A trading plan is a tool that you can use to clearly define your trading objectives and help you achieve them. In this module we explain how to construct your personal plan, and how to implement it.
What is a trading plan?
A trading plan is a structure, or a set of guidelines, to define your trading activity. It can be an extremely useful tool to help you focus on planning and executing your trading strategy. There is no absolute blueprint for the perfect trading plan – every trader is unique, and different styles suit different people – but there are certain universally accepted elements to consider when building your own plan.
Your Trading road map
You can think of a trading plan as a road map; a route to take you from where you are to where you want to be. Metaphorically speaking, it is important to have a very clear and honest picture of both of these ‘places’ in mind.
- WHERE ARE YOU NOW?
- What sort of trader are you now?
- What knowledge and experience do you have?
- How much capital do you have to trade with?
- WHERE DO YOU WANT TO BE?
- What do you want to achieve with your trading?
- What sort of timeframe do you have?
- What will success look like?
General trading plan rules
While it is true there is no absolute blueprint to constructing the perfect trading plan, there are a few general rules that will be extremely useful in almost all cases.
- WRITE IT DOWN. You should physically write down – or type – things like your reasons for trading and the key objectives that you hope to achieve. This will help you organise your thoughts, as well as giving your plan solidity.
- RECORD YOUR PROGRESS. Develop a clear and concise method of recording your trades. It is critical in planning a long-term strategy to be able to view your past and present trades, both from a learning perspective but also to keep track of which markets you are, and have been, exposed to.
- CONTROL YOUR FINANCES. Money management is a third crucial element of any trading plan. You need to have a plan for managing your investments, especially your exposure to risk.
You can use the trading diary within market insight to keep all your notes in one place. You can add notes and charts whenever you open, close or alter a position or order.
Key trading plan questions
Here are a few important questions, and some hypothetical answers, to consider when setting up your trading plan:
- What is your motivation for trading?
- To make a sustainable living
- To top up my retirement funds a little
- To make some fast cash whenever I can
- Purely to enjoy the challenge
- To make as much money as possible
- What is your attitude to risk?
- I like taking chances
- I like a balanced approach towards risk and reward
- I like to play it safe
- How much time can you give to trading?
- It’s my full-time job
- Only my spare time, but I’m committed
- This is just a hobby, for when the mood takes me
- What is your level of knowledge?
- I’m very familiar with financial markets and most trading methods
- I know certain areas in depth, but others are unfamiliar to me
- I’m fairly new to financial trading, but learning fast
- I’m just getting started and only know the basics
BENEFITS OF A TRADING PLAN
There are a number of practical ways in which your trading plan may be helpful to you:
Set up structures to manage your risk better
What does high or low risk mean for you? By quantifying this in advance, you can apply a scientific approach to assess whether a particular trade is too risky. Your risk-per-trade scale could look like this:
- Low risk: 1-2% of total equity
- Medium risk: 2-5% of total equity
- High risk: More than 5% of total equity
- Reckless: More than 20% of total equity
For example: With a £10,000 account, a 3% risk amounts to £300 on a single trade (medium risk). Another way of looking at risk is by setting up a risk v reward ratio. Find out about this and other forms of risk management in our managing risk section.
Establish entry and exit strategies beforehand
In many, if not most, cases, the timing of your entries and exits will be the most stressful and thought-over parts of the entire trade. At these times, there is an elevated risk of basing a decision on an emotional response, rather than strategy. For this reason, it can be extremely helpful to establish clear entry and exit criteria and rules to stick to.
For example, you might use charts to track certain market trends, and commit to only entering a trade when particular patterns have emerged. Alternatively, when considering your exit, you might establish profit/loss limits to stick to as the position develops. It can be very helpful just having a set of guidelines that you have established in an emotion-free environment, away from the pressure of an ongoing trade.
Stay focused and streamline your decision making
The financial markets can move rapidly at times, and it’s at these moments that you could quickly find yourself overwhelmed and more prone to rash decisions. A trading plan is a vital point of reference in these situations, because you have made a lot of your decisions beforehand, in anticipation of the dilemmas you might face. Act according to your plan, rather than make many actual decisions on the spot.
A trading plan can help to take the emotion out of your trading. Some people may attribute victories to emotion, or gut feel, but long-term success will almost always find its foundation in a considered strategy compiled beforehand.
Constantly evaluate your trades and manage your money
A trading plan often includes a trading log or diary, which you can use to track all the trades you have made and make notes about their success or failure. A trading log is an excellent tool for viewing the bigger picture. In one snapshot you can get an overview of your trading history and identify successes and mistakes made along the way.
Honesty and self-awareness are important traits here, but constant assessment of your trading is one of the best ways to avoid repeating mistakes and remind yourself of the things that have worked in the past.
Simplify your trading and maintain your discipline
A trading strategy can be a constant reminder to you of your goals and also your self-imposed limitations. Having a written plan is extremely useful in maintaining your trading discipline – it just always seems much harder to deviate from your original plan when it is clearly laid out in front of you all the time. Keep it on your desk or stick it to the wall, if it helps.
