A trading plan is a document we create for ourselves that outlines exactly how we will trade and operate in relation to our trading activities. Having a trading plan, and following it, builds consistency and allows for improvement over time. Trading based on whim or ever-changing strategies and ideas doesn’t. Here’s how to build a solid trading plan to become a better trader.
Trading well doesn’t mean making a bunch of money and then losing it all. Or steadily losing with some big wins interspersed to prolong the inevitable.
Trading well means trading consistently. It means knowing when to step on the gas and when to step on the brake. And knowing when to do this requires having a plan that lays out how we will trade and when.
When we have a plan, we are doing the same thing (that works) over and over again. We can see how it performs, and we can make incremental improvements to make bigger profits.
Without a plan, we are doing different things all the time, and therefore it becomes much harder to make improvements because we can’t be sure what is working and what isn’t.
Any trading plan is better than no plan at all. With that in mind, this article focuses on how to build a simple trading plan, which can be expanded into a thorough trading plan. After the simple part, keep building your Trading Plan by adding the sections mentioned as you gain more experience.
On a paper or the computer, write down all the sections, and then start filling in what you already have figured out. The empty sections tell you where you need to spend some time thinking and planning.
It may seem like a lot of work, but if you are serious, it is worth it. And if you don’t want to consider these things, then maybe serious trading isn’t really for you anyway. Most traders lose money, so a trading plan is one way to help make your way into the few percent that actually make consistent money.
The Basic Trading Plan – Market + Strategy
This section of the trading plan helps you build a strategy and decide what markets to trade so that you have something reliable to trade with. It also touches on when you will and won’t trade, what timeframes you will trade, when you will trade, and how you will filter your trading choices.
Which Market to Trade and When
Define which markets you will trade and the time frames you will trade them on. Are you going to day trade forex on a 1-minute chart? Trade futures on a 4-hour chart? Forex on an hourly chart? Swing trade stock on a daily chart? Trade lots of markets on various time frames?
At what times will you place your orders? Markets trade differently at different times of the day. And what order types will you use?
Trading multiple markets is fine, just define what they will be so you have boundaries on what you can do. Many brokers offer trading in multiple assets, but each market is different, and you need a plan for each if you want to trade it.
Filters further limit what you will trade. If you only day trade the EURUSD, then you don’t need a filter, you have already defined exactly what you will trade: EURUSD.
If you swing trade currencies, how do you determine what currencies to trade. Make a list of the acceptable ones based on their movement and spread.
If trading stocks you may wish to specify that any stock you trade must meet specific parameters. I only trade stocks that appear on my scan list when swing trading. That assures that I am trading a stock that is acceptable for my strategy. You may also want to trade currencies that are strong or weak.
If you day trade stocks, you may need a day trading scanning method for finding day trading stocks that you can trade regularly. Or maybe you want a scanning method that will provide you with stocks that are moving a lot that day.
Define how you will determine what you will trade. This is your filter. Having filters also makes it much easier to find trades, because you don’t need to look through all 10,000 stocks on the North American markets for trading opportunities. You can filter it down to 200, for example, and find opportunities within those.
When to Buy
You have now defined what you will trade, on what chart time frame, and filters to narrow it down.
We need precise rules that tell us when it is acceptable to buy. “The moving average is pointing up and the price is rising” is not specific enough. We need precise rules. It could be based on indicators, price action, fundamentals, anything you want, but it needs to be precise.
What analysis tools will you use? Define them. If you keep changing the tools you use to make trades, you can also assume your results will be inconsistent. I see people post charts and every time they have a different indicator on there. Be consistent in approach.
For an example of what specific means, see the criteria for the Cup and Handle pattern. It is not just some random visual pattern. I require very specific things to take a trade. Then once everything sets up, I still have a trade trigger that actually gets me into the trade. By controlling the variables, I can see what works, what doesn’t, and how to improve.
How do you know when to buy? Well, you can use someone else’s rules, or you can simply look through many charts and determine what criteria were in place at good points to buy (in hindsight). Make a list of those criteria that were in play, and then go through other charts to see if they worked there as well. If they do, you may be on to something. If not, start over.
Once you have established your buy rules, draw pictures or take screenshots of those entry criteria (or complete trades) and include them in your plan.
Once you are in a trade, how will you control the risk of that trade? Lots of trades won’t move in our expected direction. How will you determine where to cut the loss?
Not cutting losses is not an option. If you want to be a trader, cut your losses. Hoping they bounce back is not a strategy and not a good plan.
I use stop loss orders. For each trade, before I take it, I determine where my stop loss will go, and I place it at the time of my trade. That way, if the price doesn’t do what I expect, I don’t lose much.
You may also want to consider other exits. Will you exit trades before major news announcements, like earnings for stocks? Will you hold forex trades through the weekend or not? Can you hold a day trade overnight?
