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Becoming a Better Trader – How to Create a Trading Plan

Becoming a Better Trader – How to Create a Trading Plan

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The importance of a trading plan can’t be overstated, but yet the number of traders who don’t have one far outnumbers those who do. Without a comprehensive plan of attack it is easy to get off course. Your plan doesn’t need to overly detailed, a couple of pages or so will do. There are a few key components which should be included, but keep in mind there is plenty of room for flexibility so as to tailor it to your needs. Keep this acronym in mind – K.I.S.S. (Keep It Simple Stupid) – as you go about constructing your trading plan.

Whether you are a new trader building a foundation or an experienced trader struggling (happens to the best), here are 4 ideas for Building Confidence in Trading

Must have a trading plan

In anything we set out to do, if we intend on it having a shot at success, don’t we plan ahead? Some type of plan? Then so it should be with trading. Markets are too dynamic, full of too much uncertainty, to try and navigate them without a framework in place. Trading plans are imperative for creating consistent results. They are also excellent for identifying strengths and weaknesses and then adjusting so you gravitate more towards what works and further away from what doesn’t.

What to include in your trading plan

Analytical approach

This is straight forward; what do you use to identify set-ups? It doesn’t matter so much what you use, just that it makes sense and is used consistently. It could be some combination of price support and resistance, trend-lines/slope analysis, chart patterns, Fibonacci levels, moving averages, Ichimoku Clouds, Elliot Wave Principle (EWP), sentiment, fundamentals, etc. Perhaps all together something else.

Favorite trade set-ups

What set-ups work best for you (get you excited)? It probably goes without saying, but these should be at the core of your trading. Set-ups are based on the alignment (confluence) of any number of factors which make for a high conviction trading opportunity. If you are new to trading, then this will take some time to figure out, so be patient in making progress towards understanding what works best for you.

A set-up is one thing, but how you execute it is another. We discussed this in detail in this 3-part series (Trading Breakouts | Trading Pullbacks | Combining Breakouts & Pullbacks). To recap one key point: There is the set-up, then the method by which you will take advantage of the set-up. For example, three traders could identify the same consolidation pattern; one will buy the breakout, another will wait for the first pullback after the breakout, and the third trader will do some combination of the two. Knowing how you best execute trades and what works for you is important.

What markets will you focus on?

Not every market moves the same, not everyone has the same interest in trading the same markets. Know which markets you focus on. It’s a good idea to keep your universe relatively small, helps keep things simple, and allows you to learn the personalities of the targeted markets and/or currencies. You can take it a step further and focus on specific time-frames for each market category. For example, you may trade equity indices on a very short-term time horizon (days or less), but choose to trade FX from a swing-trader standpoint (several days to several weeks). You could also have dynamic exposure to one market over another, i.e. – 75% FX, 25% indices/commodities.

Time-frame, hold time

What is the intended hold time for your trades, on average? Are you a swing-trader, holding for several days to weeks using weekly/daily/4-hr charts, or do you focus on day-trading, with hold times of a few hours or less, thus using daily down to even a 1-minute chart? It could be some blend of the two.

We understand the difficulties of trading, which is why we’ve put together a variety of guides designed to help traders of all experience levels.

Risk management

While we discussed this later in the webinar, the order is certainly not indicative of its importance. Without good risk management none of the rest of the trading plan will matter, at least not for long… You need to know your risk tolerance and adopt a risk management strategy which fits you. Know how much risk-per-trade you will take and total account risk across several positions. What is the max number of positions you will hold at once? (Fewer are easier to manage.)

Have a max drawdown figure in place as ‘kill switch’ when things aren’t going well. For example, if you experience a drawdown of 10% you will either take a break or at the least reduce your trading size. Remember, job #1 is capital preservation. (For more details, check out this webinar on risk management.)

Handling adversity (and success)

When you hit the inevitable drawdown, what will you do to make sure it doesn’t become damaging? You should reduce your trading size or stop trading altogether for a short period of time so you can alleviate stress and figure out what is going wrong. It is very important to have a plan for this before it happens.

It is also important to have a plan in place for when things are going well. Overconfidence can be a killer and lead to a drawdown if not correctly managed. While it is good to press it when market conditions are conducive and you’re doing well, but you need to do so responsibly. Increasing your risk by 50% isn’t out of control, but suddenly quadrupling it is, and will likely lead to a frustrating outcome.

Have a routine for staying on track

You should set aside time to reflect on the week’s events and how you traded. It’s a good idea to regularly review your trading plan and make tweaks if necessary. Periodical trade review and journaling are excellent ways to ensure you are following the process you have outlined in your plan, as well as identify patterns in your trading. Save charts of trade set-ups which stick out to you or you did well/poorly on for review later on.

Be rigid with your plan, but not too rigid. This can take some time for the newer trader to fully understand, but you want to have some flexibility in following your plan so as to not become too robotic. Unless you are trading with an algorithm, there is a ‘feel’ component to trading which should be incorporated. The more experienced you are the more this comes into play. The purpose of a plan and rules is to give you a strong foundation and boundaries to operate within…

For the full conversation, please see the video above…

Enjoy the video? Join Paul or any of the team’s analysts live each week for webinars covering analysis, fundamental events, and education.

Past recordings you might be interested in: Handling Drawdowns; Risk Management; Analysis, keeping it simple; 6 Mistakes Traders Make; Focusing on the Process; Building Consistency; Classic Chart Patterns, Part I; Classic Chart Patterns, Part II

---Written by Paul Robinson, Market Analyst

You can follow Paul on Twitter at @PaulRobinsonFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.