The Trading Plan

Trading Course (Get Started In Trading) The Trading Plan

In order to even have a chance of making prudent decisions in your trading, it’s important to have a solid trading plan and not deviate from it. You’ll understand the importance of this throughout the lessons.

If you let go of the rules you have defined for yourself, your trading risks turn into an emotional rollercoaster, where decisions are made mostly based on the emotions the market instills in you at the moment, rather than what will benefit you long term.

In this lesson, we are going to look closer at how you can create your own trading plan.

What is a trading plan?

A trading plan is a written document that describes the rules and framework you are going to adhere to. In short, you write down what, when, and how you are going to trade.
The trading plan is personal, in the sense that it is tailored to your preferred preferences and trading style.
It’s a dynamic document, which needs to be updated regularly as your preferences change, and you discover more about yourself
A trading plan is an important tool, which helps you avoid many of the psychological pitfalls which need to be dealt with.
Depending on yourself and your trading, the style of the document will vary a lot from person to person.

Let’s now go through the components that you should consider including in your very own trading plan. We encourage you to jot down your personal reflections as you go through the lesson, to start to get a sense of what your personal trading plan should look like!

Timeframe

A trading plan should include the timeframe of your trades, meaning that you should decide already from the beginning what type of trading you wish to engage in, be it swing trading, day trading, or buy-and-hold (investing). This might seem obvious, but there are several psychological pitfalls that you could easily fall into!

For instance:

If you have bought a stock at the close of the previous day, and see how it falls a lot during the coming trading days, you might be tempted to ignore the sell signal, in hopes of selling it later once the stock has rebounded.
You could also imagine a situation when you have bought a stock on the open, and see how it rises during the first trading hours of the day. In that case, you might sense an urge to sell the position, to get out of the trade, and secure a profit.

In large, these are the same psychological pitfalls that were discussed in the earlier lesson on trading psychology.

Methodology

The trading taught in this course builds on quantitative technical analysis, and if you follow our approach, then this is what you should stick to. Even though it might seem obvious, it’s easy to fall into bad habits!

For example, if you read a business magazine or some sort of buying recommendation from your broker, you might find some stocks that are recommended by the experts for some fundamental reasons. As such, you might be inclined to buy that stock even though fundamental analysis isn’t part of your trading plan.

Strategy concept

The trading taught in this course is mainly based on mean reversion. With time, you may choose to create your own trading strategies using other types of trading concepts.

One thing to keep in mind, is that if you just trade mean reversion strategies, there will be periods when most of the stocks keep going up, which will leave you with very few buy signals. To get left behind, and witness how the market just keeps going higher can be very psychologically demanding (this is called FOMO). You might feel tempted to deviate from your set rules, and try to profit from the bullish trend. In the best of worlds, you subsequently adopt some type of trend-following strategy. However, that’s the best-case scenario.

Trading strategy

In addition to the strategy concept, you should also decide the exact trading strategies you are going to trade. By doing this, you avoid feeling the urge to modify the strategies you have, or bring in new, untested strategies, in times when your trading might be a little slow. Both entries and exits should be clearly defined by the strategy.

Market and instrument

Already from the very beginning, you should decide what markets to focus on. For example, you could decide to only focus on the stocks in the S&P-100, S&P-500, or Nasdaq Composite. You should also make sure to decide the type of instrument you want to focus on. As a beginner, it’s recommended that you focus on stocks and ETFs, to begin with. Trade small when you start!

Position Sizing

As we mentioned earlier in the course, you can control and adjust the risk you take, by changing the position size of the trade. During periods that are less favorable (according to your backtesting) you may, for instance, decide to reduce the number of open positions to reduce your overall risk level. You may also use other means of protecting yourself against market downturns, such as not opening several positions in the same market sectors, within which many stocks may be extra correlated.

Maximum drawdown

One thing you must make sure to ask yourself and include in the trading plan, is how big a drawdown you can tolerate both in one single trade, and in your account as a whole. Unfortunately, most don’t know this level until you get there.

Big drawdowns are psychologically demanding, and everybody has a different tolerance.

Nevertheless, it’s important that you decide on beforehand your maximum risk tolerance, and what you should do if your losses exceed that threshold. For instance, you can decide to use an emergency exit which brings you out of all positions once the maximum loss amount has been hit (covered soon).

Daily Routines

To reduce the risk that your trading will be affected by stress, psychological pitfalls, tiredness, a high workload in your day job, or any other similar factors, you need to create a daily routine. These routines need to be tailored to your life and habits.

In short, improvising and swing trading in new manners each day makes you more prone to making mistakes.

Try some different ways of managing your swing trading. With time you will find out what type of routines that suit you best. Then, make sure to update your trading plan, as your daily routines change. One great tip is to use a checklist, to make all daily tasks easy to execute.

One example of a trading plan could be:

that you fire up your computer every day, two hours after the market has closed.
You scan the market for buy signals, and place the appropriate orders for the following day.
Once that’s done, you have a look at your open positions, and see if there are any sell signals. If there are, you place sell orders for the coming day
The last step is to add the closed trades to your trading journal. You may also include a checkbox, which you check only if you managed to follow your trading plan that day!

Planned and Temporary Trading Stops

In times when you’re experiencing hardships that drain your energy and attention, it might be time to take a break. Quite logically, the risk of making mistakes and acting on a whim increases if you’re not feeling well.

Therefore it might be a good idea to take a break if you find yourself in such a situation. Of course, how and when this should happen should be decided in the trading plan!

Planned Revisions

Over time, your habits may change. For example, you might add new strategies and markets to your trading, or you discover that you make certain mistakes, which must be mitigated through certain changes in the trading plan itself.

You should decide an interval, such as once every quarter, when you go through the trading plan and make the appropriate changes.

You should refrain from making changes that affect the current open positions or buy and sell signals.

Conclusion

Creating a prudent trading plan and making sure to follow it, is essential to become a profitable trader. Take your time and write down your very own, personalized trading plan, your chance of success will increase drastically!