A trading plan is a set of rules that covers various aspects of your trading life. Traders with a plan will trade better than those without. The old saying in business “Fail to plan and you plan to fail” applies here. The traders with a plan can enter into the markets with better ideas of their own personal psychology, style, strategy and goals. The plan allows them to monitor their performance, evaluate their progress, and trade more objectively – with less emotion and stress. It provides a set of rules to keep them focused in the right direction, which is to be consistently profitable. A good plan strictly adhered to will help minimize losses and stay in the game longer.
A trading plan facilitates your decision-making by helping reduce the influence of your emotions from the equation so that you can trade more efficiently. It helps you become more like a cool and calculated trading robot (your trading decisions and actions calibrated to the “code” of the plan) instead of an egoistic, emotional, and stressed trader flying by the seat of his pants, making faulty, irrational judgments in the heat of the moment. If you trade with an automated system or EA, which incorporates much of your plan within its own customized algorithms, then you probably do not need to follow a trading plan as much as code it within the EA. A trading plan is a way for manual traders to become more like highly sophisticated, adaptable trading machines; and with time and experience, perhaps even better than any trading robot because of the greater computing power and adaptability of a human brain.
It is important to differentiate a trading plan from a strategy. It is easy to confuse the two.
- A strategy covers things like entry, exit, managing the trade, money management.
- A trading plan is like your business plan, covering your mindset, strategy, trading routine, goals, rewards, and emergency actions. It keeps you focused.
A good trading plan should be solid and fluid at the same time: it should be written in stone while you are trading, but subject to re-evaluation after the market has closed. It should evolve and change with the changing market conditions as well as to the new ideas, skills and knowledge of the developing trader.
What are the primary Features of a Trading Plan?
Trading plans need to be simple as it makes it easier to follow and simple approaches have proven to work over time. Here are five important features that every plan must have.
- Trading Mindset
- Trading Goals
- Trading Risk and Money Management
- Trading Strategy
- Trading Routine
We will go over each one with a bit more detail, some questions asked of each one, with some example answers.
Trading mindset represents the self-assessment of the trader regarding his particular mental attitude towards trading, his emotions during trading, his space and time for trading, and his strengths and weaknesses. Let us break these down into questions, which we will later follow with an example.
- Why do I want to be a trader (motive, talents)?
- What is my trading style (fundamental/technical, day/swing/position)?
- What are my strengths and weaknesses? (list, specify how to maximize former, minimize latter)
- Am I in the right frame of mind (are you calm and relaxed or stressed, tired, emotional)?
- How much time do I expect to devote to trading, developing my system and conducting trade research?
I am a technical trader and my style is day trading and scalping. I only have 2 hours to devote to trading each day, and in that window of time I hope to be in out and within 0-4 trades, depending on the market conditions and technical set-ups that I am watching. I will only trade on days that I am rested, relaxed, and not distracted by work, family or other events in my life. I have an extra hour in the day (in the evenings when kids are in bed) to devote to trade review and system research and analysis.
My primary strength is that I am self-confident with a good eye for the market. I can see a situation developing on a short time frame and exploit it. My primary weakness is that I become emotionally attached to the trade (or trade direction) when I have to be more adherent to the system and its exit rules. In order to handle this weakness, I will follow the rules of the exit strategy in a strict fashion, or I will work with an exit EA or script that handles more robotically the exit conditions.
There are many reasons for becoming a trader, and making money is common for all, but it is important to know your financial targets. Setting goals is an important part because it provides you with a beacon to work towards, the ability to track your progress and the motivation to work towards.
- What is my trading goal? Why do you expect to achieve it?
- What are my income targets (per week, month, year)?
- How will I know when my plan is working or not?
I can achieve this goal because my strategy is well developed and researched: it has been back and forward tested over the last 4 years to be consistently profitable. The edge factor is the high probability of winning trades.
If I can remain true to the strategy and trading plan, my goal is achievable. If, despite my rigorous adherence to the strategy and plan, I do not meet my goals, I need to reevaluate the system, the markets, and my relationship to both. If I achieve my goal for two consecutive months, I plan to reward myself by taking a holiday with my family.
Trading Risk and Money Management
Risk management focuses on the risk of each trade, the risk-reward ratio, winning probability, and position sizing. Depending on your account, the pair and the risk you accept per trade, you should be able to calculate the exact size of the position you should use for the trade. Money management, on the other hand, focuses on initial lot sizing in relation to account size, and how it increases and decreases as the account grows or falls.
- What is my attitude towards risk?
- What is my overall market risk?
- What is my stop loss?
- What is my strategy risk – that is, the trade accuracy combined with the risk-reward ratio per trade?
- What is my optimal lot size, and maximum risk per trade?
- What money management approach will I use?
- What will I do in the event of a large draw down?
