A trading plan is an essential tool for any trader. It can help you stay focused and ensure that you are making the most of your trading opportunities. In this article, we will provide you with a 11-step guide on how to write a trading plan.
Trading plans are a critical part of any good trading strategy. They provide a roadmap for executing trades, help to manage risk, and keep you on track.
I say roadmap, and that’s a pretty good metaphor. Imagine you’re headed somewhere that you’ve never been before. If you don’t have a map, how do you know which road to take? When do you exit that road? How safe is the road you’re taking?
It’s the same idea with a trading plan. You will have rules to guide you. You’ll use your trading plan to decide which trades to take, and when to exit. You’ll be able to measure how much risk a trade has, and whether you’re equipped to take that trade.
A good trading plan should be simple to follow, organized, and consistent. It should also take into account your personal trading style and preferences. It should also provide enough flexibility to apply to different market conditions.
Why Do You Need a Trading Plan?
Far too many traders don’t have a trading plan, the vast majority don’t. A trading plan is important because trading is 80% mindset 20% skill. What I mean by this is, your trading plan will help limit any issues with mindset.
Humans are emotional by nature, and one of the best agitators of emotion is money. A trader without a trading plan will have to trust that they will do the right thing. A plan will clearly outline logical and measurable information to base decisions on. You need to fight emotional urges and follow the logic within your plan.
Your trading plan is your gateway to having the trader’s edge. This is what helps you as a trader in stacking probability in your favour. It’s important to spend time on building a system that will allow you to do just that.
Your plan holds your trading strategy which helps you to find high-probability trades. It will dictate when to place trades, when to exit, and your trading risk management. If your strategy is solid, then you should take advantage.
Here’s an idea of what you DON’T know if you’re not using a trading plan:
A measurable understanding of what you want to achieve
A way of knowing if you’re on track
Consistent trading decisions
Detailed performance metrics
How to keep yourself accountable
What is working and what isn’t
How to Create a Trading Plan
Creating a trading plan can be a daunting task, but with the right approach, it can be an effective way to manage your trading. Here are 11 steps to creating a successful trading plan:
How to Create a Trading Plan:
Define your goals
Understanding risk tolerance
1. Define Your Goals
What do you want to achieve with your trading? Are you looking to maximize profits, reduce risk, or both? Once you know what you’re after, it’s easier to create a plan that targets those objectives.
How much profit will you seek when starting out? How and when does that number increase? What will your starting balance be?
Make sure your goals are measurable, set time frames. Assign how much time you want to put into actively trading. Add milestones for short, medium, and long-term achievements.
2. Understanding Risk Tolerance
Understanding risk tolerance is an important part of writing a trading plan. Everyone has a different risk tolerance, it’s important to account for that when setting goals for your trading.
Some people are comfortable with taking on more risk than others. Some may only be willing to trade small amounts of money. It’s important to find out what level of risk your own tolerance is before starting a trading plan.
Once you know your risk tolerance, match your strategy and risk management techniques.
3. Assign Risk Limits and Position Sizing
When writing a trading plan, it is important to assign risk limits to each trade. This will help you stay within your intended risk parameters. It prevents you from becoming overexposed to a particular market movement.
Whether you’re starting out, or been trading for a while, your trading plan should contain a rule for the percentage of risk allowed. You need to apply that percentage for each and every trade.
Whatever that number is, it should fit your profile. Write it down and follow it every time you sit down to trade.
Let’s take a look at an example:
I have $5,000 in my trading account trading on the NQ and each tick is $5
The % of risk I’m happy with, in this case is 3% per trade
3% of my account allows me to trade $150 of risk
$150 divided by $5 per trade, meaning I can risk 30 ticks.
So, what happens when the market is volatile and the number of ticks for each set up is 200. According to my risk allowance, I can’t trade these conditions as it exceeds my allowed risk. In this instance my risk would be 200 ticks x $5 which is $1,000.
I have 2 choices now. 1. I can sit the session out and wait for the markets to cool off a bit. or 2. because I’m trading Futures, I can drop down to a micro market where the value of a tick is smaller.
Your maximum allowed risk will be relative to your risk tolerance. I would suggest no more than 2-3% risk per trade.
4. Assess Your Skill Level
Before you can write a trading plan, you need to first assess your skill level. This is important because the success of your trading will depend on your ability to execute trades.
You can use many tools to assess your skill level, like technical analysis on a simulated account. Once you understand your abilities and limitations, develop a trading plan to help you achieve your financial goals.
5. Research and Select a Market
You’ll need to do some research before choosing the type of trading you want to do, and the product/market. You need to find a market that is likely to produce profitable returns for you. It should fall in line with your risk and skill assessments.
