Trading Plan

A blueprint for traders to take up logical trades based on specific preset criteria.

Author: Christy Grimste
Christy Grimste
Christy Grimste
Real Estate | Investment Property Sales

Christy currently works as a senior associate for EdR Trust, a publicly traded multi-family REIT. Prior to joining EdR Trust, Christy works for CBRE in investment property sales. Before completing her MBA and breaking into finance, Christy founded and education startup in which she actively pursued for seven years and works as an internal auditor for the U.S. Department of State and CIA.

Christy has a Bachelor of Arts from the University of Maryland and a Master of Business Administrations from the University of London.

Reviewed By: Josh Pupkin
Josh Pupkin
Josh Pupkin
Private Equity | Investment Banking

Josh has extensive experience private equity, business development, and investment banking. Josh started his career working as an investment banking analyst for Barclays before transitioning to a private equity role Neuberger Berman. Currently, Josh is an Associate in the Strategic Finance Group of Accordion Partners, a management consulting firm which advises on, executes, and implements value creation initiatives and 100 day plans for Private Equity-backed companies and their financial sponsors.

Josh graduated Magna Cum Laude from the University of Maryland, College Park with a Bachelor of Science in Finance and is currently an MBA candidate at Duke University Fuqua School of Business with a concentration in Corporate Strategy.

Last Updated:September 22, 2022

A trading plan is a blueprint for traders to take up logical trades based on specific preset criteria. The two main ingredients of disciplined trading are developing a trading plan and sticking to it. 

Following are a few of the reasons why you need a trading plan: 

  • More objective decisions,
  • Better discipline,
  • More room for improvement,
  • Easier trading.

It elucidates what is supposed to be done, when, why, and how. It covers a trader's personality, personal expectations, rules, risk management, and trading systems. 

It eliminates any lousy decision-making in the heat of the moment. Your emotions can get the best of you when money is on the line, causing you to make irrational decisions. You want to avoid that.

A detailed and thorough trading plan and risk control measures are the best ways to safeguard your financial interests. 

Regarding risk control, a few adages seem particularly fitting for new traders: "Trade with money you can afford to lose. Trade positions are so small that you may think, 'What's the point of even putting on the trade."

The key message is that if you can somehow minimize the personal significance of a trade, you will be better able to control your emotions. As you have fewer emotions at stake, there is almost nothing to lose. 

Making a detailed plan is imperative for every trader's market success. This article will guide you in making your first trading plan.

Comprehending a Trading Plan

A well-documented and detailed plan is a base for the trading process. It prepares investors for potential outcomes and lays out alternative options if the market does not perform as expected. 

Trading is not easy money. You must be innovative and creative in the process. The creative trader is the winning trader, focusing on the process rather than the profits. 

The more you know about your creative processes, the better you'll be at trusting your intuitions. Ironically, the first prerequisite for developing a plan is avoiding trying to be creative. 

Trading might seem tedious, as you have to do the same repeatedly. But sensible repetition with making the necessary changes over time is the guide to success.

In short, a trading plan means setting parameters for getting into and out of trades, how much money you're putting at risk, and a profit-making strategy. Think of it as a tool for keeping a cool head as you build and reshape positions when markets are on the move.

It begins with a simple self-assessment:

  • What led you to have that suspicion? Are you considering fundamental or technical variables based on market movements and chart patterns?
  • Which trading approach do you favor? For instance, do you want to square off positions on the same day or keep them overnight? Do you trade with the trend or against it?
  • What do you think the market is doing? Is momentum typically skewed upward or downward?
  • You can start drafting a plan once you've gained some perspective and have picked a list of stocks or exchange-traded funds (ETFs) suitable for your preferred research approach—fundamental analysis, technical analysis, or both.

Creating a Trading Plan

In trading, if you don't draw out a plan for your trades and develop strategies to follow, you have no way to measure your success. A trading plan helps you stay calm during a business and also ensures you have something to look to when you are confused about what step to take next or when you are stuck in a situation.

A vast majority of people do not trade according to a plan. Hence it is not a mystery why they lose money. 

Suppose you enter a trade that you shouldn't have and now are not sure about what to do. Here, a detailed trading plan would come in handy to rescue you from a losing trade.

Trading with a plan is comparable to building a successful business. We will never be able to beat the markets. Moreover, it's not about winning or losing. It's about being profitable overall.

A detailed plan should include the following components:

Component 1: Define your intention

Every individual has their reasons for getting into trading. For some, it may be capital appreciation, while for others, it can be pocket money. 

A crucial stage in developing your trading strategy is outlining your goals and the amount of time you're prepared to invest.

