There is an adage that says, “Who fails to plan, plans to fail.” This is very much true in trading as it is in every other aspect of life.
In fact, experienced traders would tell you that the difference between making money and losing money in the financial markets can be as little as methodically following a trading plan or trading without a plan.
However, new traders (and even some experienced traders) erroneously have this notion that having complete knowledge of the markets is all a trader needs to ensure success.
Well, that is far from the truth — experience has shown that, in the world of financial trading, the more we know, the more difficult it is to organize our thoughts in a clear and simple manner. Too much information breeds hesitation and doubt — analysis paralysis.
Hence, there is a need for a clearly written trading plan to guide you on what, when, and how much to trade, which is why we created this article to teach you :
What is a trading plan?
Basically, a trading plan is a trading roadmap that guides you through the entire trading process.
It is a comprehensive tool that helps you make decisions about important trading variables, such as which market to trade, which trade setups to take, how much stop loss to use, when to take profits, when to cut your losses, and how to identify other tradable opportunities.
With a trading plan, you are forced to stay focused on your trading rules, and it offers you a reference with which to judge your trading activities — including trade entries, exits, and risk management, as well as the market conditions during which you make your trades.
There is one thing you should know though — a trading plan is different from a trading strategy. While a trading strategy is a technique (technical or fundamental) that you use to find an edge in the market and probably define your trade entry and exit methods, a trading plan is all encompassing — it includes the trading strategy, risk management, personal psychology, trading records, and even the type of market to trade.
It is an organized way to implement your trading strategy, bringing in all the other factors that make for successful trading.
But the trading plan, in itself, won’t make you successful — no matter how perfect it is — unless you strictly follow it. It is only those who are disciplined enough to follow their trading plan that survive in the game.
Generally, a trading plan should consist of the following key components:
Creating a trading plan from scratch may seem difficult, so it is fine if you use someone else’s plan as a guide. However, no two traders are the same — your available capital and attitude to risk may be different. Thus, your trading plan should reflect who you are and your personal realities.
If your trading plan is not personalized to reflect your trading situation, you will find it difficult to follow the plan, and you may end up acting on basic instinct, jumping on anything that looks like a trading opportunity — in other words, trading erratically and emotionally.
The benefits of having a trading plan
When strictly adhered to, a good trading plan, helps a trader to clearly state the criteria for a trade setup and always make logical trading decisions, so as not to get involved with emotional decisions in the heat of the moment.
A trading plan should be written down and followed to the letter if you want to get all the benefits that come with it, which include:
In addition to the above benefits, a trading plan makes it easy for you to become a signal provider if you wish to become one. Your discipline, strict implementation of your strategy, and good trading records are some of the main factors investors look for before patronizing a signal provider.
Creating the best trading plan: what you need to do
Building a trading plan is not an easy task. You need to understand your personality, define your goals, and do your research to find out the strategy that suits you best and tools that would be useful for your strategy. These are the steps to follow when trying to build a unique trading plan:
State your motivation
The first thing in creating a trading plan is to state your reasons for trading the financial markets.
You need to state them clearly and outline your motivations. Here is the time to ask yourself why you chose to trade in the first place, and your answer will show if you will have the motivation to keep going when things get tough.
If your reason for trading is “to make quick money”, it is better you forget about trading and look for something else to do.
While you can make money from trading over the long term, if your only reason for trading is to make quick money, you are surely doomed to make some account-decimating mistakes, such as trading without a stop loss.
So, you need to have a healthy motivation and state it clearly. Your motivation may be to have an alternative source of income so as to enjoy quality retirement or even retire early.
It may be to forge a new career that will allow you to spend more time with family and friends. Your motivation may even be to learn about the financial markets and how to play the game so as to create a better future for yourself.
Whatever is the case, write it down.
Specify how much time you can devote to trading
It’s necessary you specify how much time you have for trading and the time of the day you can devote to trading activities. It all depends on your other engagements, such as having a full-time job.
In that case, you need to know if you can monitor the market at work or plan your trading activities after work hours.
Another factor that determines how much time you commit to your trading is the style of trading you want to adopt.
If you plan to be making many trades in a day, you will obviously need to be monitoring the markets for the greater part of the day.
But if you plan to be making a few trades a week or month and hold them for a longer time, you can easily make your trades at night after work.
Whatever you choose, put it down in your plan
Determine how much capital you are starting with
Examine yourself and determine how much you can afford to start your trading journey with. This is not something you rush through; take your time and think it through.
As a beginner, you are liable to make serious mistakes. So, it is advisable you start with an amount that even if you blow your trading account, you are not so financially wrecked that you can’t pick yourself up and push ahead.
It does not necessarily mean starting with a few disposable bucks, as you won’t make any appreciable profit from $100 or $200 trading capital.
What we mean here is, take your time to raise a reasonable trading capital, but start with just a third or a fifth of that amount so that if the first attempt goes wrong, you still have enough capital to start again.
Write down your trading capital and your investing plan.
