Writing A Trading Plan
Trade like a pro and plan for success.
There shouldn’t be any hesitation in trading. When it comes to pulling the trigger and entering a trade the trader should have cut the decision making process to a bare minimum and have a full understanding of what constitutes a valid entry and exit. It is essential that we write a trading plan. This preperation will allow traders to remain calm, while in the heat of the moment, during volatile trading days. Most importantly this will allow traders to take advantage of opportunities without having to over analyse the situation.
The famous military philosopher Sun Tzu once said, ‘every battle is won or lost before it even begins’. This certainly rings very true when it comes to trading forex and the financial markets in general. Sun Tzu also said “he will win who knows when to fight and when not to fight”.
The composition of a trading plan should help traders learn to identify when to trade (fight) and when not to.
Where is your trading at?
Before you progress with the following steps. Are you prepared for live trading? Have you proven your trading system by demo trading it and will you stick with it through a series of losses? Back testing has never been easier with tools like Forex tester. Any new technical trading strategy can be tested with Forex tester on historical data and subsequently taken into forward testing if successful.
It can be extremely valuable knowing that your system can pull out of drawdown when you have experienced a big string of losses. Testing can certainly help in this regard.
Define a trading plan and commit to following it.
There is something very powerful about committing your trading plan to paper and it is no secret among professionals that this is one of the most important and beneficial things you can do as you strive to become a profitable trader. We will now look at some of the elements that can be used as a starting point when you work on your trading plan:
1. How do you run your trading business on a day to day basis?
Outline your plans and routine starting with the following areas:
-Trading times. Do you only trade a London open breakout system? Maybe you trade a gap closing strategy that demands you are at your computer late on a Sunday night. Identify what time of the day is the optimum time for your system and make rules accordingly. Don’t just randomly turn the computer on, spit on your hands rubbing them together and say “I’m going to trade now!”
- Event risk. How does economic data fit in with your trading strategy? Market moving news is released throughout the day. Intra-day traders can make calculated decisions regarding how they manage positions around this economic data.
Let’s take an extreme example to illustrate why this point is so important. Professional traders do not typically enter highly leveraged positions based around technical analysis just before the US non farm payroll report… Does your current trading strategy cater for this? Define a set of rules around how you will manage your trading when economic data is due.
- How do you record your trade results and what do you do with the data? Is there a regular, scheduled analysis of past trades with a view to improving the trading strategy?
- Will you trade if you are under stress with family issues. How do you intend on quantifying this? (i.e. score out of 10 for your “state of mind” etc).
- Do you have a disaster recovery plan if your IT systems fail? Do you have an alternative broadband connection, laptop, power etc. Do you have a desktop setup that is optimised for trading?
- What does your Trading log look like? It should have a post-trade analysis section with lessons learnt. What was good about the trade and what was bad (if anything)? We need to learn from mistakes to keep any future ones to a minimum and leverage any successful areas.
2. Clearly defined money management rules.
This is possibly the most crucial part of the trading system. Anyone who is serious about trading must be able to manage risk.
- How much do you risk per trade? Is it calculated on a percentage basis or by some other metric? Do you take open positions into account when calculating total equity?
- How many positions are you willing to keep open at any given time?
- Do you trade multiple correlated pairs? How do you track correlation data?
- How many losses before you stop trading for the day/week/month?
- Do you have a minimum risk reward ratio that needs to be achievable before entering a trade. Are you allowed to modify profit targets after the trade has been executed?
3. Trade entry and exit plan.
- Define the trade entry criteria as clearly as possible. Try to capture as many “discretionary” elements as possible.
- Do you need a simple signal to be triggered in order to enter a trade or does it take a confluence of events? How much weight do you put on each element?
- Are all exits treated equally? Do you differentiate between trend and counter-trend trades?
- How is the trend defined?
Make the trading plan work for you!
The above points are not meant to be an exhaustive list. Start by capturing as much information as you can and add to the trading plan whenever you come across any new scenarios/content that you deem to be valid. Everything should be geared towards improving the bottom line when trading.