Before you think about hitting the buy or sell button you need to have a tried and tested trading plan in place. Having a trading plan before starting to trade is much like having a map before starting to travel. Trading the markets is like no other profession in the world. Unless you get an internship in one of the big banks, you are probably going it alone like the vast majority of retail traders. The ease at which you can open a trading account, deposit £5,000, £10,000 or £50,000 and begin trading straight away with no clear understanding of the markets or definitive rules to keep you and your hard earned capital safe, is a major reason why so many retail traders lose money.
Trading can be one of the most lucrative endeavours you ever undertake, providing you have a clear plan with and tested rules to follow. If you don’t, it will likely be one of the most costly.
Basically, having a trading plan helps traders treat trading more like a business. Most people interested in forex trading already know that anyone running a business requires a business plan in order to have an organized basis from which to achieve greater success. When I worked in the oil and gas sector, every single task was carried out under a strict set of rules. If I decided to stray from the tried and tested rules in the oil sector, it could have had severe consequences. If you trade your account without a clear set of rules it will likely have severe consequences for your capital.
A Trading plan will help with your psychology and emotional trading
Your trading plan will help keep your psychological and emotional trades as close to zero as possible. Emotions such as greed, fear, hope, and despair can cause serious psychological issues when trading Your trading plan is a good way to manage them in the heat of the trade when planning a trade or when about to execute a trade.
Shouda, coulda, woulda are three of the most common words from new traders who do not have a trading plan. You are the one who must be consistent in an inconsistent market: consistency comes from you, not the markets.
How to create your trading plan
Which markets are you going to trade? Stocks, Indices, forex, futures, commodities, and the list can go on. We all specialise in our day jobs, so why would we not specialize in trading? Most retail traders look at far too many different markets and don’t fully understand all the factors affecting each of those markets, they know a little about each market without fully understanding them and are always on the look for another trade, any trade.
In the real world of our chosen profession, we are experts in our field. My specialty is now trading currencies but when I was offshore, my speciality was an inspection. I didn’t try to tell procurement how to do their job and they didn’t tell me how to do mine. Think of trading as a business: pick a sector and learn everything you can about it. Make that sector your speciality.
What time can you realistically dedicate to trading? If you work full time, then end of day trading is going to be the best option. If you are an end of day trader, you don’t want to be taking a quick punt on your 30-minute lunch break. You only look at the charts at the end of the day. Perhaps you work from home but still have other priorities to attend to, maybe setting the hours of 8:00 am to 11:00 am would suit your work schedule. In a normal 9 to 5 job there are set hours one must work. Treat trading in much the same way. This will stop you from opening your broker app where your mind will likely trick you into taking a trade, in the hope of making some money or close out a winning trade in the fear of losing profits.
What are your entry and exit rules? Your entry and exit rules will be a detailed sequence of steps to follow before you enter a trade or place a resting order. You must already have a clear plan of what to do if the trade triggers such as, stop loss placements, target’s when to move to break even, scaling in or scaling out, when to take profits and what to do if any red flag news events are on the horizon. There are literally a 1,000 ways to enter, manage and target your trades. As Tony Robbins would say, find someone who is already doing what you want to do and model them is the quickest way to achieving your goals.
Risk management / position sizing.
This is quite possibly the most important part of your plan. How much are you willing to risk on a single trade?
How many open trades are you willing to have with your maximum risk open in the market?
How much risk are you willing to have as resting orders, meaning if all your resting orders were to trigger and fail, how much would you will be willing to lose?
For new traders, no more than 1% of capital should ever be risked on a single trade. When you have consistency and a track record, this can be increased to 2% maximum. Typically professional traders go the other way. They decrease their risk and raise capital with a proven track record and good money management.
Money management is by far the most important part of your trading plan and it is this section that will decide upon your success. It is never the amount of losing trades that finishes off a trader, it is the amount you lose on those trades that finishes of the trader. With good money management and a positive risk to reward, you will remain in the game long enough to trade profitably.
Let’s look at an example of the 1% rule.
You start off with a £20,000 account and risk 1% per trade, £200. A loss of £200 on £20,000 is easier to handle than a loss of £2,000, which will induce revenge trading leading to further losses. As your capital grows, so does the amount of capital you can risk. £25,000 at 1% is £250 per trade. Likewise, if you slip the other way as your capital decrease so does the amount of capital you can risk. A good rule to have if you lose a maximum % in a week or a day depending on the time you can dedicate to trading, you stop trading until the next day or the next week and this will really help keep those emotions in check if you hit a losing streak.
Having a trading plan gives you certainty in an uncertain market, if X happens then you do Y, If Y happens then you do X. Because you have a tried and tested methodology this gives you the confidence to take the trade despite what the monkey mind is saying inside your head. The voice in your head looks through the filters of fear and greed. Having a trading plan will manage your risk and manage you in the markets helping you achieve the consistency so many crave. By trusting your trade, you allow the trade to play out as your trading plan says it should and you continue to improve yourself and your strategy.