Write out your trading goals
As the Oracle of Omaha, Warren Buffet, would say, “The first rule of the game is to preserve your capital, and the second rule is to never forget the first one.” So, your primary goal as a trader is managing your losses so that you can be in the game long enough to start making profits.
Nevertheless, you need to create some specific, measurable, attainable, relevant, and time-bound (SMART) goals for yourself, both in the short term and long term.
A short-term goal may be that you want to execute all trades that match your trade setup in all the markets you are watching for the month. Your long-term goal may be to increase your trading capital by 20% in the next 1 year.
Whatever is the case, make sure you note them down.
Determine your trading style
It is important you examine yourself, determine the type of trader you are, and note it down. To discover the type of trader you are, you need to understand your personality, your risk appetite, and the amount of time you can commit to trading.
Generally, there are four styles of trading to choose from:
- Scalping: This involves placing lots of trades in a day, with each lasting from a few seconds to some minutes.
- Day trading: Here, trades are opened and closed within the same day.
- Swing trading: A medium-term trading that involves holding trades for some days or weeks.
- Position trading: This is a long-term trading style where trades last for several weeks, months, or even years.
Determine where you belong and write it down.
Choose the markets you want to trade
The financial markets are so wide that you can’t possibly trade them all. Even if you choose to trade only the forex market or the stock market, you can’t trade all the currency pairs neither can you trade all the stocks on the New York Stock Exchange (NYSE), for example.
So, it becomes necessary that you choose the markets you want to trade and put them on your watch list. They could be only currency pairs, stocks, indices, commodities, or a combination of a few instruments in these asset classes. Those are the markets you should be monitoring for trade setups.
Write them down in your trading plan.
Determine your trading strategy
This is the epicenter of your trading plan because it is how you identify your edge and when to enter the market. It consists of several aspects of finding a tradable opportunity in the market, and here, we will discuss it under the following:
Determine all these factors and write them down in your plan.
Determine your risk management parameters
For every trading strategy, there is an appropriate risk management approach for it. Some traders simply make use of a specified number of pips when placing a hard stop loss, while others place their stop losses beyond a significant market structure.
It is left for you to determine the best stop loss approach for your trading strategy, and you must be ready to accept that loss if it happens. On no occasion should you widen a well-placed stop loss when the price is gunning for it.
Furthermore, you need to decide whether to use a set and forget approach or move the stop loss to breakeven when the price has moved in your favor. If you choose to move your stop loss, you have to determine the right time to move your stop loss to breakeven.
Determine what works for your trading system and note the necessary parameters down in your trading plan.
Specify your trade management procedure
You need to specify how to manage your trades, especially the ones that are making profits.
Of course, the bad trades would get stopped out at the stop losses, so your concern should be how you take the profits the market offers you. There are three common options for this:
So, specify your profit taking approach and note it in your trading plan.
State your money management rules and growth plan
Your money management rule is all about the percentage of your trading capital you are willing to risk in each trade. It determines a lot of your risk control parameters, including the dollar amount you risk in each trade and the lot size you trade, which, in turn, determines how much leverage you use.
While experienced traders may use 2%, 3%, or more of their account balance per trade, as a new trader, it is advisable to risk only 1% of your account balance in each trade. Another thing to consider is your growth plan.
Whatever risk percentage you wish to use and the growth plan you have, state them clearly in your trading plan.
Specify how to handle adversity and manage your emotions
After getting everything right, one thing that can work against you is your emotions — fear, greed, hope, excitement, anger, and others.
While those emotions are part of who you are, if you don’t keep them under check, they will sabotage all your efforts. Fear will make you miss a trade setup; greed will make you chase a missed trade; hope will stop you from cutting your losses; excitement will make you jump the gun; while anger will make you break your screen.
Document how to handle each of these emotions in your trading plan. It can be taking a break after a specified number of wins or losses to clear your head, using an EA that automatically places a stop loss immediately you enter a trade, or closing trading for the day if your emotional capital is running low.
Create a trading journal
You must have a trading journal where you enter every detail about each trade you make. Some of the details you should enter in the trading journal include:
- The date and time of trade entry
- The trade setup used
- The entry price
- Your stop loss
- Your profit target
- Your exit level if closed prematurely
- The reason for exit
- The profit or loss made
These records make it easy for you to review your trading result when the time comes.
Specify your review timeline
Finally, you need to specify how often you will be reviewing your trading plan. Since the market is very dynamic, your trading plan is simply a work in progress — there will always be a need to tweak it a little to suit the current market condition. Thus, there’s a need to state how often you do that.
You can review your trading plan at the end of each month, or more commonly, after a specified sample size of trades (say 20 or 30 trades) has been reached. Whatever you decide, make sure you document it in your trading plan.
How to implement your trading plan
After creating your trading plan, it is very important that you test it in a risk-free environment to know how well you can implement it before going live.
Thus, you have to create a demo account and try to implement every aspect of the trading plan — you need to be comfortable with them before trading the plan on a real account.
But know that the real test of your ability to execute your trading plan can only happen when there is real money on the line — that is when your trading psychology is tested.
Whether demo or real account, here are some tips to help you implement your trading plan more easily: