HOW TO DEVELOP A TRADING PLAN. PART 1
Trading is a business and if you want to be successful you should treat trading as a business. The only way to be a successful trader is planning – there is no other way.
There is a saying: “Absence of a plan results in the failure of your plan”. It might sound weird, but this saying should become your slogan if you set the goal to become a successful trader. Any successful trader who constantly makes a profit would tell you: “you have only two options: either you act in accordance with a developed plan or empty your account”.
It is great if you already have a developed trading or investment plan! And although availability of such a plan doesn’t yet guarantee a success, you have already eliminated one of the main obstacles. If your planning methods still have shortcomings or you devote little time to preparation, you may have problems with achieving a fast positive result, however, at least you are capable of identifying and changing your route. If you document your process, you will be able to understand what works for you and how to avoid making mistakes which cost you money.
If you do not have a trading plan, you could consider the following components of a good plan as an example.
Every trader should have his own plan, developed with consideration of his personal trading style, goals and skills. Somebody else’s plan will not help him since it doesn’t take into account all his qualities. The main idea of a plan lies in the fact that a trader should stay calm at the moment of execution of a trade and avoid excessive reflections, since he should conduct the whole analytical work at the stage of planning. Professionals are calm and self-possessed during trading while beginners start to bite lips before executing a trade and start losing their heads when they are in a trade.
As soon as you develop a habit of developing a trading plan, you will see that trading becomes more objective, you become less emotional and trades become more selective. At the end, a trading plan would become your only true ally at the moments of unpredictable events in the market and would protect you from making premature decisions in any scenario of developments.
Below is an example of 10 mandatory things which should become parts of a good trading plan:
1. Assessment of personal qualities
Are you ready for trading? Have you tested your trading system on the demo account and are you confident in the efficiency of your trading system? Will you be able to stick to your own trading signals without hesitation? Trading in financial markets is a constant search for compromises. Real professionals are properly prepared and namely they take money from the other, less prepared, players, who do not have their own trading plans.
2. Mental preparation
How do you feel yourself? Have you had a good sleep? Are you ready for a fight? If you feel that you are not sufficiently prepared for a fight in the market emotionally or psychologically – it is better to take a day off than to lose money. You are destined to lose money if you are out of balance, angry or are busy with something else. Many traders have what they call ‘trading mantras’, which they repeat over and over again in order to get prepared psychologically and emotionally for future trades. Invent your own mantra in order to enter the required state.
3. Identify your risk level
What is your trade risk percentage from the amount of your trading capital? Optimally, it should be within 1% – 5% of the amount on your trading account within a trading day. It means that in the event of making losses within this limit during one trading day, you should stop trading. The risk level is identified by your trading style and limit risk boundaries. Nobody says about it but risks are the only thing you are capable of controlling in the market. Your main task, as a trader, is not to make money but simply to survive! It is critically important to have a sufficient reserve of ‘gunpowder’ for the next fight even if everything went wrong today.
4. Set your goals
You should have a clearly set realistic (!) size of profit and risk/reward ratio before you enter a trade. What is the minimum risk/reward ratio acceptable for you? Many traders do not enter into a trade if the potential profit doesn’t exceed the risk thrice. For example, if a stop for one trade is USD 1, your profit should be USD 3. Identify a weekly, monthly and yearly profit in percentage of your trading account and constantly assess its dynamics. Again, very few say that really good traders, to whom serious investors trust their money, first of all, are distinguished not by a huge profitability percentage but by availability of smoothly growing yield curve without sharp jumps and falls!
5. Do your homework
What is the news background and what did take place in the world before the trades are opened? What is the situation in other markets? What were the markets that traded during the night session? What are the important economic or political events expected during a trading day and at what time? Print out a list of such news and stick it to the wall in front of you. Decide whether you want to trade on the eve of publication of such news. The majority of traders are absolutely right to avoid executing trades before publication of important reports, statistical or economic data or political statements. Professionals, unlike the rest of the market participants, trade probabilities rather than gamble and try to avoid an unjustified risk in any way possible.