Whatever you decide to do, determine how and when you will cut your losses and other circumstances where you need to get out of a trade.
Also, consider whether you will use leverage or not? Leverage magnifies returns and losses.
Once you have established your risk management rules, draw pictures or take screenshots of those stop loss criteria (or complete trades) and include them in your plan.
Position sizing is how much capital we allocate to a trade.
If day trading, we may use all our capital (and even more with leverage) on a single trade. When swing trading we may distribute our capital between several or many trades.
This article discusses some ways to position size.
How much capital we deploy on a trade isn’t random, it should be calculated and pre-planned.
- Have position sizing rules for strategies you are comfortable with.
- Also have position sizing rules for when you are starting out. You may want to start out with a smaller position size until a strategy (and you) prove yourself profitable.
- If you end up trading a small position size than usual, how you will build-up to the ideal position size? What does that process look like? What is your benchmark for knowing it is time to increase your position size?
- You may also want position sizing rules for if you hit a losing streak. Does your position sizing method change? If it changes (like being reduced) how and when does the position size return to normal?
When to Take Profits
This is probably one of the hardest things in trading, at least psychologically. People typically have an urge to lock in small gains but then have regret when the price runs further. Or they try for bigger gains, but have regret when a nice profit (but not a BIG profit) turns into a loss.
Define how you will exit trades. You could use a trailing stop loss (and there are many types) or a profit target. Or you could exit when you get a certain indicator or price action signal, or when the reason for the trade no longer exists.
Go through charts and experiment with different things to see if something works better. There is no perfect solution, only ideas that work better than others.
When Not to Trade
You may get valid signals based on your strategy, but are there conditions where you aren’t allowed to take the trade?
When day trading, I don’t take trades right before major economic news announcements, and I have to close trades before the announcement. So I can’t be in trade right around high-impact news.
When day trading, I also have volatility requirements. If the price isn’t moving much over the last one or two hours, I don’t trade, even if a valid trade signal occurs.
When swing trading stocks, I stop buying into new trades if my market health indicators turn negative.
When won’t you trade, and why?
The times you choose not to trade should be periods where the strategy has poor or unpredictable performance. By looking through many past trades you may determine that many losses occurred during a certain time, around certain events, or shared common traits. You can use that information to avoid taking those trades in the future. Update your trading plan with the information.
Backtesting and Real-Time Testing
You now have entry and exit rules, and your position size tells you how much you are risking on each trade. You also know when not to trade.
You already went through charts to find your entry and exit rules, so you may already have a good idea of how your strategy performs, but it is a good idea to do more testing.
Go through historical charts, preferably in many types of market conditions (up, down, sideways, volatile, sedate) and see how the strategy performed based on your rules. If you don’t know where your exact entries and exits are on the historical charts, then the rules are not specific enough.
Write down all the profits and losses. This will give you an idea of how the strategy actually performed over the lookback period. The more trades included the better.
If the plan is profitable over many trades on the historical charts, implement it on a demo account and see how you do.
If you want to start live trading right away, use a small position size as set out in your position sizing section. This assures that you don’t blow through capital testing out an idea.
Updating the Plan
Updates to the plan are only made OUTSIDE OF TRADING HOURS. This way, we aren’t allowed to change our plan while we are trading when our emotions may be high and logic low.
Updates should be backtested and/or well thought out before being added. Updates must align with the other elements of the plan. The elements of the plan work together, and should not conflict. If an update creates a conflict, resolve it before trading.
Nothing gets traded with real capital unless it is in the trading plan and has been run through this process.
How You’ll Review and Improve
You have a plan you are going to trade. Awesome. Whether things go well or poorly, how are you going to improve? How are you going to track your trades?
Will do you do a daily review of your trades? A weekly and/or monthly review? What are you looking for? Glancing over charts, with no action steps, doesn’t do much. Will you implement action steps for improvement and will you allocate time for making those improvements? How will you track your trading mistakes, and what constitutes a mistake for you?
The main focus should be to determine if you followed your trading plan rules or not. If you did, great, if you didn’t, there is work to do.
Over many trades, if you find you did follow your rules but you lost money, then the trading plan may need to be revised. The strategy you are using isn’t working.
If you didn’t follow the rules, then you have no idea if the trading plan works or not, and you have a really big problem (whether you made or lost money) because you have no idea if your results are repeatable. So here, you need to work on building your discipline and finding ways to follow your plan.
If you find you have trouble following your plan, the first step is to check out my video Why We Mess Up Trades. It provides some tools to help.
Additional Features to Add to Your Trading Plan
A daily routine makes things so much easier because it assures you have done everything you need to do, each day, to prepare yourself for successful trading.
