How to make your Trading Plan ?
What is Trading Plan?
Having a suitable trading plan is one of the most important aspects of trading. It’s there to act as your own personal decision-making tool, helping you answer vital questions like what, when, why and how much to trade. Your plan should cover your personality, attitude to risk, trading goals, risk management rules and any trading strategies you intend to follow.
It is vital for your trading plan to be personal to you. It’s no good copying someone else’s plan, because that person will very likely have different goals, attitudes and ideas to you. They will also almost certainly have a different amount of time and money to dedicate to trading.
What’s the difference between a trading strategy, a trading plan and a trading diary?
You’ll hear these terms used a lot in the industry, often interchangeably, but for the purposes of this course we’ll be talking about specific things when we refer to them:
- A trading strategy defines precisely how you should enter and exit trades. For example, ‘Buy gold when it drops below $1250, sell when it reaches $1350’ would be a very simple trading strategy.
- A trading plan is a comprehensive blueprint covering everything from your goals, motivation and attitude to risk, through to risk management rules and analysis of past trades. It can (and should) include both your strategies and your commitment to keeping a diary.
- A trading diary is a written record of everything that happens when you trade, including entry and exit points, profit/loss, trading statistics and even your emotional state before, during and after each trade.
Why is a trading plan important?
It makes trading easier
A trading plan gives you guidance on when and how you should trade. Without a plan you might be constantly worrying about which market to trade, whether to take your profits early, let your losses run, or if you’re missing out on other opportunities in different markets. With a trading plan you’ve done all the thinking upfront, so you can wait for the right market conditions and trade according the parameters you’ve set for yourself.
It helps you trade without emotion
A plan can remove emotional decision-making in the heat of the moment. You should already know your desired profit, and acceptable loss, on every trade before you place it. This means you’ll be able to cope with any dramatic changes in the market price as your trade is in progress. Realistically, markets can only go up or down, so you should be able to plan for every eventuality beforehand.
It helps you to maintain discipline
Discipline is an extremely important trait for a trader. Anyone can get lucky on a few trades, but a disciplined trader is much more likely to be profitable in the long run. And if you have a solid trading plan, discipline is much easier to maintain.
Say you start using a simple trading strategy – for example, you go long on the S&P 500 every time it goes up more than 0.5% in one day, with the expectation it will continue to rise.
However, after a couple of trades your strategy doesn’t seem to be working very well and you’ve lost some money. Do you abandon it immediately?
Depending on your circumstances, you might decide to stick with it. You can then find out if there’s a fundamental flaw with the strategy, or if you were just unlucky with the first few trades.
If it’s the former, is there a way you can tweak the strategy based on the results of your trades? By maintaining discipline and sticking to your plan, you could potentially turn a losing strategy into a winning one – or at least discover how and why it wasn’t successful.
It enables you to improve
By following a trading plan, and maintaining a trading diary, you can keep a record of what works for you and what doesn’t. This is useful for analysing your own performance and improving as a trader. A full record of every trade makes it much easier to learn from your mistakes, and to evaluate which trades you won (or lost) by luck or by judgement.
How to make a trading plan
All trading plans are personal and unique, so there’s no set formula for creating the perfect plan. However, most should address the following in some capacity:
Why do you want to become a trader? Is it for the money, for the excitement, or simply to learn more about how the financial markets work? Whatever it is, it’s a good idea to write it down because your motivation is an essential part of who you are as a trader.
Before you get down to the real business of trading, it’s sensible to work out how much time you can commit to it. Individuals looking to make a large number of trades per day, for example, will need to dedicate a lot more time to trading than, say, investors looking to buy assets that will appreciate over several years.
It’s also important to spend enough time preparing yourself for trading, which includes education, practising your strategies and analysing the markets.
Once you’ve written down your motivation for trading and the amount of time you’re willing to commit, you can start defining your trading goals. These goals shouldn’t simply be grand statements about how you’re going to buy a big house or a yacht with your winnings. To be effective, trading goals need to be Specific, Measurable, Attainable, Relevant and Time-bound. In short, they need to be SMART goal setting.
The first statement is a SMART goal:
- The figures are specific
- You can measure your success
- It’s attainable, assuming you have enough trading capital to start with
- It’s about trading, so it’s relevant
- There’s an explicit timeframe
- Attitude to risk
Market prices are always changing and even the safest financial instruments carry some degree of risk. An investment that seems like an exciting opportunity to one person may feel dangerous and stressful to another. So before you start trading it’s important to work out how much risk you’re prepared to take on, both for each individual trade and over your trading strategy as a whole.
Your attitude to risk usually goes hand-in-hand with your trading goals. For example, a trader looking to make 100% returns every year might be happy to take on increased risk to achieve the objective. While a more conservative investor might only want to risk a small amount of investment capital to realise 10% yearly growth.
It’s also crucial to look at the following:
- Trading times – when is the market open?
- Volatility – on average, how many points does this market move in an hour/day/week?
- Position/contract size – how much will you gain or lose for every point of movement in the price?
- If these factors don’t fit with how you want to trade, or your attitude to risk, then pick another market.
Once you’ve made your decision, it’s important to stay focused. The more you understand about your market and why the price moves, the more likely you’ll be able to predict future movements with accuracy.
For a trading plan to work it needs to be backed up by a trading diary.
This is where you record everything that happens during a trade, including why you entered it, the expected profit and maximum risk, the entry point, exit point and how the market behaved during the trade. You should also record how you felt before, during and after the trade, as this will help you keep your discipline and avoid making decisions based on emotion.
If, for example, you closed a trade early because you were afraid the market was going to turn – write that down. Did the market continue in your favour to reach your target level, or did it move against you as you thought? Record why you decided to deviate from your plan. Did your emotions get the better of you, or does your plan need revision?
Record keeping also enables you to see how you’re performing over a period of time:
- Are you generally profitable or are you losing money?
- What’s your win percentage?
- When you win, is it usually by more or less than when you lose?
- Are particular markets/times of day/trade setups more profitable than others?
- Keeping track of these statistics will enable you to become a better trader and help you on the way to achieving your goals.