WHO NEEDS A TRADING PLAN?
The short answer to this question is: everyone does. From first-time traders to experienced professionals, there is nobody that can unequivocally say they are above or beyond a trading plan. Your experience will no doubt influence the extent to which you could use and benefit from a trading plan, but using a trading plan in the way that suits you is undoubtedly in your best interest.
How you use your trading plan is up to you, but we have outlined a few essential tips for creating it in the next section. You can also see examples of a trading plan and trading log.
CREATING YOUR TRADING PLAN
Your trading plan is a tool that you shape to suit your personal trading style. You can include anything that you find useful, but working through the following steps should provide all the essentials you need.
KNOW YOURSELF AS A TRADER
First and foremost, you should be able to complete this sentence: ‘I want to be a successful trader because…’ Secondly, you should honestly assess your strengths and weaknesses, with regards to trading specifically, but also any personal traits that might influence your trading.
DEFINE AND UNDERSTAND YOUR TRADING GOALS
Setting your trading goals is one of the most important steps in developing a trading plan. It is also the step that most people neglect. You should try and be as specific with your goals as possible, both in terms of profit and timeframe. Only by defining and quantifying your goals will you be able to measure how far you’ve achieved them. Most trading plans suggest you identify detailed trading goals on a daily, weekly, monthly, six-monthly, annual and lifetime basis.
It may strike you as silly or impossible to come up with daily trading goals, or pointless to try and settle on a lifetime trading objective. But, more than the actual outcome, it is the thinking that goes into these goals that is important and ultimately beneficial.
DECIDE WHAT TYPES OF TRADING YOU ARE INTERESTED IN
You have several options available to you when you are considering trading on financial markets. Some people prefer to stick to a single trading method, others have successfully incorporated different trading types into the same plan. Whatever route you decide to take, the most important thing is that you understand your options beforehand and make a decision, as part of your trading plan, to stick to a particular system.
Of course you can adapt your trading plan as you develop as a trader, but what you want to avoid is trying out a new type of trading on a whim without doing the research to see if it suits your trading style.
IDENTIFY YOUR MARKETS AND TRADING TIMEFRAMES
As well as knowing which trading types you are interested in, you should also identify the markets that you are best suited to. One prime consideration is your level of knowledge on particular markets (be it company shares, commodities, indices, foreign exchange) and the factors that drive them. The more you know, and the more you are interested in the subject, the greater care you will be able to take.
Similarly, you should consider when these markets are open and whether you will be able to offer them the proper attention at important trading times.
ESTABLISH YOUR PERSONAL TRADING SYSTEM
A trading system will apply a series of rules to make trading into an almost automatic process. You’ll need to decide whether you would prefer your trading to be mechanical, where you pick a trading system and let it guide all your trading decisions; or discretionary, where you make decisions on a case-by-case basis.
If you decide to use a trading system, it should include:
- Set ups – the conditions you look for in a market that you think give you a high probability of a successful trade. It can be useful to have a clear idea of the set-ups on which you like to trade – such as following higher highs, lower lows or moving averages.
- Trigger points – the precise moments that you want to trade on – such as a market moving through a new high or low.
KNOW WHAT YOU ARE WILLING TO RISK
Risk management is possibly the most important aspect of your trading plan. Techniques for managing your risk are covered in our managing risk module, but they certainly play an integral part in any trading plan. From a trading plan perspective, it is important that you consider your money and risk management rules, establish them to suit your trading style, and stick to them through good and bad trading times.
Good questions include:
- What proportion of my account am I prepared to risk on each trade?
- How many positions am I prepared to run at any one time?
- What is the maximum account exposure I am prepared to accept?
DECIDE HOW YOU WANT TO MANAGE YOUR OPEN TRADES
This aspect of the trading plan deals with your handling of your open positions. This is when you can be most subject to emotional responses – you see the market drop, and you want to cut your losses, or the market spikes and you feel tempted to hold your position even longer. In these emotionally charged situations it is essential to already have a strategy in place that you can call on.
KNOW HOW YOU PLAN TO KEEP RECORDS OF YOUR TRADING
It’s amazing how often people neglect this aspect of the trading plan, especially as it can be such a vital learning tool. If you regularly update a document of all your previous trades, including various details that made them successful or not, you can only learn from these in the future. A simple spreadsheet is all the record you need to keep, but a comments section is particularly useful. Include everything from how well you stuck to your strategy, and what worked and what didn’t, to how you felt on the day or at the time.
You may be pleasantly surprised at how easy it is to identify successful trends and then repeat them in future trades.
TEST YOUR SYSTEM
You can back-test the system you have chosen against historical data, to establish whether it would have held up against recent market movements. You can do this manually, or there are various facilities set up by certain financial services providers to do it for you. Another testing option, offered by some financial services providers, is a demo account. Depending on the provider and your preferred means of trading, you can actually set up an account with imaginary funds and implement your trading strategy for a limited time to test its viability.