- What is my broker and hardware risk?
Note: a good calculator to help you determine your position sizing relative to your ideal percentage risk per trade can be found here: Position size calculator
Since I will be risking 50 pip stop loss for every potential 25 pip profit target, my risk/reward ratio is 1:2. It is not the best risk reward ratio but I expect to come out ahead with the 75% probability of a winning trade, as determined by backtesting.
I aim to risk only 1% of my account on any given trade. Since I am going to trade with $1000 with a 50 pip stop on EUR/USD, I can trade with 2 micro lots at a time (2 micro loss of 50 pips = -$10). My money management approach is fixed fractional: I will trade 0.01 lots per $500, increasing it or decreasing it for every $500 up or down in my account. I will be starting out with $1000 (a sum I can afford to lose), and my starting lot size will be 0.02, as per my money management rule. I will lock in profits with a trailing stop that protects 50% of the profits after 15 pip move in profit. I will stop trading in a day if 5% of my account has been lost. In the event of a 30% draw down, in any given period, I will stop trading for the month and review my system and risk/money management approach.
My main broker is Forex.com/UK; I do not have a secondary broker because I do not need one. In the event my PC crashes, I have a backup, mirrored PC that I can trade from. My MT4 platform is free, my two pcs have been paid for, so the only expenses I incur are electricity and brokerage transaction costs.
The core of the plan is the strategy, which consists of the entry and exit rules. Most strategies fall within three groups: trends /breakouts, retracements, and reversals. A setup is the set of characteristics that help you identify the right conditions for a trade, and a signal is a specific condition that is met that triggers your trade. Both entries and exits can have setups and signals. We will be looking at both.
- What are your setups for entry?
- How will you find your setup?
- Which signals will trigger your entry?
- What are my setups for exit?
- What signals will trigger your exit?
- What are the profit targets (and profit protection mechanisms)?
- What are the stop losses and adjustable stops to limit loss?
My entry setup will seek to identify the larger trend of EUR/USD via the 100 and 200 period moving average of the H1 chart. The trend is UP/DOWN if EUR/USD price is above/below both the 100 and 200 moving average of the H1. Once trend direction has been established, I will be awaiting a secondary setup on 100 and 200 period moving average of the M5 chart. If EUR/USD retraces back to the 100 MA of M5, the retracement condition has been met. The specific signal: buy /sell if EUR/USD bounces upwards/downwards from the 100 MA of M5.
Having a routine in place is a way of reviewing progress and ensuring discipline. Your brokerage statement will be logging all your trades, but you should be reviewing and keeping notes for each one. It is vital to keep track of your past trading in order to recognize past mistakes and avoid them in the future.
- What is your routine?
- Have you analyzed your last trades?
- What questions will you ask of a winning trade?
- What questions will you ask of a losing trade?
- What promises do you make to yourself?
I will review all my trades every day to make sure I have adhered to all aspects of my trading plan. If I have winning trades, I will guard against overconfidence and ponder the reasons for the win. If I have losing trades, I will guard against negative emotions, examine each one to see what I can learn from it, and remind myself that the execution of plan is more important than outcome. I will evaluate my emotional state of mind to ensure that I am calm, relaxed and ready to enter the market again with a professional attitude.
If I break any rules of my trading plan, I will stop trading for the day and focus on the reasons why there was a breach of discipline.
Trade your plan consistently. You can make modifications to improve its performance, but be disciplined in your approach.
Remember, you should be executing your personal trading plan through a demo account prior to using real money. You will then see how it works, iron out any bugs, and fine-tune your entries and exits before risking a single penny. You should have done some back testing on the strategy and plan, but do not rely on only that. There is no sure way to properly back test a manual trading system–for the eye and human bias can play tricks on you. You should trade your system in a demo account for a number of months, keeping in mind that the system or plan might need a lot of modification, or be scrapped altogether as faulty, like 95% of them are. Only when the plan has been thoroughly back and forward tested as reliable and consistent should you be looking to trade it with real money.
Later on, when you have ironed out and formulated the best scenarios and conditions for your trading plan, you might want to explore ways to codify it into an automated robot or EA. Theoretically, all trading strategies and plans can be codified–no matter how subtle and sophisticated–and there are plenty of advantages of doing so. It would be nice to have the robot inherit your ideas so that it can continue with your hard won legacy and experience–working while you rest, making money while you enjoy your life.
Alternatively, you might love trading so much, or you have become a super disciplined trader with your plan, that you do not want or need to have a robot replacement. Thanks to the rigid adherence to your trading plan, you have become the cyborg trader of your dreams–able to conduct your trades consistently, logically and according to rules, without interference from whim, emotion, or ego. You just need to remember to become human and emotional again after your trading session, otherwise your friends and family will think you have gone nuts.