In your daily routine, especially your pre-trade routine, you may wish to calm your mind for a few minutes, choose a specific focus, visualize implementing each of your strategies and holding a trade to completion (winner and loser), reinforce what you will do if you make a mistake or encounter a common problem.
Every day, I like to reinforce that I have no expectations for today. I know my strategy produces great returns over many trades, but I don’t know what my results will be today or on a particular trade. So I let any expectations go. I will trade what the market offers, nothing more, nothing less, using my strategies.
It is advised you review the strategy section of your trading plan before trading, every day, so the look of a good trade is fresh in your mind (the strategy section of your trading plan has pictures or drawings).
Daily routines are covered more in Make a Daily Routine to Improve Your trading, Discipline, and Life.
Short-Term and Long-Term Objectives
Defining your objectives will actually help you with building a plan. A trading plan for someone that wants to make 10% per year will look very different than someone who wants to make 200%.
Most people start with the goal of making as much money as possible, but don’t actually come up with a number and then work backward to see how that might be achieved with the plan. The plan may not be capable of achieving the goal. Or the plan may exceed the goal, but when we have a windfall we aren’t expecting this can actually cause some people problems. They blow it all because they are unprepared for it and think it is so much money that they can start to “play” with it.
Do you want to trade for extra income? To build wealth? Do you want to trade full-time and replace your current income? Do you want to be the best trader in the world? Do you want to hit certain profit milestones?
Is your current strategy scalable to reach long-term goals?
Is trading a destination on its own, or is it a means to an end? If it’s a means to an end, what is your exit plan? How will you know it is time to quit?
If you have tested your strategy, and you know the typical reward:risk and win rate of the strategy or plan, then you can start to calculate how much profit potential there is in the strategy based on position sizing and how many trades are taken. Here are some example scenarios for how much a forex day trading can make.
How will you meet your short-term and long-term goals? What steps will you take? Break it down to a trade-by-trade level. Include it in the plan.
Cheat Sheets / Checklist
For any market you trade, have a cheat sheet. This is basically a condensed version of things you look for on each trade. Your trading plan has all the details, your cheat sheet sits beside you and is a quick reminder of the main points that create or nullify a trade.
If you prefer, you could also think of this as a checklist. Things that need to be there, or can’t be there, in order to take a trade. It may also include reminders to yourself about common errors you make and how to avoid them.
How To Handle Trading Psychology Issues and Negative Tendencies
We ALL have issues that will affect us while we are trading, the only difference between people is how honest they are with themselves.
As you start trading, you will notice things that cause you to mess up trades (a trading mistake is when we don’t follow our trading plan, it has nothing to do with making or losing money). Sometimes it is something random, but often mistakes will be linked to the same issue.
We may be doubting ourselves, we may be overeager, we may get greedy, we may get scared, we may not be paying attention (distracted).
It is up to us to find ways to minimize these issues, at least while we are placing trades. Brainstorm how to reduce the severity of these issues.
It may include constant reminders, working on problem areas of our life, doing a parts negotiation, visualizing more before trading, or having someone oversee our trades.
Those problems aren’t going to go away no matter how you long trade unless you actually take specific steps to improve them. What will those steps be? And how will you monitor your progress? The weekly and monthly reviews help here.
How to Handle Big Wins, Big Losses, and Winning and Losing Streaks
You happen to be swing trading in several stocks, and two of them have buy-out offers within the same week for more than 100% in profits overnight. You just made more profit in a few days than what you typically make in months.
Or maybe you just had a stellar run. You’ve accumulated a massive return compared to your normal returns. Realize that this is likely a statistical anomaly. Over time, you will experience good runs and bad runs purely as a result of wins and losses being clustered together.
Do you pull some of the money out? Do you keep trading with the larger amount? Do you alter position size at all? Change nothing?
Decide BEFORE it happens, because a big win can affect your psychology and result in not making the best decisions. Many traders report that their worst stretch of trading coming comes after a good stretch.
The same goes for a big loss. A stock you are holding has bad news and gaps down 50% almost instantly. You only wanted to lose 5%…so you take a loss 10x what you expected. It happens. Or maybe you are on a losing streak. How do you deal with that in terms of your trading? Do you reduce your position size? Do you take a break? At what drawdown percentage of your account do you reduce position size or take a break? 10%, 15%, 20%?
Do you have a point where you stop trading altogether?
How You Handle External Inputs
I only trade my own strategies and trade ideas. I don’t care what other trader’s opinions are. I don’t watch the news, read market commentary, or listen to other’s “tips”. I don’t get wrapped up in trying to forecast where things may go. I trade the strategies in my trading plan and that is it.
BUT, I do have several performance coaches that I regularly see who help me trade my trading plan the best I can. I regularly attend self-improvement and psychological workshops, and anything that may improve my mental performance for trading my method.
After you have developed your trading plan, will you still listen to other’s trade ideas and commentary? Why?
