Last Updated on 12 June, 2021 by Samuelsson
A popular adage goes this way: “Who fails to plan, plans to fail.” Planning is essential to the success of any business, and trading is not an exception. Any experienced trader you as about his success secret would tell you that having a good plan and being disciplined enough to implement it is the difference between making money and losing money in the financial markets. But what is a trading plan, and how do you create it?
A trading plan is a set of rules you write down that governs how you participate in the market. It covers every aspect of your trading, including your trading strategies, money management, risk management, trade management, the markets to trade, when to trade them, how to keep a trading journal, and how often you review your trading journal. Your trading plan is like a roadmap that guides you through the entire trading process.
In this post, we will discuss the topic under the following subheadings:
- What is a trade plan?
- Understanding trading plan
- The advantages of having a trading plan
- How to create a trading plan: Forex trading plan checklist
- How to put your trading plan into good use
What is a trade plan?
Surely, there are many things you may want to know about how to plan for your trades. If you love trading the forex market, you may be wondering: what is a trading plan in Forex? Well, irrespective of the market you trade(Forex, equities, or futures), a trading plan is a set of rules you write down that govern how you participate in the market.
Your trading plan covers every aspect of your trading, including your trading strategies, money management, risk management, trade management, the markets to trade, when to trade them, how to keep a trading journal, and how often you review your trading journal. Your trading plan is a roadmap that guides you through the entire trading process.
Essentially, your trade plan is like a roadmap that guides you through the entire trading process. Now, you may ask: what is the process of trading? It is basically the process you go through when placing a trade: choosing the market to trade, spotting your trade setup on the chart, knowing how much of your capital to risk in the trade, placing a trade, setting your stop loss and profit target, managing the trade, exiting the trade, recording the outcome, and reviewing the outcome later with other those of other trades.
Therefore, a trading plan is a comprehensive tool that you use to prepare your decisions regarding important trading variables — such as which market to trade, what constitutes a trade setup, how much stop loss to use, when to take profits, and how to identify other tradable opportunities — before facing the market so that you don’t have to make those decisions at the heat of the moment. It forces you to stay focused on your trading rules while offering you a reference with which to judge your trading activities.
Understanding trading plan
To explain it better, let’s consider the following:
Trading plan vs. trading strategy
Of course, a trading plan is different from a trading strategy. A trading strategy is a method you use to find your trade setups, but a trading plan is all-encompassing, as it contains everything from the trading strategy and risk management to the trading journal and how often you review it.
A trading plan shows how to implement your trading strategy, along with other elements that make will make your trading successful. However, having a great trading plan won’t make you successful, no matter how perfect it is. You can only succeed if you strictly implement the plan.
Contents of a trading plan
For the most part, a trading plan should consist of the following key components:
- Your short-term and long-term trading goals
- The capital available for trading
- The markets you intend to trade
- The time you have for trading
- Your trading strategy
- How you intend to manage trades (trailing stops, )
- Your attitude to risk
- Your risk management rules
- Your methods of documentation and review
- Your growth strategy
While creating a trading plan from scratch may seem difficult, you can find a trading plan template to model your own. However, it is best to create your own plan so that it would reflect who you are and your personal realities. When your trading plan is not personalized to reflect your trading situation, you may not be able to follow it strictly, which may lead to erratic trading or analysis paralysis.
The advantages of having a trading plan
If you are disciplined enough to create a good trading plan and adhere to it, you will enjoy a lot of benefits that come with it, which includes the following:
- You get to plan your trades ahead: With a trading plan, you get to prepare for your trades in advance, so you know exactly what to look for in the market. You know what constitutes your edge, when it occurs, and how to spot your trade setups.
- You will make objective trading decisions: Your trading plan tells you what to do in any market condition. You would know whether it is safe to enter a trade or not, and when you’re in a trade, you will know when to cut your losses, and when to take profit. In other words, it prevents you from making important trading decisions at the heat of the moment and reduces your chances of making costly trading errors, such as shifting your stop loss or missing a trade setup because of fear from a previous loss.
- You will become a more disciplined trader: If you consistently implement your trading plan, you would become a rule-based trader and won’t have to depend on discretion. Also, when you strictly implement your plans, you will know what works and what doesn’t work, and why they do.
