A trading plan is a collection of guidelines a trader adopts to facilitate a profitable trading life. It is a framework that states your trading instrument, the goals, market entry and exit, the trading strategies (trends, counter-trends, breakouts, consolidations), and, most importantly, proper risk management.
It is the habit of professional traders to develop a concrete trading plan to have an edge in the market. It is counterproductive to invest before establishing your trading plan. If you do so, your capital might be at risk. With that said, let's go through the process of developing an appropriate trading plan.
How To Create A Trading Plan
Guidelines for developing a trading plan:
• Set your goals
• Choose your analytical approach
• Select your favorite trade setups (entries)
• Limit the market to focus on
• Think about your holding period
• Know your risk tolerance and risk management (stop loss, take profit, and exit)
• Psychology and emotions
• Journaling
Set Your Goal
Setting your trading goals (profit targets and risk/reward ratios) is a huge step in developing a successful trading plan. It is appropriate to assert your goals before entering a trade. It boils down to your risk management; which we'll talk more about as we go.
Choose Your Analytical Approach
Choosing your analytical approach is another vital component of a solid trading plan. With it, a trader can identify trade setups, resistance, moving averages, Fibonacci levels, trend lines, Elliott wave theory, or fundamentals, chart pattern (consolidations, trends, breakout), and price action.
This initial step of the trading plan allows traders to narrow their focus on a handful of scenarios that aligns with the trading goals. After that, traders can look for opportunities to trade based on preferred trade setups.
Select Your Favorite Trade Setups (Entries)
Your favorite analytical approach triggers a trading setup, which, for example, would be viewing a consolidation pattern. It is usually listed in the analytical approach as a chart pattern. Your trade setups trigger responsive action from the trade, meaning you could either trade a breakout or wait for a pullback. Another example would be identifying the sequential higher high and high low sequence, which implies an uptrend. The trader could then wait for a retracement and place the buy order at the next support.
Setups are simply pieces on the chart falling in place, leading to high trading chances for newbies in the forex industries. It could take some time to figure out your favorite trade setups; however, it is advisable to stick to trends.
Limit The Market To Focus On
A colossal mistake so-called professional traders make is not sticking to a particular instrument. There are instances where traders with multiple instruments: trading the forex or CFDs at the same time tend to lose focus on their trade. It is advisable to adhere to a particular instrument, either forex, futures, stocks, or commodities— and not all of them at the same time.
Think About Your Holding Period
Time frames will depend on the person or type of trader. Scalpers and day traders focus on short term trades (trades opened and closed on the same day). Medium-term traders hold trades for a few hours up to a few days and are referred to as swing traders. While Long term trading involves time frames ranging from several days, weeks, months, and in some cases, years. Determine which of these categories is your most preferred.
Know Your Risk Tolerance And Risk Management (Stop Loss, Take Profit, And Exit)
An essential part of developing your trading plan is risk management. A trading plan without proper risk is like building a skyscraper without a solid foundation. It's on its way to collapsing, or in this case, you blow your account. Traders need to discover their risk tolerance, which corresponds to setting stop loss to limit downside risk. When setting your stop loss, there are different rules to follow. However, they are all applicable in the sense that you could either set your stop loss tactically (using the ATR and other ones of such). It is said not to risk more than 1% of your account, so after calculating what 1% is in your account, you shouldn't take trades more than 1%. Lastly, you can decide to risk only 30 pips on all trade and abiding by it strictly.
While exiting your trades, your take profit should be an excellent risk to reward ratio, meaning if you risk 30 pips on trade, your risk to reward should be around 1:3. Consequently, you make a profit of 90 pips, which would be where you exit your trade.
Psychology And Emotions
Trading successfully in the financial markets calls for a collection of skills. They include the ability to evaluate your psychology and don't play mind games with yourself and your hard-earned capital. If the setup doesn't fit in your plan, leave it no matter how lucrative the opportunity. It's better safe than sorry. And the emotional aspect of the whole psychology thing is you closing a trade while still running after setting your stop loss or closing a trade before hitting the take profit mark.
Journaling
A trader's best tool for performance management is a trading journal. It is where you keep track and review daily trades for better output and future reference. A journal can help you track progress and study mistakes made when entering or exiting a trade. Do make a trading journal where you record your vital metrics for future use.
Metrics you should record down on your pc or book.
1. The date you took the trade.
2. Timeframe
3. Setup
4. Instrument
5. Lot size
6. Price in
7. Price out
8. Stoploss and take profit.
9. Profit and loss in your currency (dollar, pound, Euro, Swiss franc).
Final Words On A Top Trading Plan
The steps to developing a reliable trading plan are not limited to the ones listed above. But they are necessary if you want a trading plan that works. Do understand that the trading plan's primary objective is to keep you on task and work effectively and efficiently to make the right trading decisions.