Will you subscribe to a certain newsletter or signal service? Why?
Will you get trader coaching? With who, and why? There is nothing wrong with these things, but make sure it is a conscious well thought out decision.
Think about the inputs you want in your life, that will benefit YOUR trading style. Keep those inputs, leave the rest.
Balance Work and Life in the Trading Plan
Most people come to trading because they want more money, but they also want more time. They want to leave their job and be able to trade a few hours a day to make a good living. They want to have time to do all the other things they enjoy.
It is possible, and yet when I talk to new traders (and many experienced traders too) the exact opposite has happened. Trading has taken over their life. It consumes way more time than they originally thought. They are addicted to checking their charts. They have swapped being tethered to a job to being tethered to the markets. It’s fine if that is a conscious choice, but for many “It just happens”, and that is not healthy.
Like anything in life, trading requires boundaries. How much time will you spend trading? What time of day? Will you do your trading at the same time every day/week/month?
Will you check your trading account on your phone? How often, and why do you need to?
Will you check your charts/account when you are with your family or friends? Will you trade from your phone (not recommended!)?
Does your trading schedule allow for the things in life that you wanted more of? How do you align your trading so you get more of those things?
How does trading affect your family, friends, and other relationships? How can you make trading IMPROVE these things?
Work gives you holidays? When will take holidays from your trading?
Withdrawals and Compounding
Traders that make money are faced with withdrawing capital to put toward something else, or maintaining the money in the account and attempting to grow it even more (compounding).
How and when you will you withdraw capital? Monthly? When you make a certain amount of money or are up a certain percentage?
Can you withdraw available capital without trades having closed? For example, your balance may have been 100,000 and now it showing 120,000 based on open positions, but you haven’t actually closed those trades yet. Can you withdraw any available capital based on those potential profits? The choice is yours.
Is your strategy capable of being compounded significantly? If you risk a fixed amount on each trade, your account will increase, but more slowly than if you risk a percentage of the (growing) account on each trade.
If you are going to compound make sure your strategy is actually designed to take advantage of the larger amount of money. Otherwise, if the money is not being used, it may be better to withdraw it.
If your account grows quickly, do you feel psychologically ready to trade a $100,000 account the same way you traded a $10,000 account? What about a $1,000,000 account? That may be a ways away, but it is important to think about.
Basically, how will you pay yourself? When will you pay yourself? And if you just want to keep compounding the money, when will you eventually withdraw it?
This section directly ties into you short-term and long-term goals.
Independent Trader, Proprietary Trader, Business
Most people just start trading on their own, with their own money. They are independent and pay their own taxes.
Proprietary traders work for companies. The company typically provides them with capital, and then the company pays the trader. The trader pays their taxes out of the (typically) monthly paycheck they get for their performance.
Some traders may decide to operate as a business. They run the business and act as a trader for their own business. They pay and file business taxes, pay themselves from the business’s trading profits, and then also have to handle their own finances.
Which one is right for you will depend on which options are available to you, and in all cases, it is worth talking to an accountant if you are serious about making an income from trading.
Define your trading business model in the trading plan.
Savings and Taxes
If you think a bad stretch for your trading will never occur, you are lying to yourself. You have not been honest with your limitations and the life circumstances that could arise over time to throw you off track. Sickness, deaths in the family, divorce, breakups, having to move, having children, depression, things that distract you, lack of interest, and the list goes on. Eventually, things happen, and they WILL affect your trading.
Saving is a requirement. At some point trading revenue will dry up, for whatever reason, and for however long it takes to get it back on track.
If you have money saved for such times, or alternate streams of income, then these periods aren’t so bad. There is less pressure to start making money again.
If there are no savings, it will make these times much more difficult. Add to that the immense pressure of HAVING to make money from trading when you are not. Ouch.
Determine how you will save, and how much, so you can weather any storms that may arise.
Taxes are also a reality of trading. How will you handle putting aside money for taxes? Will you try to implement any tax-saving scenarios? Do you need an accountant if you are unfamiliar with this area of tax law?
Final World on Building a Complete Trading Plan
These are all things you want to consider in your trading plan. But if you think through all these topics, you will be way further ahead than most people out there who just come to the market and hope to make some money. PLAN!
The more you plan, the better equipped you are to handle situations as they arise. And we all know life is messy, so we may need to update our plan from time to time. That’s ok, update it as life and goals change.
But put time and effort into those changes and making the trading plan. This isn’t just for certain types of people. This is for everyone who wants to be a better a trader, and wants to give themselves the best possible chance at success.
You get out of trading what you put in. If you don’t know what you want, specifically, and haven’t laid out a plan to get there, trade results will be random and the long-term result will likely be failure.
Thoroughly plan, and you will have a much better chance at success.
Cory Mitchell, CMT
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