Developing a Trading Plan

The purpose of a trading plan is to provide you with a realistic and systematic process as well as documenting each consideration relevant to successful and profitable trading.
In the last lesson, we talked about the importance of treating your trading like a business and the need for a business plan.  Your trading plan is just an extension of your business plan – it will document the nuts and bolts of
HOW YOU ARE GOING TO OPERATE YOUR BUSINESS!
Let’s look at the components of a good trading plan.
Click on each of the topics below and information on that topic will appear in the right hand column.

Your Trading Style

Your trading style is simply a way of describing how you are going to approach the business of trading.
There is no right or wrong answer here. Your trading style will depend on your personality and your goals and objectives. To determine your trading style do your research and as you learn ask yourself a series of questions.  The answers will help you develop your philosophy of trading and start to develop your trading style.
Remember that your trading style is not set in concrete and may change over time.
Your trading style should consider and determine:
Time-frame
  • Are you going to be a day trader or a longer term investor or something in the middle?
  • What time-frame charts are you going to consider in your decision making?
  • How are you going to determine whether the market is trending in your particular time-frame?
  • Tip: the answers to some of these question will largely depend on how much time you have available which we looked at in the Business Plan lesson.
Markets
  • What market or markets are you going to trade?
  • Are you going to trade only ASX top 50 stocks or will you have a broader universe from which to take trading opportunities?
Approach
  • Are you going to use fundamental or technical analysis to determine your entries and exits?
  • What type of analysis suits your personality?
  • Are you going to be a systematic (mechanical) or a more discretionary trader?
  • Do you have the time to look for entries based on the type of analysis you choose?
  • Are you going to follow trends or be a counter trend trader?

Trading Goals

We talked about business goals int he Business Plan lesson and of course your trading business goals may be the same as your trading goals or you may choose to break them down into longer or shorter term goals.  There is no right or wrong way to approach your goal setting.  Choose whatever works best for you!
Trading goals will help keep you accountable and motivated so they should be realistic and ‘SMART’.
Think about the following questions:
Are the criteria of the goals you set something over which you have control?  For example your goal may ‘To make $x profit per month’ but you HAVE NO CONTROL over the profit you make, only over the risk you take.  Perhaps a better goal may be ‘To reduce my average loss as a proportion of my average win’.  Your trading exit rules (more on this topic later) can then focus on actions that help you reach this goal.
What goals are you going to have so that you continually improve as a trader?  Experienced traders will tell you that professional development goals are just as important as monetary goals.

Money Management Rules

Money management is all about managing your losses (and therefore preserving your capital) to give you the opportunity to let your profits run and be successful as a trader.
You can have a range of money rules.
Consider the following questions:
What percentage of the money you have available for trading (your trading capital) are you prepared to risk on any one trade?  A lot of trading books say 2% but 1% may be a little more conservative for a new trader as it gives them the chance to make mistakes without blowing up their account or losing too much capital.
How much of your trading capital are you prepared to lose in any one month before you will stop trading and assess the situation?  It is not unusual for traders of any experience to have 7, 8, 9 or 10 losing trades in a row?
How much drawdown in dollar terms are you psychologically capable of wearing?  If you have an idea then you can work backwards using worst case scenario planning to help you determine your risk per trade percentage and your monthly maximum loss amount.
What minimum risk reward ratio are you prepared to accept when taking a trade?  The potential reward has to be worth the potential risk.  A 1:3 risk reward is usually an acceptable return for most traders.
How will you determine your position size?  Note:  we provide practical examples of how to do this for CFDs in Module 3

Entry Rules

Entry rules are a set of rules and guidelines that dictate the the conditions that need to be present for you to take a trade.  Your rules clearly define your ideal trade setup and your trade entry triggers.
Consider the following questions:
  • What methodology or patterns are you going to use to indicate an ideal trade setup?
  • What does price action have to ‘show’ after you see an ideal set up for you to take a trade?
  • Have you back tested your rules to see whether they are profitable?
  • Do you understand price action and volume and the concepts of support, resistance and trends?
  • What indicators are you going to use to confirm your decision to enter a trade?
  • Are there any market conditions that have to be present before you can even consider taking a trade?
NOTE:  Traders get ‘hung up’ on trying to find the ‘right entry’.  Experienced traders know that the setup and entry isn’t the real key to successful trading.  It is more important to have the right (right for you that is!) money and trade management rules to be successful.
Hint: find setups that have a high probability of success and spend more of your energy in making sure you follow your rules!

Exit/Take Profit Rules

Design a robust set of exit and take profit (trade management) rules which clearly let you manage your risk by keeping your losses small and provide you with the opportunity to let your profits run.
Ask yourself questions such as:
  • How will you determine your initial stop? Will you use logical technical stops or another more arbitrary method?  The size of your trade can be determined by knowing your initial stop and the $ risk per trade you are prepared to take. Note:  We look at stops and position sizing in more detail and provide examples in Module 3.
  • How are you going to protect your profits?
    – Will you automatically take profits if your positions rises by a certain percentage?
    – Will you use a trailing stop?  If yes, what method will you use to determine your trailing stop?
    – Will you use a time stop?
  • Are there market conditions that if displayed will mean that you will tighten your stops or exit positions all together?

Daily Weekly Monthly Process

Successful traders know the importance of having a routine. This means a process that you follow to ensure that:
  • market conditions are right for trading
  • all your entry criteria met before taking a trade
  • you are in the right frame of mind for trading
  • you keep on top of your record keeping
  • you remain focused on the task at hand.
Hint:  Our Trading Journal Template coming up in a future lesson provides a great example of a process that you can use or refine for yourself.

Mindset

Some experienced traders say that psychology plays the biggest part in a traders success.  Others argue that it is money management!  Whoever, is right it is important that your trading plan provides you with guidelines to help you manage your mindset.
Consider the following questions:
  • What is your trading personality?  Hint: we provide a quiz starting later in this module to get you started on this topic in a future lesson.
  • What are your strengths and weaknesses?  Consider doing a regular SWOT analysis for you and your trading business. Write down the 1. Strengths 2. Weaknesses 3. Opportunities 4. Threats. Doing this takes effort, however it’s one of the quickest ways to improve your results.
  • What activities are you going to undertake to keep you focused and on top of your game?  Physical exercise can play an important role in this as does regular relaxation sessions.
  • How are you going to reward yourself when you reach your monthly or yearly goals?
  • What thoughts are you going to repeat to yourself (or write down and display near your trading computer) to motivate you and help you psychologically?
  • What rules or guidelines do you need to help you control your emotions?

Review Process

Your trading plan should document how you are going to review your progress as a trader.
Consider the following questions:
  • How are you going to keep track of your trading statistics (win/loss ratio, average win size, average loss size, expectancy, trading mistakes)?
  • What process will you put in place to check whether you are following your rules on each trade you take?
  • What questions are you going to ask yourself at the end of each trading session?  These could be as simple as (change the time frame to suit your trading style):
  • What did I do well today?
  • What could I have done better?
  • What have I learned?
  • What should I do differently tomorrow?