The Ultimate Trading Plan

A trading plan is used to express the actions you will take to express your trading system in the market through entries, exits, and position sizing. A trading plan sets the parameters for executing your signals with real capital in the markets based on predetermined signals. A trading plan is created when the market is closed to be used when the market is open.

How do you write a trading plan?

Before you can trade you must first have a trading plan. A trading plan tells you how to specifically execute your trading system in real time with real money. A trading plan forces discipline and consistency onto your trading by allowing you to create a framework of trade execution based on your research to help manage your emotions and impulses when they are activated by price action, profits, and losses when real capital is at risk.

Here are the questions to ask to gather the data for creating your trading plan.

  • What markets will you trade?
  • What timeframe will you trade them on?
  • What will be your entry signals?
  • What will be your exit signals?
  • Are your stop losses at price levels that will avoid the noise of normal price action and only be triggered when you are proven wrong?
  • How will you use trailing stops to maximize gains?
  • Will you have a price target or will you just leave your profits open ended?
  • Have you back tested your entry and exit signals across multiple market environments to ensure they were profitable long term?
  • How big of a position size will you take for each trade?
  • What do you want your maximum loss on any one trade to be?
  • What are your goals for annual returns?
  • What do you want to limit you maximum drawdown to?
  • What is your expected winning percentage?
  • What is your goal for risk/reward ratio?
  • How many open positions will you have at one time?
  • How much will be your maximum risk exposure at one time?
  • How will you position size based on the underlying asset’s volatility?
  • Will you use margin?
  • Will you use leverage in your trading?
  • Are the markets you are trading liquid enough and have tight bid/ask spreads?
  • Will you keep performance records to monitor the quality of your trade executions?

How do you structure a trading plan?

A trading plan must be structured to minimize losses when wrong and maximize gains when right about a trade. It should express your signals specifically so they can be executed quickly with no hesitation.

Stop losses and proper position sizing minimize losses. Profit targets and trailing stops can maximize gains. Never trade so big that your emotions or ego become too loud to execute your trading plan.

Your trading plan must be based inside the context of your system using your watchlist, time frame, risk tolerance, and return goals to express your strategy in an actionable way.

What should a trading plan contain?

Entering a trade

You must know clearly at what price or technical level you plan to enter your trades. Will it be a break through resistance, a bounce off support, or a specific price, or based on indicators? You must be specific and it should be a high probability area on the chart for a winning trade.

Exiting a trade

At what level will you know you are wrong and at what level will the risk/reward ratio begin to skew against you? An exit can be based on a loss of support, a price level signal, a trailing stop, or a predetermined stop loss. Know where you are getting out before you get in.

Stop placement

You must either have a mental stop, a stop loss entered, a time stop alone, or a time stop with an indicator.

Position sizing

You determine how much you are willing to risk on any one trade before you decide how many shares to trade. How much you can risk will determine how much you can buy, based on the equities price and volatility.

Quick formula to calculate your potential trading account loss percentage per trade:

(Entry price – Stop loss price) x Shares / Total trading capital

Money management parameters

Never risk more than 1% of your total capital on any one trade. (2% maximum for aggressive traders who can handle bigger drawdowns.)

A 20% position of your total trading capital gives you a potential 5% stop loss on your position to equal 1% of total trading capital.
A 10% position of your total trading capital gives you a potential 10% stop loss on your position to equal 1% of total trading capital.
A 5% position of your total trading capital gives you a potential 20% stop loss on your position to equal 1% of total trading capital.

What to trade

Trade things you are comfortable with. Swing trading range bound stocks, trend trading growth stocks, or trend following commodities or currencies. Trade what you know.

Trading time frames

Are you a day trader, position trader, swing trader, or long-term trend follower? If you are a long-term trend follower, don’t get shaken out of a position in the first day by taking profits or getting scared. Know your holding period and adjust your plan accordingly.

Back testing

Don’t trade any method until you have reviewed charts over a few years to see how you would have done. Alternatively, utilize back testing software to analyze historical data for your system. There are also precooked systems like CAN SLIM, The Turtles Trading System, and many Trend Following Systems. You need to begin trading knowing you will have an edge over time.

Performance review

Keep a detailed record of your wins and losses. You need to be sure that your method is working in real trading. Review this after every 20 trades. Also, if you had any issues with discipline, then make notes, learn from your mistakes, and the make necessary adjustments.

Risk vs. Reward

Enter high probability trades where you are risking $100 to make $300, always ensure the risk is worth the potential reward with a 1:2, 1:3, or greater risk/reward ratio.

All successful businesses must have a plan and traders that want to be successful are no different. If you don’t have a plan to express your trading edge in the markets you are just participating in randomness and relying on luck.

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