- You can easily review your trading results: A good trading plan would require you to have a trading journal where you record every aspect of each trade, including time and date of trade, the setup, entry price, stop loss, profit target, exit level, the reason for exit, profit or loss, and more. You will use these data to evaluate your trade executions and their corresponding outcomes.
- You can easily adapt and improve your plan: As the markets are always changing, you need to also review, improve, and adapt your trading plan to the prevailing market condition. With your trading records and assessment after a series of trades, you can decide to tweak your plan to reflect the present market conditions.
How to create a trading plan: Forex trading plan checklist
It is not easy to build a trading plan, so you may be tempted to look for an example of a trading plan to model your own after. However, you need your plan to be unique. Getting a Forex trading plan example wouldn’t allow you to create a personalized plan that suits you. It is best to create your own trading plan from the scratch.
What you need is to understand your personality, know your trading style, define your goals, and establish your trading strategy. To create a unique trading plan, follow these steps:
1. State your trading goals and objectives
You can many different goals in trading, but the primary thing is to survive the market and then start making profits. To survive in the market, you must protect your capital so that you can be in the game long enough to start making profits. Warren Buffet once said, “The first rule of the game is to preserve your capital, and the second rule is to never forget the first one.”
But in addition to that, you need to create some SMART (specific, measurable, attainable, relevant, and time-bound) goals, both short-term and long-term goals. Perhaps, your short-term goal may be that you want to execute all trades that match your trade setup in all the markets you are watching for the month, while your long-term goal may be to increase your trading capital by 20% in the next 1 year. Write both goals in your trading plan.
2. Determine how much time you can devote to trading
You need to not only specify how much time you have for trading but also state the time of the day you can devote to trading activities. First of all, will you be a full-time or part-time trader? If you have a full-time job, you may only trade part-time, so you have to plan your trading activities after work hours.
Furthermore, the style of trading you want to adopt would also determine the time you commit to your trading activities. If you want to be a day trader, you will obviously need to be monitoring the markets for most of the day. But if you want to be a swing trader, you can spend only a few minutes a day in front of the screen. Whatever you decide, note it in your trading plan.
3. Know your trading style
You need to know the type of trader you are and the trading style that fits you. To understand the type of trader you are, you need to understand your personality, the amount of time you can commit to trading, and your risk appetite. Note your style of trading in your plan.
There are four styles of trading, and you can choose to employ any of the styles:
- Scalping: Making plenty of trades in a day, with each lasting from a few seconds to some minutes.
- Day trading: Opening and closing trades within the same day.
- Swing trading: Holding trades for some days or weeks to milk the swings on the daily timeframe.
- Position trading: A long-term trading style where trades are held for several weeks, months, or even years.
4. Choose the markets you want to trade
You can’t possibly trade all the financial markets, so you have to choose the markets you want to trade. Your choice of market may be based on anything: liquidity, volatility, trends, etc. Some of the markets you may want to trade include stocks, indices, commodities, Forex, future, and options.
Once you have chosen the markets to trade, you have to write them down in your trading plan. Those will be the market you will monitor to look for trade setups and make your trades.
5. Find out the right trading strategy for you
Your trading strategy is one of the main aspects of your trading plan because that is what shows you an edge in the markets. Your trading strategy may be based on fundamental or technical analysis or even both. While fundamental analysis tries to determine the intrinsic value of the asset so as to exploit any mispricing, technical analysis tries to use historical price action to forecast how the price would move in the future. Technical traders create strategies using price action patterns (candlestick and chart patterns) or indicators, such as moving averages, oscillators, etc.
Whatever your strategy is based on, it must be able to show you a trade setup, the timeframe or timeframes on which it should be traded, and how long your trades should last on average. Be sure to establish all these factors and write them down in your trading plan.
6. Document how to use your trading capital
You should know how much you want to start your trading journey with by now, but if you don’t, it’s time to evaluate your finances to know how much you consider a disposable income. Of course, your trading capital has to be a portion of your disposable income — only trade with what you can afford to lose.
Since you are a beginner, you are likely to make some account-blowing mistakes. So, even if you have a lot of free cash, don’t throw everything into the market at once. You should reserve some funds so that if you lose your first trading capital, you can fund your account and try again. Many traders blow up their first account but tend to get it right on another attempt.
The advice here is to keep a reasonable trading capital but don’t use all of them to fund your trading account immediately. Divide them into two or three so that if the first attempt goes wrong, you still have another capital to start again. Be sure to document this in your trading plan.
7. State your money management rules and growth plan
Now that you have stated how to disburse your trading capital, you need to state how much of your account equity/balance you want to risk in each trade. In other words, what percentage of your account equity do you bet in each trade? Experienced traders may use 2%, 3%, or more of their account balance per trade, but new traders are advised to risk only 1% of their account equity/balance per trade.
Your money management rule can determine your position size in each trade. When you find the dollar value of your preferred account risk, you can use it to calculate your position size if you already know the size of your stop loss. Another thing to consider is how to increase your position size as your account grows. The best approach is to continue using your account risk percentage to determine your trade size. Whatever you decide, document it in your trading plan.
8. Write down your risk management parameters
Every trader uses a risk management approach they deem for their trading strategy. Some simply use a specific value — a certain percent of the stock price (say 5% or 10%) for stock trading or a specific number of ticks in the case of futures trading — for their stop loss, while others make use of market structures, such as the support/ resistance levels or trendlines to determine where their stop loss order can be placed.
You should know the approach that works for your trading strategy and add it to your plan. Also, you may need to state how you intend to manage your stop loss when the trade is already in play — do you set and forget, or do you manage it as the trade progresses? Whatever you decide must be included in your trading plan.
9. State how you intend to take profit
Your trading plan must include how you intend to take profits when you are in a trade. There are many ways you can do that but the three common options you can use are as follows:
- You set your profit target and leave it alone, hoping that the price hits it and gets you out with an already determined amount of profit.
- You place multiple partial profit targets at different levels and take your profits in parts. In other words, you are scaling out of your position.
- You set your stop loss order to trail your profit as the market progresses in your favor.
Be sure to document your preferred option in your trading plan.
10. State your emotional circuit breakers
Trading psychology is very essential in achieving success in trading because your emotions, such as fear, greed, hope, excitement, anger, and others, can sabotage all your efforts. For example, fear can lead you to miss a trade setup, while greed can make you chase a missed trade. Also, you may become hopeful that you let a losing trade turn to a catastrophic loss, or you might get excited and overtrade.
Practicing rule-based trading, with a plan for every aspect of the trading process, will surely help you avoid making trading decisions when emotions are running high, but there will be a time when you will need to take a break to regain control of your emotions. For instance, you may want to take a break after 3 consecutive losses so that you end up revenging on the market. How much break you need and what you do to regain control should be documented in your trading plan.
11. Prepare your trading journal
Your trading plan should stipulate how you take records of your trades. Do you keep a manual trade journal or an electronic one? If electronic, does your trading platform have an automated one; is it enough, or do you need to create a Spreadsheet for documenting your trading activities? Whether manual or electronic, for each trade, your journal should include the following:
- The date and time of trade entry
- The trade setup used
- The entry price
- Your stop loss
- Your profit target
- Your exit level if closed prematurely
- The reason for exit
- The profit or loss made
- The time and date of closing the trade
12. State how often you want to review your trading results
Last but not least is to state how often you will be reviewing your trading results to know whether to tweak your plan a bit to reflect the current market conditions. The financial market being a dynamic environment, your plan should be reviewed from time to time but not haphazardly.
How often you do your reviews is up to you to decide: it can be at the end of each month or after you have traded a specified number of trades that make up your sample size (say 30 trades). Whatever you decide, be sure to include it in your trading plan.
How to put your trading plan into use
You should test your trading plan in a risk-free environment before implementing it in your live account. So, here’s what you do: create a demo account and trade according to all the rules and criteria in your trading plan. The idea is to apply every aspect of the trading plan while demo trading so that you know whether you’re comfortable with your plan.
Here are some suggestions when trying to implement your trading plan:
- Create a simple checklist that you can easily tick before making a trade
- Make sure the relevant factors tick right before taking action in the market, such as entering a trade, moving the stop loss, or exiting the trade,
- Be sure to respect your emotional break rules: leave your trading desk and take a walk, chat with a friend, or go for lunch, or taking a walk
- Document every action in your trading journal
- Review your journal as stipulated
- Get a trading plan software if you need to
When you are comfortable implementing your trading plan in paper trading and making money with it, you can progress to a real account. The real test of your ability to execute your trading plan comes when you are trading real money.