Trading Plan: Step By Step, How It Works, Definition, Examples, and Rules

A trading plan refers to having a framework that guides you through your entire trading process. It is your guide to executing your trading system, factoring in risk management and personal psychology. It defines the conditions under which you identify markets, enter trades, exit trades, and manage risks along the way. Your trading plan ensures accountability and keeps you focused on your personal strategy.

There is a common saying that “he who fails to plan, plans to fail.” That is the case in financial trading. In fact, the difference between making money and losing money in the financial markets can be as simple as trading with a plan or trading without one. So, it is critical to have a trading plan strategy when playing the financial markets. But what is a trading plan strategy?

In this post, we answer some questions about the trading plan strategy. At the end of the article, we provide you with an example of a trading plan strategy backtest.

What is a trading plan?

A trading plan strategy refers to having a framework that guides you through your entire trading process. It is your guide to executing your trading system, factoring in risk management and personal psychology. It defines the conditions under which you identify the markets to trade, enter trades, exit trades, and manage risks along the way.

Your trading plan ensures accountability and keeps you focused on your personal strategy. This is why most trading professionals advise that you should never risk any money until you have developed a trading plan strategy.

Why should I use a trading plan?

Your ultimate goal as an investor or a trader is to attain consistent profitability. A trading plan strategy is a road map that helps you remain on track to your targeted objective. Here are some of the reasons why you should use a trading plan:

  • It makes things easier
  • It keeps you on track at all times
  • It helps you to make objective decisions, rather than emotional decisions when the going gets tough
  • It helps you to know when to tweak your trading system
  • It helps you to maintain trading discipline

Steps to building a trading plan

The following are the essential steps to building a successful trading plan:

  1. Identify your motivation: Identifying your trading motivation and the amount of time you’re ready to spend is critical in developing your trading strategy. Ask yourself why you want to be a trader, and then put out your goals for trading.
  2. Determine how much time you can devote to trading: You need to factor in how much time you can devote to your trading operations. Can you trade while working, or must you handle your transactions early in the morning or late at night? Your answers can help you plan better.
  3. Establish your objectives: Your trading aim should be explicit, quantifiable, realistic, relevant, and time-bound rather than stated (SMART). ‘I hope to grow the value of my whole portfolio by 15% in the next 12 months,’ for example. This objective is SMART because the numbers are explicit, you can assess your performance, it is reachable, it is about trade, and it has a time range.
  4. Define your trading personality and style: You should also consider your trading style. Your trading style should be determined by your personality, risk tolerance, and the amount of time you are prepared to devote to trading.
  5. Determine how much funds you have available for trading: Consider how much money you can afford to invest in trading. You should never put more money in danger than you can afford to lose. Trading is fraught with danger, and you might lose all of your trading capital if you don’t know what you are doing.
  6. Specify your account risk per trade: This is very important, as it would determine your position sizing and risk management methods. You can state that you risk only 1% of your capital in any trade. That is what you use to calculate your position size or stop loss when one is known.
  7. Determine the markets to trade: You should specify the markets to trade: stocks, futures, cryptos, commodities, and so on.
  8. Specify your trading strategies: You must document the strategies you want to use and the market conditions to use each, or whether you want to trade all the strategies at all times.
  9. Document how to keep your trading journal: Your trading journal can be electronic or manual if you are using a manual trading method. For an automated trading system, the journaling is automated as well.
  10. Specify how often you evaluate your trading performance: This could be done monthly or quarterly, but it may be better to base it on the number of trades taken. You specify the number of trades that constitute a good sample size for your evaluation.

What is an example of a trading plan?

A trading plan can be quite detailed, but at minimum, it should contain an outline of what, when, and how to trade the markets you want to trade, and it should also cover how risk will be managed. Here is an outline of what a trading plan for a forex trader can look like:

The markets to trade