There are many markets out there, so it is important that you find one that is right for your investment goals, and risk tolerance.
Personally, I like Futures trading. The futures markets allow me to access the markets directly. I can trade a variety of assets, and trade leveraged products.
Once you have identified the market that you want to trade, the next step is to select a strategy.
6. Create A Trading Strategy
There is no one-size-fits-all trading strategy. There are many successful day trading strategiesout there. The one that works for you, will depend on your investment goals and risk tolerance.
That said, there are a few key steps you can take to develop a successful trading strategy. First, consider your investment goals, (you identified these in step 1). Are you looking to make short-term profits or are you hoping to achieve long-term growth?
There are 4 main types of trading:
Scalping (open trades for seconds to minutes)
Day Trading (open for minutes to an hour or 2)
Swing Trading (open for days, weeks, or months)
Long-term investing (1 year+)
You need to also consider your risk tolerance (you identified this in step 2). Are you comfortable with the potential for losses? What size losses are acceptable?
Taking this into account, you will be able to filter markets down to those appropriate.
If you are looking to day trade, you will need to learn how to read candlestick charts. These types of charts are among the most used tools in trading. Along with trading indicators they allow traders to perform technical analysis. This is how traders find good trades.
Technical analysis will not only allow you to find trades, it will help you set targets and exit points.
If you want to start trading, you will need to understand technical analysis. Consider studying an existing trading strategy rather than building your own. A consistent strategy, focused on limiting loss and maximising profit, is one you might want to learn to trade.
7. Have Rules for Trade Entries
One of the most important things you can do to improve your trading is to have rules for when and how you enter trades. This will help you to stay disciplined and reduce the risk of making mistakes.
There are a number potential entry rules, but some common ones include:
Having a trade setup using technical analysis
Having a risk to reward ratio
Having risk limits to stay within
Having a clear and visible profit target
Having a clear and visible exit point
Not having placed your maximum trades for the day
Not having reached your maximum drawdown
Not having reached your profit target for the day
Have a pre-trade check-list. If a trade doesn’t meet all these checks, then don’t take the trade.
First, can I identify a pattern with a high probability of being profitable?
Do I have confirmation of that pattern?
Can I set my stop at the last failure point without risking more than I am allowed?
What is the volatility/ PVI at the time of the trade what’s the likelihood to pay a defined target?
Is the market too volatile for me to be trading right now?
These are some of the things that you can consider.
8. Have Rules for Trade Exits
One of the most important aspects of trading is having rules for when and how to exit a trade. This allows you to maintain discipline and avoid emotional trading decisions.
There are many factors to consider when making these decisions. They include, the size of your position, the market conditions at the time, and your risk tolerance.
Every trade you place should have a stop loss which exits a trade when price reaches a given point. Your technical analysis will provide a price that indicates when a trade breaks down. This means the trade won’t be profitable, so to limit losses, you exit.
Your stop losses are per your risk tolerance and maximum allowable drawdown.
Your technical analysis will also tell you where the trade’s target is. Most traders set the profit target when placing the trade.
9. Use a Trading Journal
A trading journal is the best way to record and review every trade that you place.
Reviewing your trading journal can help you identify any errors that you might be making. In hindsight, you’ll be able to look at your trades with a logical frame of mind. This will help you better dissect your trades.
There are several things that you should record in your journal to take full advantage of it, let’s break them down.
First you need to note the market that you are trading, and what the market conditions are like. You could also note how confident you were feeling about trading these conditions.
Note down the statistical information. This can include:
Date and time of the trade
The number of contracts traded
Direction of the trade, e.g. Long or Short
The entry price for the trade
The type of setup, for example ABC pattern long
Your target and stop positions and what risk to reward they represent
Your exit price and the result for that trade, including win/loss and the dollar amount.
10. Analyse trading Performance
Traders analyse their trading performance to improve their skills.
Your trading journal will be able to note targets for the session and whether you reached them, and why or why not. You need to not only understand how your performing, but also why you’re performing that way.
Without analysis you won’t be able to improve your trading, because you won’t know what needs changing.
An important thing to note when analysing performance: You want to know if you are profitable or not. But, that’s not the full story. You should measure your performance on how well you follow your plan.
If you follow your plan but have a loss from time to time, that’s fine. If you follow your plan exactly and have many losses, you may need to revise your plan.
11. Revise Your Trading Plan
Set yourself timeframes for what you should review your plan. This will help you in measuring how well your plan works, and if you need to change anything.
Other reasons to revise your plan:
Drastic change in market conditions
Change in trading session
Change in market traded
Increased or Decreased account size
Remove setups that don’t work
Changes in life goals
Lifestyle changes that affect your plan
BONUS TIP: Trade Your Plan!
