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Developing a trading plan

Benefits of a trading plan

There are a number of practical ways in which your trading plan may be helpful to you:

 

Set up structures to manage your risk better

What does high or low risk mean for you? By quantifying this in advance, you can apply a scientific approach to assess whether a particular trade is too risky. Your risk-per-trade scale could look like this:

Low risk: 1-2% of total equity
Medium risk: 2-5% of total equity
High risk: More than 5% of total equity
Reckless: More than 20% of total equity

For example: With a $10,000 account, a 3% risk amounts to $300 on a single trade (medium risk).

Another way of looking at risk is by setting up a risk v reward ratio. Find out about this and other forms of risk management in our managing risk section.

Establish entry and exit strategies beforehand

In many, if not most, cases, the timing of your entries and exits will be the most stressful and thought-over parts of the entire trade.

At these times, there is an elevated risk of basing a decision on an emotional response, rather than strategy. For this reason, it can be extremely helpful to establish clear entry and exit criteria and rules to stick to.

For example, you might use charts to track certain market trends, and commit to only entering a trade when particular patterns have emerged. Alternatively, when considering your exit, you might establish profit/loss limits to stick to as the position develops.

It can be very helpful just having a set of guidelines that you have established in an emotion-free environment, away from the pressure of an ongoing trade.

Stay focused and streamline your decision making

The financial markets can move rapidly at times, and it’s at these moments that you could quickly find yourself overwhelmed and more prone to rash decisions.

A trading plan is a vital point of reference in these situations, because you have made a lot of your decisions beforehand, in anticipation of the dilemmas you might face. Act according to your plan, rather than make many actual decisions on the spot.

A trading plan can help to take the emotion out of your trading. Some people may attribute victories to emotion, or gut feeling, but long-term success will almost always find its foundation in a considered strategy compiled beforehand.

Constantly evaluate your trades and manage your money

A trading plan often includes a trading log or diary, which you can use to track all the trades you have made and make notes about their success or failure.

A trading log is an excellent tool for viewing the bigger picture. In one snapshot you can get an overview of your trading history and identify successes and mistakes made along the way.

Honesty and self-awareness are important traits here, but constant assessment of your trading is one of the best ways to avoid repeating mistakes and remind yourself of the things that have worked in the past.

Simplify your trading and maintain your discipline

A trading strategy can be a constant reminder to you of your goals and also your self-imposed limitations.

Having a written plan is extremely useful in maintaining your trading discipline – it just always seems much harder to deviate from your original plan when it is clearly laid out in front of you all the time. Keep it on your desk or stick it to the wall, if it helps.

 

Who needs a trading plan?

The short answer to this question is: everyone does. From first-time traders to experienced professionals, there is nobody that can unequivocally say they are above or beyond a trading plan.

Your experience will no doubt influence the extent to which you could use and benefit from a trading plan, but using a trading plan in the way that suits you is undoubtedly in your best interest.

How you use your trading plan is up to you, but we have outlined a few essential tips for creating it in the next section. You can also see examples of a trading plan and trading log.