A trading plan is a set of rules and guidelines that define your trading performance, financial goals, rules, risk management and criteria for entry and exit positions.
Why is it so important to know how to create a trading plan? Because if you know how to create a trading plan, you’ll know on which market to trade, how to cut your losses, when to take profits and find other opportunities for investing. But first, we have to understand what a trading plan is.
A trading plan is…
It is a full decision-making tool that helps you determine what, when, and how to trade. Every trader has an individual trading plan suited only for her/his style, goals, risks tolerance, capital available, motivation for trading, the market you want to trade.
A trading plan is a methodical tool that helps traders to identify and trade securities. If you want to have a successful trading plan you have to take into consideration a number of variables such as time, risk and goals. A trading plan gives you control of how you will find and execute trades, the conditions you will buy and sell assets. Moreover, it determines how large a position you will take, how to manage it. Also, your trading plan will determine what assets you can trade, as well as when to trade or when not to.
But there is also one important step more. Never invest before you make your trading plan because your capital might be at risk. A trading plan will guide your decision-making process.
To know how to create a trading plan you must understand it is different from a trading strategy. Trading strategy means you know how and when to enter and exit the trade.
The benefits of knowing how to create a trading plan
Since the trading plan defines the reasons why you are making a trade, when and how you are making a trade, it is an outline of all your trades. If you follow your trading plan, you’ll be able to minimize errors and losses.
Okay, creating a trading plan isn’t the most exciting thing you can do in your lives, and maybe that’s the reason why so many traders think about it as an irrelevant thing. How to think about the trading plan while some sexy things jump every second? News, charts, trend lines, hot stocks are more exciting, right? Wrong!
Without a trading plan, you cannot use all these sexy tools, you have to couple them with your plan to produce reliable results.
What do you think now, do you need to know how to create a trading plan?
Frankly, the trading plan is not necessary to make a trade. You can trade without a plan. But, if you want to hit the road of successful traders, you will need it. We are pretty sure you don’t want a hold-and-pray strategy because it isn’t a strategy at all. It is a sure way to lose everything you have. Maybe it’s better to go to a casino where there will be more chances to win something. Remember, trading isn’t gambling.
And without a trading plan, you’re gambling. The truth is that you may have some winning trades from time to time, but your progress will be questionable. Your losses will be bigger than gains, think about this and do smart trading. Learn how to create a trading plan, so create it.
How to create a trading plan?
Follow the old saying: If you fail to plan, you plan to fail. Every trader should follow this expression as it is written in stone. While trading you have only two choices: to follow a trading plan and have a chance to win or trade without a plan and lose with almost 100% possibility.
So, let’s create a trading plan and see what you have to take into consideration while doing that. Here are some hints.
First, set your goals.
What do you want to get from the trade? Please, be realistic about your expectations toward profits. This will come with a bit more experience. Experienced traders, for example, expect the potential profit triples the risk.
Can you see how much you have to be focused on risk? So, you must focus on risk. Your trading plan has to mirror your risk tolerance level. You have to determine how much risk you are willing to take. How much of your portfolio are you willing to risk on one trade? And you have to do that for every single trade. The regular risk range is from 1% to 5%, but usually, it is 2%. If your account is small you can take a bit more risk to get a bigger position. But if you lose a predetermined amount at any period in the day, you get out and stay out. Take a break, and then attack another day, when things are going your way.
Do your research before you enter the trade.
Explore the big winners, take a look at the stock charts and find possible spurs to the value of a stock. Be careful while doing this. Your research has to be accurate as it can help you discover if the stock is going to perform in your direction. You can’t be sure 100%, but it will be easier for you to know that you did everything possible to avoid losses.
Importance of entry and exit in a trading plan
You must give equal importance to the exit of a trade if you want to make a profit.
Set a stop-loss, to secure your pull out if things aren’t going in your direction. But you really have to get out at that point. Do you know your profit target? Get out when your profit target is met, don’t be greedy.
Take a pen and write down your plan
Exactly. It is the best way to show how responsible you are toward your capital invested. It is your hard-earned money, you don’t want to fool around with that. Put your trading plan in a visible place, stick it to your computer, for example. Yes, we are recommending your trading plan has to stare at you all the time while you are trading.
When you exit your trade, review it afterward. You will need to study how the trade went. If something was right or wrong you will be able to repeat or avoid it. So, take notes and keep them in your trading log.
What do you have to determine else?
Your stock trading plan should include additional factors to ensure it is completed.
First is liquidity
Liquidity can be a problem. When trade stocks this can be a serious element that needs to be considered because you can find a lot of stocks with very low liquidity. This doesn’t mean you should trade only large-cap stocks. You wouldn’t like to limit your opportunities.
Just filter out the stocks without enough turnover to get in and out of the market quickly. For example, you can trade stocks that have an average daily turnover of 10 or 15 times the size of the position you want to take. Don’t avoid small stocks because they can provide you to trade wider.
Second is volatility
Your trading plan should take into account the volatility of the stocks. Some stocks are more volatile some less but, generally speaking, the stocks are volatile. This should befall your trading rules as part of a trading plan. So, adjust your trend filter for the volatility of the stocks. You may have a lot of benefits using that. Your trading plan should be adjusted for what you will do if stocks go bankrupt or are taken over at a premium. You have to position yourself if it happens and you have to do so in advance to protect your overall portfolio.
A trading plan should consist of all these factors mentioned above. The stock liquidity, volatility, risks, goals. Consider them when writing it. But even if you do this and more, there is no guarantee that your trades will make you money. As we said numerous times, the stock market is a zero-sum game. It is a system of winning and losing. You have to be prepared for that. One day can be extremely successful but the others could be a total disaster. There is no profit without risk and you can’t always win without an occasional loss. Remember, if you lose a battle, you may win the war. Don’t expect every trade to be a success and every stock in your portfolio to be a winner. Let your profits rise and lower your losses. That’s the way to win this game.
We hope you have a better picture of how to create a trading plan now.