How To Create a Trading Plan
here are countless ways to trade, and some newer entrants to the market find themselves spending hundreds or even thousands of dollars in classes and courses in search of the perfect strategy. But while trading strategies usually fit into a subcategory of styles, your individual trading plan should be unique to you.
Developing a successful trading strategy means studying yourself as well as the market, and your trading plan with its very precise rules is the core of this.
Let’s explore the act of formalising your approach to the market into a trading plan.
What is a Trading Plan?
A trading plan is a precise set of rules for entering and exiting trades, as well as other information such as what assets you will be trading and risk management rules such as stopping trading after x losses.
Some plans include the element of discretion in terms of the trading strategy itself, but usually the other rules (such as only risking a maximum of 2% of capital per trade) should be non-negotiable.
Despite the fact that trading plans are all about rules, there are no hard and fast rules for actually developing a trading plan. Still, there are items that it should always include, such as the size of your risk capital, risk per trade, assets traded, max drawdown, personal risk management rules, steps for journaling, and long-term goals.
Unlike a trading strategy, a trading plan not only specifies how trades will be entered and exited, but how it fits into the bigger picture of your trading.
Trading as a Business
If you want to be a professional trader, then it is essential that trading is viewed as a business, not a hobby or even a job.
First of all, treating it as a hobby means there is no real commitment to learning the trade, as it’s just something you do on the side.
Secondly, viewing it as a job might lead to frustration if you’re used to a regular paycheck.
The reality is, trading is a business with its associated costs and risks. Your goal should be to maximise your business’s potential for survival and hopefully profitability by constantly improving and keeping on top of the market.
Why is a Trading Plan Important?
A trading plan helps you to keep in line with the logic of your trading strategy by keeping your decisions consistent.
Making good financial judgments in the heat of the moment is more difficult without a plan. Knowing how you will react to various scenarios ahead of time can provide multiple benefits.
For instance, when everything is planned ahead of time and according to the parameters of your trading strategy, it makes the trading process a simple case of execution. Is the trade not panning out as expected? No problem. You should have a clear exit strategy for trades that aren’t working. Is the trade going in your direction? Great. You should know where you will take profits, whether that’s an exact price level or rules to look out for that indicate it’s time to close the position.
A trading plan also ties in with a trading journal. If you have precise rules and you accurately track them, you may figure out why some trades perform well while others do not, potentially increasing your edge. But better than that—you will practise disciplined trading.
Understanding your edge enough to follow your trading plan will also reduce negative emotions and cognitive biases.
With the killer-combo of a good trading strategy, armed with a solid trading plan, a journal, and the discipline to consistently execute and monitor your trades, you are bound to experience enhanced trading results.
What should be included in a Trading Plan?
There is no such thing as a standard trading plan because no two traders are the same. Trading styles as well as risk tolerance both play a significant role in each individual’s approach to the markets.
- Defining Your Edge
Markets can be volatile, which is good for profits—but only if you’re on the right side. For this reason, knowing your edge; where it comes from and how it works, is the first step in writing a good trading plan.
- General Trading Preparations
Depending on your trading strategy, marking off major support and resistance levels, setting alerts, as well as noting the times of potentially significant events on the financial calendar should all be on your to-do list.
- Entry & Exit Rules
What gets you in and out of the market is the bread and butter of your trading plan. Trading patterns will never be exact, but you should know what you are looking for in terms of signals.
Some traders put more emphasis on exits rather than entries, the argument being that a skiller trader can get out of even the most poorly timed trade with just a small loss or even a win.
- Define Your Risk
On any given trading day, each trade should have a maximum loss amount before the trade is invalidated and completely liquidated (usually 2% of capital). You can also have a maximum risk parameter for how much exposure your portfolio is subject to, especially when trading across multiple asset classes. It is a good idea to consider correlations, where 2 longs in the same asset class may be essentially doubling your position size.
- Rules for When to Switch Off
If you are angry, distracted, or preoccupied, then your trading plan essentially goes out the window. This is why it’s important to cover it in your trading plan before it happens. This is more of an issue for discretionary traders, but even algorithmic traders can suffer from this, as they must also decide when to switch a trading algorithm on or off.
- Contingency Plans
What will you do if the internet goes down and you still have an open position? What if your computer freezes up just as you are entering a trade and you’re not sure if you managed to set a stop loss or not? Professional traders always have a backup plan, even if that means just logging onto their account via their phone to close any open positions until they can solve their equipment issues.
Expert traders are also good at keeping detailed records. There are many different directions you can go with this, and it largely depends on your particular trading style. But keeping a record of the day, time, asset, direction (long/short), as well as outcome of the trade (especially with charts) can give you insights into patterns of your trading system or even your own behaviour over time.
- Analyzing Performance
If you’ve kept good records and have a good sample size, then you can delve into the how and why of the trades. It can be helpful for avoiding repeating mistakes, but it can also occasionally open up insights into how to fine-tune your trading strategy.
How to Stick to Your Trading Plan?
Newer traders often say how difficult it is to stick to their trading plan. There are many reasons for this. Often, it is simply down to the fact they are always making changes based on the latest indicator they read about, failing to maintain consistently and test their approach over time.
A lack of clear trading rules can also be a problem. It’s best for amateurs and professionals alike to keep their trading strategies as simple as possible, to avoid overcomplicating things. Trading plans that are not clearly defined are challenging to follow and easy to abandon. A tendency to overthink and be subject to analysis-paralysis may be the result of such a trading plan.
Conversely, if a plan is clearly defined, it can be implemented more efficiently. The process becomes more accessible. Yet even novice traders say they still have difficulty following a trading plan, even when they have painstakingly outlined it. That’s because it’s then a question of self-control discipline.
Somewhat ironically, disciplined people sometimes find it a struggle to stick to a trading plan, as they often expend the necessary energy in other parts of their lives. Some research suggests that disciplined people prefer certainty, but anyone who has spent even a short time in the market knows that they are anything but certain.
This is why traders should embrace the uncertainty and take solace in their trading rules.
Understanding Your Strategy
Knowing where your edge comes from, how it works, and keeping a lid on excessive risk is what separates the wheat from the chaff. Keeping your focus on your trading plan will allow you to avoid the unnecessary stress of worrying about the outcome of any individual trade, instead focusing on process, execution, and long-term results.
Having a little to lose, being rested, and being able to focus will also help you develop the proper mindset of a winning trader. Sometimes viewing trading as a game can help traders to avoid trading their PnL, and instead focus on one thing: winning.
We’ve all heard the phrase that past results are not indicative of future returns. Trading is difficult, and profitability cannot be guaranteed.
But there are ways to increase your odds of success, and a solid trading plan is one of them.
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