Write down your trading goals after asking yourself why you want to become a trader. Understanding your motivations for trading will enable you to separate the deals you should make from those you don't. 

Trading is an art, and it's like a business. You have to develop the eyesight to spot chart patterns and trends and learn to exploit these opportunities at the right time. 

The famous aphorism, "Time is money," is highly relevant in trading, wherein you have to be quick with your fingers, or the Trade is gone. Do not mistake this for FOMO- quality trades do show up frequently. 

You must learn to develop the skill to identify these trades and time them in your favor to pocket the big bucks.

Sometimes, we spot opportunities everywhere (our mind becomes greedy), and out of these, if we take unplanned trades, we may incur a loss. Hence, it would be wise to decide why you want to trade.

Component 2: Your time horizon/trading style

There are different types of traders, and their trading style is based on the time they hold an active position. The following are the different types of trading styles:

1. Positional trader: Position trading is a strategy wherein a trading position is held for an extended period (generally weeks or months) to achieve profit. 

2. Swing trader: Swing Trading is a strategy focusing on taking smaller gains in short-term trends and cutting losses quicker. 

3. Day trader: Day trading involves actively buying and selling securities within the same day. It consists of relatively large volumes of short and long trades to capitalize on the intraday swings in price action.

4. Scalper: Scalping is a method of high-frequency trading where the trader typically makes multiple trades each day, trying to profit off small price movements.

After determining your trading style and time horizon, you can move to the next element in your plan- "Entry Strategy."

Component 3: Entry Strategy

This element of your plan is crucial and will test your market knowledge. 

Let's break it down into smaller chunks:

  • Trend: Firstly, you have to identify the market trend. There are generally three movements- short, intermediate, and long term.

  • Market Structure: The next step in the process is to locate where the price is relative to the trend you identified in the first step. It will allow you to deploy relevant strategies for the different scenarios. 

Let us say the price in the current market structure is sitting in an uptrend, and simultaneously the intermediate/long-term trend also happens to be bullish; this will give you a higher conviction to go long in the Trade.

  • Price Action: The concept of price action is an entire world in itself. It comes under the domain of technical analysis. 

This step is the most fun of them all. Here, you've to analyze the charts, mark critical supply and demand zones, and more.

Here's an example of a stock consolidating and nearing a breakout:

In the chart above, the price has just broken through a resistance level— where selling might be strong enough to prevent a further price increase. 

Limit your trading to equities that have overcome resistance levels and where trading volume is above average—not just for the trading day as a whole but also for the particular hour.

Following consolidation, the price typically moves powerfully in either direction. In this situation, a trader searching for an entry opportunity would consider purchasing slightly over the resistance level at 2621. 

The trader might also set a stop order at 2593 to help reduce their risks in the case of a reversal.

The stop order would change into a market order to sell the stock if the price fell below 2593. The risk is not reduced; however, there is no assurance that the execution of a stop order will occur at or close to the stop price.

Here's another illustration of a stock that has pulled back from a recent peak and is suffering a retreat. 

We're looking for a potential entry point if the stock takes a short break before surging again.

Start by searching for a point of support or a price at which demand would be sufficiently strong to halt future drops, such as when the stock returns to a moving average or a previous low.

  • Indicators: Trading indicators are quantitative computations shown as lines on a price chart and can be used by traders to spot specific market signals and trends.

Leading and lagging indicators are two examples of several categories of trading indicators. 

A lagging indicator looks at historical trends and signals momentum, whereas a leading indicator forecasts future price moves. Visit our technical analysis page for more details on this topic.

Component 4: Calculate Risk to Reward Ratio (RRR)

Before you start trading, calculate how much risk you're prepared to take on – both for individual trades and your trading strategies. Deciding your risk limit is very crucial. 

Even the safest financial assets contain some risk since markets are dynamic and ever-changing. It's entirely up to you as a rookie trader whether you want to take on less chance to get a feel for the market or more significant risk in the hopes of making more gains.

Even if you constantly lose more games than you win, you can still turn a profit. It simply boils down to reward vs. risk. 

The risk-reward ratio that traders prefer to utilize is one of three or higher, which means that the potential profit from a transaction will be at least twice as great as the possible loss.

Compare the amount you're risking to the possible gain to determine the risk-reward ratio. As an illustration, if you're investing $200 in a trade with a potential increase of $600, the risk-reward ratio is 1:3.

Component 5: Position Sizing

Position sizing is a crucial idea in practically all investments, and it typically has something to do with intraday trading.

Investors can determine the number of units they can buy within the level of risk they are willing to take by carefully assessing position sizing. They will benefit from maximum returns with fewer risks, thanks to this.

