A good trading plan can act as your own personal decision making tool, helping you decide what, when and how much you should trade. And perhaps most importantly, it can let you know if a trade has been open too long.
Why do you need a trading plan?
In the heat of the moment, making objective decisions about your trades can be difficult, leaving you at the mercy of emotion and gut feeling. A trading plan helps you make logical decisions, even when the stakes are high.
How to make a trading plan
Here are a five simple steps to follow when creating a trading plan:
1. Define your goals
Write down what you want to achieve from your trading. If possible, break it down into daily, weekly and monthly targets.
2. Assess your market knowledge
Be honest about your expertise. Which asset classes, regions and markets do you really know? Focus on the areas you understand, and start filling in any gaps in your knowledge.
3. Decide your acceptable risk…
How much of your total capital are you willing to risk on a single trade? And, if you have multiple positions, how much are you willing to risk overall? Most novice traders start off with lower risk, but deciding your own risk limit is important.
4. And your risk-reward ratio
It also helps to decide what potential reward you need from your accepted level of risk. If your risk-reward ratio is 1:2, for example, you’ll know not to make trades that don’t offer potential profit double to their potential loss.
5. Start a trading diary
Keeping track of all your notes and trades from each day is a great way of finding out what is working, and what isn’t. Make sure to review which strategies have helped you to achieve your goals.