A trading plan is a comprehensive framework that guides your decision-making in any trading activity you undertake. A trading plan is to forex trading and CFD trading what a business plan is to a business. As the adage goes, ‘if you fail to plan, you plan to fail’. This is especially true in trading where risk is ever-present in the markets. A trading plan is not merely a trading strategy. A trading strategy will guide how you will enter and exit trades in the markets in a manner that enhances profitability and reduces risk exposure. A trading strategy can be based on technical analysis or fundamental analysis. A trading strategy is just one component of your overall trading plan, which goes beyond that to also capture your overall trading goals and motivation, your trading journal, risk management techniques, money management rules, as well as your trading psychology.
Why is Having a Trading Plan Important?
The ultimate aim for any investor or trader is to achieve consistent profitability in the markets. A trading plan is a guide that ensures you will stay on track on your journey to your desired destination.
It does so by:
- Making Trading Simpler. It is easier to do something when you know what must and should be done. A trading plan lays out all the criteria that must be met before any trading decision is made. It will always point you in the right direction no matter the distractions present.
- Enhancing Objective Decision Making. Trading is about decisions. Good decisions will make you money, while bad decisions will cost you money. Having a trading plan ensures that you will make objective decisions at all times; and not subjective decisions that are driven by emotions which can eventually cost you a lot and put your trades and capital at risk.
- Building Trading Discipline. Trading is a marathon, not a sprint. It is important to build a solid trading plan and following it with religious discipline throughout your entire trading activity. This is the only path to long-term, consistent profitability in the markets. While traders will generally follow the daily financial news, technical analysis indicators, such as the RSI, Moving Averages, CCI or MACD, and forex signals to pinpoint potential trading opportunities, sticking to your trading plan is of utmost importance.
- Highlighting Areas that Require Improvement. One of the core components of a trading plan is a trading journal, which is essentially a diary or record of your trading activity. Journalling your trading activity will help you to assess the performance of your trading strategies as well as other factors of your trading plan, such as risk management and trading psychology. This will, over time, highlight the areas where improvements can be made to help you become a better trader.
How to Develop a Trading Plan
- Personal analysis: Ensure you are ready to trade and that you are able to follow your signals without hesitation. Find out what are your strengths and weakness prior to entering the trade.
- Trading goals: Start off by writing out your trading objectives and setting realistic goals. Look at, and assess your financial goals and timeframes for reaching each trading goal and ensure that when you have made a successful trade you will close the position, don’t get greedy.
- Motivation. Take the time to understand your motivation for trading and what you would like to achieve.
- Assess your trading strategy: Determine if you have the correct strategies for identifying and taking advantage of trading opportunities in the market. It is even wise to test the strategy in a demo account to ascertain its performance before you can roll it out in a live account where real money can be made or lost.
- Be prepared mentally: Outline the conditions that will ensure you are in the trading zone. This involves psychological and emotional readiness to face the trading world. It may mean everything from getting enough sleep as well as being in a positive mood and environment that is devoid of any kind of distractions, whether physical or psychological.
- Perform thorough research: You must do your homework before any trading day or session begins. This involves learning as much as possible about the markets or assets to trade, their most important price levels, and their fundamental picture at the time. Doing thorough research simply means ‘not gambling’ in the trading arena. Research will also boost your trading confidence and make you stay objective throughout your trading activities.
- Identify your markets and trading timeframes: Select your trading style and market according to your knowledge and expertise. The best market for you is the one that you are familiar with. There is no sense in entering a trade in a foreign market that you have no knowledge about and assuming it will be profitable. In addition, ensuring that you are aware of each markets trading session hours is necessary, there is a certain amount of attention that these trades need at the important trading times.
- Know up front what you are willing to risk: Every time you open a position or fund your trading account be sure to enter an amount that will be the maximum amount that you will be willing to risk. Again, do not get emotionally wrapped up in the trades, fund the account and stick to the initial balance. Control your finances by means of money management. Then decide when to open a position and in which direction (buy or sell), this can be determined by analysing charts or reading up on the latest market analysis.
- Specify your entry and exit points. Meaning you must set your stops losses and profit targets, while providing room for adjustments but not getting emotionally absorbed by your trading.
- Manage your emotions! Do not let your feelings cloud your judgement, treat your trading like a business. (More on Trading Psychology)
- Comprehensive journalling: Keep a detailed journal of all your trading activities. This is before you enter a trade, during the trade, and even after the trade is closed. Record your reasons to enter and exit any trade, as well as the targets and underlying emotions or psychological feelings during every stage of your trading activity. If you want to succeed in your trading business, be an excellent accountant – record everything!
- Analyse your trading plan: Make conclusions of all your trades and determine what needs to be enhanced, and what areas you will need to improve or adjust.
Elements that should be added to your trading plan:
- Profitability goals should be realistic. Determine the amount of risk or reward you are willing to accept or take on each trade. Most traders will only open a trade if the potential reward is at least twice their potential risk. This means that for every $1 risked, there should be an opportunity to make at least $2. Goals can be made in absolute dollar terms or as a percentage of your portfolio and should be periodically reassessed.
- How to determine the size of your position according to your trading budget. Position size is a very important element of trading risk. A big position size can mean that a few trades can wipe you out of the market, but a small position size may also hinder the chances of you attaining your trading goals. For most traders, an ideal position size should not expose more than 5% (even lower) of their capital on any individual trade.
- Record your trades as a means of keeping tabs, such as what was opened and what was closed in either profit or loss. In traders’ jargon it’s called “trading diary” and it’s a powerful tool to evaluate your overall performance and accuracy of predictions you make.
- How to manage your positions in Metatrader 4 or Metatrader 5 terminal once they are open and live in the markets. Take the time to learn more about the AvaTrade trading platforms before you trade. You can also open a demo trading account so that you can learn more about managing your trade positions without the risk of losing any money.
- Impartial criteria that the trader will use for selecting, entering and exiting trades. The markets are ever-changing and as such, your criteria will need to be flexible based on the asset selected, the market conditions, and more.
- Outline the emotions you go through during every trading decision you make. Write them down and learn how to expect and control them.
- A work in progress. Understand that your trading plan is a work in progress. The markets are fast and dynamic, and as you grow as a trader, ensure that your trading plan adapts as well to capture your new research or changing investing goals and ambitions.
Stick to your plan!
Questions to ask yourself when planning:
- What is your motivation for trading?
- What is your attitude to risk?
- How much time can you spend trading?
- What is your level of knowledge?
Why create a trading plan?
The same reason as when you start building a house, first you need an architectural blueprint. You would not simply start with buying the bricks and cement without having the correct foundations laid and knowing very well before you enter how much money you have to spend on the house.
It is much the same with trading, even if you have market experience it is not enough to go into a trade blindly. Forex and CFD trading should be treated like a business, that has an organized structure from which it can grow into a successful business.
Furthermore, when there are sudden changes in the markets, the trading plan will assist you with keeping in line with your objectives, and perhaps guard you from making any hurried decisions you could later regret. Trading objectively with your plan in place will allow you to have more confidence and less emotional participation.
Everyone should have a trading plan
Whether you are just starting out in the trading world or you are a seasoned professional, it is always advised to be prepared. A good trading plan will help you in many aspects, such as identifying your goals, organizing your research and finding trading statistics. The decision on which direction to trade in to stay in line with the markets will assist you in managing your emotions when on a losing streak and aid when recovering from a bad trade.
The markets don’t choose who they like, and anyone is at risk, new or experts, and without a plan the market will have no mercy. With more assistance in your day-to-day trading AvaTrade can help you with planning your trades as well as evaluating your risk. Join us now and get the best support 24/5 in your language.
Trading Plan main FAQs
- Do professional traders use a trading plan? Professional traders use very detailed trading plans that they stick to almost religiously. This is one of the characteristics that make them professionals. In addition, the trading strategies included in their plans have typically been rigorously back-tested and improved over time through the use of a trading journal and regular evaluations of trade results. The trading plans used by professionals will have very specific money management criteria, along with specific entry and exit rules.
- Does using a trading plan guarantee success? Nothing guarantees success in trading, but a solid trading plan can help to avoid failure and put you on the path to a more successful trading career. Having a trading plan eliminates some of the roadblocks to success, making it easier to not just place winning trades, but to hone your trading skills over time so that you become increasingly successful the longer you trade. With a proper trading plan used consistently each trade brings you one step closer to becoming a master trader.
- Can I change my trading plan? You will absolutely want to change your trading plan as you become more experienced and learn more about the markets and yourself as a trader. There is little that is static about a good trading plan. It should evolve and change based on changing market conditions and along with the changes in your own trading skills and tendencies. The trading plan should also take your goals into account. You might also find that your entries, exits, stop loss targets, and profit targets all change based on changing conditions.