A trading plan is used to express the actions you will take to express your trading system to the market through entries, exits, and position sizing. A trading plan defines the parameters for executing your signals with real capital in the markets based on predetermined signals. A trading plan is created when the market is closed for use when the market is open.
How to write a trading plan?
Before you can trade, you must first have a trading plan. A trading plan tells you how to specifically run your real-time trading system with real money. A trading plan imposes discipline and consistency on your trading by allowing you to create a trade execution framework based on your research to help you manage your emotions and impulses as they are activated by price action, profits and losses when real capital is at risk.
Here are the questions to ask to gather the data needed to create your trading plan.
- In which markets will you trade?
- How soon will you exchange them?
- What will be your entry signals?
- What will your exit signals be?
- Are your stop losses at price levels that will avoid the noise of normal price action and only be triggered when you are wrong?
- How will you use trailing stops to maximize gains?
- Will you have a price target or will you just leave your profits open?
- Have you tested your entry and exit signals in multiple market environments to ensure they were profitable over the long term?
- What position size will you take for each trade?
- What do you want your maximum loss on a trade to be?
- What are your annual return objectives?
- What do you want to limit your maximum drawdown to?
- What is your expected winning percentage?
- What is your risk/reward target?
- How many vacancies will you have at the same time?
- What will be your maximum risk exposure at any given time?
- How will you position the size based on the volatility of the underlying asset.
- Will you use margin?
- Will you use leverage in your trading?
- Are the markets you trade on sufficiently liquid and do they have tight bid/ask spreads?
- Will you keep performance records to monitor the quality of your trade executions?
How to structure a trading plan?
A trading plan should be structured to minimize losses when wrong and maximize gains when right on a trade. It must express your signals specifically so that they can be executed quickly without hesitation.
Stop losses and proper position sizing minimize losses. Profit targets and trailing stops can maximize gains. Never trade so big that your emotions or ego become too strong to execute your trading plan.
Your trading plan should be based in the context of your system using your watchlist, timeframe, risk tolerance and return goals to express your strategy in action.
What should a trading plan contain?
Enter a business
You need to be clear at what price or technical level you plan to enter your trades. Will it be a breakout through resistance, a bounce off support, or price specific, or based on indicators? You need to be specific and this should be a high probability area on the chart for a winning trade.
Exit a trade
At what level will you know you are wrong and at what level will the risk/reward ratio begin to work against you? An exit can be based on a loss of support, a price level signal, a trailing stop or a predetermined stop loss. Know where you are exiting before you enter.
You must either have a mental stop, an entered stop loss, a time stop alone, or a time stop with an indicator.
You determine how much you are willing to risk on a trade before deciding how many shares to trade. How much you can risk will determine how much you can buy, depending on stock price and volatility.
Quick formula to calculate the potential loss percentage of your trading account per trade:
(Entry Price – Stop Loss Price) x Shares / Total Trading Capital
Money management settings
Never risk more than 1% of your total capital on a single trade. (2% max for aggressive traders who can handle larger drawdowns.)
A position of 20% of your total trading capital gives you a potential stop loss of 5% on your position to equal 1% of total trading capital.
A position of 10% of your total trading capital gives you a potential stop loss of 10% on your position to equal 1% of total trading capital.
A position of 5% of your total trading capital gives you a potential stop loss of 20% on your position to equal 1% of total trading capital.
What to trade
Exchange things you are comfortable with. Swing trading range related stocks, trend trading growth stocks or follow the trend of commodities or currencies. Share what you know.
Are you a day trader, position trader, swing trader or long term trend follower? If you are a long-term trend follower, don’t get knocked out of a position on day one by taking profits or being scared off. Know your holding period and adjust your plan accordingly.
Don’t trade any method until you’ve looked at the charts over a few years to see how you would have done. You can also use backtesting software to analyze your system’s historical data. There are also precooked systems like CAN SLIM, The Turtles Trading System and many trend following systems. You need to start trading knowing that you will have an edge over time.
Keep detailed track of your wins and losses. You need to be sure that your method works in real trading. Review this after every 20 trades. Also, if you have discipline issues, take notes, learn from your mistakes, and make any necessary adjustments.
Risk vs Reward
Enter high probability trades where you risk $100 to win $300, always make sure the risk is worth the potential reward with a risk/reward ratio of 1:2, 1:3 or higher.
All successful businesses must have a plan, and successful marketers are no different. If you don’t have a plan to express your trading edge in the markets, you are just participating in chance and relying on luck.
Trading Plan Template Download
Click below picture to download
- it’s a Microsoft Word model.