To break bad trading habits, you need to view success and failure in a different way. A success isn’t whether you had a profitable trade. A failure isn’t when you have a losing trade.
You should measure success and failure by whether you followed your plan.
Did I make an undisciplined trade? That’s a failure. You can’t reinforce poor discipline by congratulating yourself, should that trade be a winner.
If I have a losing trade but follow my plan exactly, that’s a success. Hard luck, move on, the market doesn’t move the way it should 100% of the time.
Reward yourself when you do follow your trading plan, regardless of the outcome. Praise yourself, pat yourself on the back. This was a win; you did good today.
Regardless of whether you win or lose, if you followed your plan, you did the right thing, be proud.
Adjusting Your Trading Plan
Most often you shouldn’t alter your trading plan. There are a few situations where you do want to review your trading plan.
Review the plan if normal market conditions have changed and your plan stops working. You may have created your trading plan for a specific type of market. If that changes, look to see how you can alter your plan to accommodate.
If you have grown your account to a size outlined in your goals, you may want to review. Now that your account is larger it might be appropriate to revisit the size of your trades. The opposite is also true for losses. If your account has decreased you might want to consider reducing position size.
You may choose to revise what market you trade and at what time. You might consider adding or removing trade setups, or how you find trades. If you do this, make sure you back-test on a simulated trading account.
Your revision could be as simple as grading your plan every 6-12 months. While you should always trade your plan, there are times where you may need to tweak.
Trading Plan Example
Now that you know what goes into a trading plan, let’s put together an example.
My reason for trading is:
I want to build my account to a point where I can derive a regular income.
My goals are:
I plan to start with a simulated trading account, and trade a live account after 6 months practice. I will only do this if I have proven myself profitable on a consistent basis.
I will start with a small account looking to double the account within 18 months of trading. I will increase my position sizes if I can double my account and remain consistent.
Risk and Skill
My risk tolerance is:
I am moderately conservative. I am seeking higher than average returns and I am happy to assume a small to medium amount of risk.
I’m looking to trade a somewhat volatile market to take advantage of larger targets. I will do this while maintaining reasonable risk management constraints.
My risk limitations are:
My maximum allowed risk per trade is 2% of my total trading account size. I will only place 2 trades per session. My daily maximum drawdown is 4%
My profit target is roughly 1.5 to 2 times the amount of risk in the trade.
My skill level:
I’m new to trading, and have a basic knowledge of trade setups. I am currently trading 2 setups until I become proficient.
I will be practising these skills on a simulated account until I am consistent. Once my skills are at an acceptable level, I will begin trading a live account.
Market and Strategy
My market to trade:
I have chosen to trade futures; this will allow me to use level for larger gains. I need to ensure that I manage my risk well to avoid larger losses. I chose the futures markets so that I can take advantage of a smaller account requirement. Check out my article on Options vs Futures for more information.
I will begin trading the Micro E-mini NASDAQ. I will trade in the Asian session to begin with.
My trading strategy:
I plan to day trade. I want to do this for around 90 minutes per day. I am seeking short-term gains.
I have 2 setups in my trading plan:
Simple support and resistance in trending channels
My strategy tells me that my risk is place just beyond the failure point of these patterns. If the failure point is too far away or takes too much risk, I don’t trade.
My trade entry rules:
I will only place a trade if it matches my patterns and fits inside my allowed risk.
I will set my risk to reward between 1:1.5 and 1:2 to help in keeping my winners bigger than my losers. For each dollar of risk, my profit target will be $1.50 to $2.
If I’m not confident in where these exit points are, I won’t trade.
I can’t trade if I have already placed 2 trades, hit my max drawdown, or hit my target for the day.
My trade exit rules:
I will place a stop loss and take profit on my trade when I execute. I won’t move my stop further from my entry. I may choose to move my stop closer to my target it I become profitable.
Journal and Trading Plan Revision
Using my trading journal:
My trading plan states that I must use my trading plan every time I trade. I will enter the key statistics of all trades. I will also include screenshots and review my mindset.
I will review my trades each day and do a full review for the week on Fridays. My analysis will focus on whether I followed my trading plan, and if the strategy is working when I do so.
Revising my trading plan:
I will review my trading plan every 6 months. Each 6 months I will consider if I increase my position sizes when trading. I will also consider a review if my performance is either positive or negative on a consistent basis.
Trading Plan Template
Now you know what to put in your trading plan, you can write your own. To get you started you can download this trading plan template. This will help you note down everything you need for setting your trading plan.
Writing a trading plan can be daunting, but it is worth it in the end. Trying to trade without a plan leads to emotional and erratic decisions making. Strategic guidelines for your method and goals, help you make more logical decisions.