10 tips to create a perfect trading plan

How to Create a Trading Plan

Just as you wouldn’t consider setting off on a yacht voyage without nautical charts, a well-equipped craft, and a plan for dealing with maritime contingencies, neither should you embark on a trading endeavour without well-researched forethought.

But what is a trading plan? A trading plan guides your trading and answers big questions like what securities to focus on, how to identify the most promising assets or trades, how quickly to make trades, and how much risk to take on. It also clarifies what your goals are as an investor or trader.

Full answers to these broader questions lead to a system of actionable rules that can govern specific decisions for a coherent and shrewd approach to your trading activity. Read on for more information on how to set up a trading plan.

Make the plan your own

You have unique motivations, goals, knowledge, and risk tolerance. No two traders are exactly alike, so no two trading plans should be either. Copying the trading plan of a successful trader is no guarantee of success for you.

Set entry rules

These rules establish when you will enter a trade. They are commonly based on price levels or a technical indicator signal.

Set exit rules

These rules can be for take-profit orders, which are ways of specifying when you will sell an asset to realize your gains. They can also be for stop orders, which contain your losses within pre-established limits.

Decide on the size of your position

This can be expressed as the proportion of your total capital you are willing to risk in a given trade and is directly influenced by your risk tolerance. Setting this percentage helps you decide where to place stop losses.

Make rules related to volatility

For day traders, for example, a security or market with little volatility may not be worth trading, as the chances of turning a profit are slim. Part of their plan may be to only place trades when a certain amount of volatility is present in the market.

Define your stance on leverage

Leverage means borrowing money to increase the size of your position. It magnifies your potential gains but also your possible losses. Make sure your plan regarding leverage is consistent with your rules for the size of the position and risk tolerance.

Take correlated assets into account

Correlated assets are assets that have parallel price movements. If you hold positions in two stocks that follow a similar trajectory, your exposure to that factor is magnified. This may not be bad. It just needs to be considered and addressed in your plan, so you aren’t unwittingly taking on more risk than you intended to.

Keep records of your trading

Without data about your past activity, decisions about how to improve in the future will be subjective. An essential tool here is a trading diary. Write down technical details and your emotional state, reasoning, and any deviations from your plan.

Stick to the plan

Even the most thick-skinned traders can be enticed to make emotional decisions when large sums are on the line. A trading plan gives you the emotional and temporal distance from situations and keeps your trading activity as logical and rational as possible. Your efforts to create a comprehensive and watertight plan will come to nought if you chuck them out the window in a moment of panic or euphoria.

Be willing to revise your trading plan

This advice may seem to be at odds with the previous tip, but the key is how you go about revising your plan. Revising does not mean throwing caution to the wind whenever your plan grates on your intuition or excitement. It’s an analytical activity that’s divorced from the thrill or pain of the moment. If your plan is not making money, it’s time to overhaul it. If you feel you can improve the plan, calmly and deliberately weigh the potential improvement and test it against different scenarios.

Creating a trading plan is complex but essential, so be patient and give yourself time to continue gathering information about how to write a trading plan that successfully serves you and your particular goals.