Here’s the brutal truth. There’s a reason why every trading coach or mentor on the globe kicks off their presentation demanding to know why you don’t have a trading plan.
It’s because you’ll fail as a trader without one.
Trading plans reduce the emotional element to your trading. If we are not so attached to our decision-making process, we can cut bad trades when we see them, limit the loss to what it is right now, and move on to the next trade.
So, why do you need a trading plan?
Stuart McPhee is a private trader and author of Trading in a Nutshell, Third Edition. He also runs a trading website at tradingasxshares.com
“You need a set of rules to protect you from doing all the silly and emotional things that most traders do,” he said. “Your trading plan is comprised of your rules. One of the important things in designing a trading plan is that it suits your personality otherwise it most likely won’t work for you.”
You can’t just having a trading plan “up in your head” either.
“Writing your trading plan down also forces you to formalise your approach rather than relying on emotions and hunches to guide you when an important decision is needed,” McPhee added.
Developing your plan
To build a plan that suits you, you must first understand yourself.
“In order to develop a trading plan that is right for you, you must undergo some form of self-discovery,” McPhee explained. “You need to assess your levels of risk tolerance, patience and time available, just to name a few.”
The important thing to remember is that your trading plan should not be complicated.
“Never picture your trading plan as a detailed document containing pages and pages of information because then it will overwhelm you and may deter you from compiling one in the first place,” he said.
Think in the simple terms of the three main questions and once you have answered those questions, then you can add some detail to it as time goes by. Developing a trading plan will help decision-making significantly. It will provide you direction and purpose and have you making sound trading decisions.
How do you build one?
McPhee says we should concentrate on a few specifics.
“Primarily, your trading plan answers three questions. First, under what circumstances will you enter a trade? Second, how much money will you commit to or risk on the trade? Lastly, under what circumstances will you close the trade?” he said.
You also need to be aware of a number of secondary issues.
“There are also broader issues to list as well, including which market you will trade, capital, drawdown rules, shutdown, reviewing process, and rewards to name only a few.
“All traders need to review what they are doing on a regular basis. From your reviews, you will modify your processes and rules, which are listed in your trading plan. It is all part of the evolution as a trader.”
Six simple rules for your trading plan
Number One: Don’t bet the shop. You should only ever risk a small portion of your overall pool of available funds. Number Two: Use stops. Don’t be afraid to cut a losing trade at a pre-determined exit point. Always plan for failure. Number Three: When you’re ahead, stay in the game. Use trailing stop losses if possible. Number Four: Go with the trend. Number Five: If you’re trading stocks, stay with stocks that have good volume. Number Six: Nothing obvious to trade – don’t trade.