What is the trading plan?
A trading plan is a set of rules that a trader follows in their trading. Without some kind of plan the trader will fail. In our opinion there are several different levels to a trading plan. When I first started studying trading I read a lot of books. In those books the authors would talk a lot about having a trading plan. The books would say this trading plan should be something that you should be able to give to someone else. They should be able to follow it without any problem. I really did not understand at first.
How do we develop a trading plan?
To develop a trading plan the first thing you need to do is come up with some trading rules. Trading rules are the predetermined actions you will take when the market is open.
These rules may include the following:
1) how much will I buy?
2) how much will I risk?
3) what will I trade?
Your rules can be what you want. It’s your plan.
I hear from nurses that things get crazy in the hospital only full moon. People have babies. Crime may even be higher. You might want to include that in your trading system. The rule might be always or never trade on a full moon.
You might not want to trade close to a holiday. If that is the case then write it down. It’s your rules. Obviously there should be some research that goes into the trading plan. Some people put P/E ratios in the plan. Some people don’t want to trade close to earnings season. Your plan can literally be tailored to you.
Test Your Trading Plan
Once you have developed your plan you need to test your plan. There are several ways to test your new trading plan. The first way should be to back test. When doing a back test of your plan it is important not to modify or curve fit to the back test. Anybody can make a plan that will make money in the past. You want to use historical data to test your plan but not to build your trading plan.
Once you tested your plan on historical data you need to test it through paper trading. This will keep you from losing real money. The key is to test, test, and test.
Once you have tested your plan you have to trade your plan. This is when you put the money behind the plan. This is where for the first time the psychology of trading comes into the equation. The psychology of trading can ruin your whole trading plan.
Trading plan template
When making a trading plan it would be good to make a template. Before you make your template ask yourself a few questions.
1) What do you want to trade?
2) What is the volatility of the stock market or the market you want to trade?
3) What is your buy signal?
4) When will you get out if it goes in the wrong direction? (Max loss)
5) What is your trading stopped based on?
Answer these questions and you are well on your way to creating a trading plan. You might want a single stock-trading plan that is a little different from an index or futures trading plan. This is up to you when you’re trading a plan make sure that you follow your plan.
Trading plans are personal. Many people use a trading plan and make money. They write it down and put it in a journal and they can even teach it to their kids. If you’re going to use a trading plan it should be so systematic that you could program it into a computer. Only then will you know that you are trading the same way every time. Our trading plan is now computer-based. We don’t write down anything. We let the computer calculate and we just do what it says.
You can do the same with your system. It needs to be repeatable. You need to trade like a robot.