A sound trading strategy lays out the parameters for how much risk you're willing to take on every trade. Consider that you don't want to expose yourself to the possibility of losing more than 2 to 3 percent of your account in a single transaction. 

Here is an example: A trader interested in a stock trading at $100 per share with a total capital of $200,000. 

The highest trading budget the trader could set was $10,000, or ten percent of the account. Thus, the trader can only purchase 200 shares ($20,000 x $100).

Let's assume the trader doesn't want to lose more than $4,000 on this transaction out of a total investment of $200,000. The trader can withstand a decline of $20 per share. 

The trader has a stop loss target of $80. This stop order may never need to be used, but it's there in case the Trade goes wrong.

Component 6: Exit Strategy

When creating an exit strategy, account for both trades that go in your favor and those that don't. Even though you might be tempted to continue profitable deals, you should resist the urge and seize the opportunity to benefit.

When a trade is going your way, you can consider, for example, selling a portion of your position at your initial target price and letting the remaining run. It is known as trailing your posts. 

Or if the stock drops below a support level, you can place a stop order at that price to help manage your risk and be ready for when a trade goes against you.

You can use the 21-EMA (Exponential Moving Average)  or the 9-EMA to trail your positions. One should be aware of the emotions that arise while seeing a green figure in the P&L that may make you exit the Trade out of fear of losing the available profits. 

Following your trading plan should be your goal, no matter what. Never exit impulsively out of fear, or it turns into a habit. 

Pro tip: Be conservative while placing targets and generous while placing a stop-loss. 

The reason behind this is that there are times when you place a tight stop-loss, and the price might just hit it and rally in your direction, thereby making you an unnecessary loss, which you do not want. 

Likewise, it is wise to have a target a few points lower than the actual target as there is a tendency for the price to reverse from a few moments lower and not hit the same target levels.

How to make a Trading plan

You can use the following structure to help you formulate your own trading plan. Keep in mind that the trading plan is the personal blueprint, and therefore you should not copy or imitate someone else trading strategy. 

1. Why do I want to trade?

Example: I want to learn more about the financial markets and become an individual trader. I want to be able to make a living out of it.

2. What type of trader do I want to be?

Example: I am a student and also do a part-time job, so right now, I will focus on saving money for trading.

In the meantime, I would learn more about the markets, and once I've figured out what type of trader I want to be (Positional Trader, Swing Trader, Day Trader, Scalper), I will implement relevant strategies related to my trading style.

3. What am I looking to achieve out of trading?

Example: Ultimately, I want to grow my capital by 20% in the next six months. To achieve this, I plan to take up opportunities three or more times every week, but only when they fit my strategy. 

Along with this, if I am meeting my target every six months, I would want to increase my risk every three months, with proper risk management in place.

4. How do I plan my entry?

Example: I will spend a minimum of 2-3 hours every day studying charts and identifying important supply and demand zones, price action zones, market trends, etc. 

Additionally, I would look at the global markets and study the financial statements of a company before taking up a trade. This will help me improve my analytical skills to a great extent and give a boost to my conviction.

5. What is my RRR (Risk Reward Ratio)?

Start by comparing the amount of money you want to risk on each trade with the potential gain. Traders generally prefer a RRR of 1:3. Therefore, if your risk on a trade is $300 and you have estimated a potential profit of $900, the risk-reward ratio is 1:3.

6. How many positions can I take?

Position sizing and RRR are the names of the game. Once you've ascertained the amount of loss that you can take, the next step is to calculate the number of shares you can transact relative to your risk.

7. When do I exit my positions?

Example: Being a new trader with relatively zero trading experience, it would be sensible not to be too greedy and fall into the emotional trap. 

Once I see the price hitting my target level, I will exit my positions and keep my laptop/desktop aside. I will not be greedy and look at the charts to squeeze out more profits. 

On the other hand, if my stop-loss gets triggered, I will accept the loss and not indulge in revenge trading to cover up the loss.

Finally, you need to maintain a trading journal either in pen-paper format or in an excel sheet to record all your trades for weekly review. 

Reviewing your trades every week will assist you in understanding what mistakes not to make and what steps need to be taken more often to book consistent profits. 

The process of elimination is a universal concept that finds its application in almost everything. 

In trading, if you know what 'not to do,' that is much better than knowing 'what to do because doing the right thing will surely guarantee profits, but doing the wrong thing will eat up the gains and leave you with pennies, which you do not want. 

Here's an in-depth video explaining how to make a trading plan:

Researched and authored by Marazban TavadiaLinkedIn

Reviewed and edited by Aditya SalunkeLinkedIn

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