexander Elder  Page 5 
 Decision Making Tree
2007

1. Money management - does the 6% rule allow me to trade?

a. If the answer is no, just paper trade
b. If yes, go to step 2.
2. Am I generally bullish or bearish?
a. New high/low index trend
b. Trend of the S&P
3. How do I find stocks to consider for trading?
a. Find interesting industry groups
i. Look at stocks in the group from the cheapest up (to about $10)
ii. Quickly mark interesting stocks
iii. Rule out any stocks trading under ¼ mil shares daily
iv. Work up interesting stocks
b. Listen to rumors and news [whatever stock I find, drop into my own system]
i. Spike
ii. Media
iii. Friends
4. analyze interesting stocks for risk/reward
5. Define your favorite time frame [My favorite is daily]
2. Go one time frame up
3. Make a strategic decision [Am I a bull, bear or undecided?]
a. Compress the chart to the max – cheap or expensive?
b. Slope of moving average?
c. Price above or below value?
d. MACD bullish or bearish? Any divergences???
If stock in a straight line, horizontal or diagonal, MACD tends to degrade
to zero and its signals not useful
e. Force Index – how strong? Any divergences??? Recent spikes?
f. Are we interested in looking at the daily chart?
If the weekly chart makes you bullish or bearish – proceed to the daily;
otherwise, move on to the next stock
4. Return to the daily chart to make tactical decision
• Where to buy?
• What is profit target?
• What is the stop?
a. Slope of moving average?
b. Price above or below value?
c. MACD bullish or bearish? Any divergences???
d. Force Index – how strong? Any divergences??? Recent spikes?
e. Does this stock belong to an A, B or C group?
f. Establish target (probably on a weekly chart)

Decision‐Making Tree Copyright 2009 Alexander Elder  Page 6 
 g. Establish stop (probably on a daily – where you do NOT expect the stock
to go)
h. Divide the distance from entry to target by the distance of entry to stop;
need better than 2:1 ratio
i. If we have a distant entry point in mind, do we place a Chihuahua order?
5. What money management rule will I apply? 2% or lower?
6. How many shares am I allowed to buy?
a. How many will I buy?
7. Complete record keeping
8. Continue to monitor

Decision‐Making Tree Copyright 2009 Alexander Elder  Page 7 
Decision Making Tree
2006
(based on a $100,000 stock account, no current positions, )

1. Money
a. Does the 6%-rule allow me to trade?
b. If yes, what is my 2% limit?
2. Check all market indices (weekly)
a. How bullish or bearish?
b. Change from previous week – bullish or bearish (“taking the temperature
of the market”)
3. Check all market sectors, industry groups
a. How bullish or bearish overall?
b. Change from previous week – bullish or bearish?
c. Most strong / Most weak sectors
Most strong = stopped declining, starting to pick up
Weakest = stopped rising, went flat, bear. divergences
4. Look for the strongest stocks in strongest groups
a. Cheap
b. Exclude low volume
c. History and prospects ($18/$2 vs. $200/$2)
d. Consider group leaders and laggards
5. Look for the weakest stocks in weakest groups
a. Expensive
b. Exclude low volume
6. Buy candidates
a. Start with a weekly chart
i. Cannot be “red”
ii. Was red, is blue
iii. Look for divergences
iv. Is the rubber band overstretched?
v. Set potential price targets
b. Go to the daily chart
i. Cannot be red
ii. Is the channel worth trading?
iii. Is it in the sweet zone?
iv. Are the indicators saying buy?
v. Stop level
7. Count money
a. The 2%-rule / maximum size
b. Entry to Stop / Entry to Target – ratio
8. Action
a. Place your limit orders
b. Try to risk similar size

Decision‐Making Tree Copyright 2009 Alexander Elder  Page 8 
 c. If uncertain or fearful, reduce size
(2 goals of trading: to make money and to learn)
d. Entries in spreadsheet and trading diary
9. Manage trade
a. Daily marketwatch updates
b. Buy slow, sell fast
c. Pull up stops (remember to contact broker)
d. Reevaluate targets
e. Add to positions?
10. Exit trade
a. Update spreadsheet and diary
b. Rate and analyze performance (incl entry and exit)

Decision‐Making Tree Copyright 2009 Alexander Elder  Page 9 
Decision Making Tree
2005
1. Does the 6% rule allow me to trade this month?
a. Do I want to use 6% limit or less at this time?
b. Make a total risk decision consciously
2. What markets will I trade?
This decision tree will be for stocks
3. Broad Index review (Dow, NASDAQ, S&P) - “Generals”
a. Monthly indices – Are we in a bull market, a bear market or a transitional
market?
b. Weekly charts for intermediate trends
c. Bonds, Gold, Crude (if desired)
d. New Highs – New Lows
e. Look at the calendar: FED announcements, options expiration
f. Awareness of time: seasonality, duration of current trend
4. Index and sector review (TC or similar program, Impulse or another method)
a. Index review (electronics, real estate etc.)
b. Sector review (Media General Groups in TC)
i. Express my level of bullishness and bearishness of the market
ii. Where is the action? Find especially bullish and bearish groups
5. Select tradeable stocks (find “rich dirt”)
a. Quickly scan component stocks of selected groups and subgroups for
attractive longs (in strong groups) and shorts (in weak groups)
b. Prune the list to end up with “rich dirt”
i. Apply volume filter
ii. Price filter (buy cheap, short expensive)
iii. Cut out stocks that don’t talk to me
6. Select stocks to trade (what is my analytical process)
a. Monthly – cheap or dear
b. Weekly – trend, Impulse, divergences
c. Daily – trend, Impulse, divergences, envelopes, volume, Force Index
d. Aim to buy below value, short above value
7. Zoom in on every stock (process rich dirt)
a. Entry, stop and target (consider using envelopes)
b. Compare risk/reward and select the best candidates
8. Trade sizing
a. Decide on risk allocation to bull and/or bear
b. Decide on 2% or smaller
c. Decide the number of shares
d. Place the limit order, stop and possibly target
9. Housekeeping
a. Enter the trade in a spreadsheet (Marketwatch, Organizer etc.)
b. Create a diary entry
10. Manage the position

Decision‐Making Tree Copyright 2009 Alexander Elder  Page 10 
 a. Adjust stops, profit targets, size
b. Do-a-Martin when necessary
c. Exit position earlier than planned, if necessary (shoot longs with red
weekly Impulse, shoot shorts with green weekly Impulse)
d. Add intermediate documentation, if desired
11. Dealing with closed positions
a. Complete spreadsheet and diary
b. Assemble statistics on your trading
c. Watch out for psychological trends in your trades

Decision‐Making Tree Copyright 2009 Alexander Elder  Page 11