Many traders enter the trading arena with no clues on how they’re going to navigate it. They simply buy and sell when they feel like it which is a recipe for disaster. A trading plan on the other hand will guide you to making sound decisions while trading.
And that is precisely what a trading plan is for, to guide traders in the rough torrential waters of the financial markets. In today’s article, I will be going through the essentials of every trading plan that all traders need to consider. You can think of it as a sailor having a compass and map to guide him in the pacific ocean. Let’s roll!
Steps of Writing a Trading Plan
1) Money management
You need to understand how much capital you’re willing to lose on each trade as a % of their account.
As a rule of thumb, you should keep it to 2% and below. Anything less is fine but anything more could potentially result in a heavy draw down. So if your trading record shows that you ever had 10 losses in a row, risking 2% a trade would result in a 20% draw down. Would you be able to stomach that? That is the question you need to ask yourself. If not, you should consider risking less per trade.
So how would you enter the market? Are you trading breakouts, pullbacks, candlestick patterns, etc. The rules for entries are limitless and you as a trader need to define your entry rules strictly. If not you will be simply firing one trade after another which makes no sense because you will not know which approach is working and which is not. So in this section, you need to think through what are your methods of entry and state them clearly. For new traders, simply find one setup and stick with it till you’re more experienced. As you grow as a trader, you’d realize you will develop more tools in your arsenal and you’d definitely have more than 1 way of entering the market.
3 Trade management
This is not to be confused with money management! Trade management means how you would manage your trade when you are in one. A critical question to ask yourself would be when will you set your stop loss to break even? Will you scale in? Will you scale out? Is there red flag news that will affect your trade? Or perhaps some of you will like to be ‘set and forget’ traders whereby you just input your entry, stop loss and take profit. That could be an option as well. Nonetheless, you must know how you will manage the trade!
This is the part that most traders tend to neglect. Remember, your entry doesn’t make you money but your exits do! For exits, there are a variety of methodologies you could consider. You could take profit at a support resistance level, the daily average true range, 127 or 162 fib expansion, a fixed risk-reward. All I can say is this aspect of trading is the most discretionary.
As you gain more experience over time, you’d know which exits are more optimal than the other. E.g. if I’m trading in a range I will look to take profit at the support resistance level. If I’m in a strong uptrend, I will look to ride the move as the price keeps making higher highs and higher lows.
5) Account management
Account management is all about funding and scaling the risk of your trades. For new traders, if you have $1000 to spare, i would suggest funding half that amount for your account and leaving the other half in the bank. Thus hypothetically you have $500 to play with and you’d risk $10 per trade (which follows our 2% rule). So let’s say you are getting good at it and you’ve increased your account size to $750 which is a 50% increase. Now risking 2% would be $15 a trade instead of the $10 earlier.
However suppose you had a drawdown and you’re left with $250, risking 2% a trade would be risking $5 per trade now instead of the $10 earlier. Now do you see a recurring pattern here?
When you’re up, you can risk the same % per trade but your nominal gains are larger due to the fact of compounding! When you’re behind, you risk the same % per trade but your nominal losses are smaller because of de-compounding (if that’s a word) which can help prevent blowing up your account.
In summary, a trading plan will help you to engage the markets in a more systematic manner. It should cover your money management, entry, trade management, exits and account management. A trading plan will definitely help you trade in a more consistent manner as everything is laid out in black and white.
Remember when you trade consistently you get consistent results. When you trade inconsistently you get inconsistent results!
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