Vital Ingredients of a Trading Plan

In a previous post ‘3 Actions Today to Massively Improve Your Trading and Investing Success’ I detailed that a trading plan is necessary if you want to become a successful trader.

Question is, how do you create one and what should even be in it?

I myself pondered this for a long time when I first began, hoping to get it right. I read all the books, went to seminars and they all said you needed one but none really said exactly what should be in it.

However, what I also found was that I was too caught up into producing the ‘perfect’ plan before I thought I was ready to start and that it probably delayed my trading progress by about 3 months.

Firstly, here is my simple definition of a trading plan.

It is a simple document, which details your mission and purpose for trading and investing, your goals, your daily routine and actions, your risk management criteria and position sizing rules, your trading and investment systems and your market analysis.

For those who want to treat trading like a hobby and something you can do in your spare time after work when you feel like it so you can tell people you are a ‘trader’, please don’t pursue this endeavour. It will be costly. Not only will you not get the results you anticipate, your entire account is likely to become nothing.

You are better off getting your excitement elsewhere.

For those who want to treat it as serious business, I am here to help because trading and your trading plan is like running your own business with your own business plan, except there are no bosses to report to, and no employees to manage.

Your trading plan, like everything else in life will evolve over time, as you become a better investor and trader.

Where most go wrong, including me is that they try too hard to perfect their plan thinking this will be the ultimate end document throughout my whole trading career. It will not be.

So don’t get bogged down into all the nitty gritty details, as this will only slow down your progress of actually placing real funds into the market, which is the ultimate teacher of all.

Here are the essential elements of your trading plan. This is based on my experience over the years as I have stripped out the non-essential elements, which delays most people’s progress.

  1. Your Mission and Purpose of Trading

In a previous post ‘Trade Your Way to Financial Freedom’, I mentioned about your why.

So you must know your ‘Why’ because if you don’t, you will easily quit when things don’t go according to plan and in trading, this is very common as you are dealing with unpredictable markets.

For example when I began, my big ‘Why’ was to be able to create the financial, time and location freedom, free from the daily 9-5 grind of full time employment. That drove me and whenever I hit a pothole during my journey to this dream, I kept on going no matter what.

For without the Why, I would either have easily quit or gone off on a tangent.

  1. Your Trading Goals

Most people mistake the first purpose for goals. They are not the same. Where mission and purpose is your why, your goals are your shorter-term targets.

For example, when you first begin, rather than aim for ridiculously high returns and place all that pressure on yourself, it may be to complete a trading course to learn all you can, then your next goal maybe to then begin trading live.

It is these little steps, which will help you ultimately lead to your purpose.

See why I mentioned that your trading plan will evolve over time as it will be constantly updated as you progress in your journey?

  1. Skill Assessment and Love

This sounds like an odd title by adding love into it. With skill assessment, it’s simply to assess yourself honestly about your investment and trading skills as it stands. Don’t ever be too proud to admit you don’t know something because you are better off acknowledging this and then going out to learn it than pretend you do and make a big financial mistake after the fact.

When I talk about love, I am referring to the markets you would like to participate in.

There is a wide variety of markets out there but it is best you define your affiliation with one, stick to it and be good at it than trying to tackle all at once. In the end, you will find the love for one market compared to another.

For me, it was stocks and the options over these stocks. Although I learned about Forex, Futures, and Bonds, I felt very comfortable with stocks because I could physically see each stock as a business of providing products and services for people and I could therefore affiliate with them from a business point of view.

  1. Daily Rituals and Actions

This is a very important one as it forms the basis for your success. I use the word rituals not from a religeous point of view but from a discipline point of view.

You will find that successful people in all walks of life whether it be in business or in the markets they have set up a series of actions or type of regular behaviour, which serves them to complete their goals and reach their purpose because they no longer need to think because it is so ingrained into them.

This is different to everyone because everybody is each unique in their own way and so you need to find what works for you to best enable you to effortlessly trade.

For example, I start my day with water hydration and weight or cardio workouts to get my body ready for the day. I then spend my day analysing the markets to prepare for the days trades when the markets are closed. I will then visualise myself completing the trades as if it has already happened and when the markets open, it is very easy to just execute my plan since I have already lived through the process once.

  1. Risk Management and Position Sizing

This is talked about lots but little understood because most people focus on returns rather than risk. I always say, look after the risks and the returns will look after itself because it does.

Before you enter the markets, you must always know the maximum risk you have set for your entire portfolio and for each individual trade since all the individuals add up to the whole. If the combination of individual trades all go wrong together and adds up to a blow out the risk you deem unacceptable, then you are in effect taking on too much risk on each position.

This is the concept of position sizing. It answers the question, how much to invest into each opportunity, and when these all add up, how much risk is my portfolio undertaking at any point in time, also known as ‘portfolio heat’.

  1. Trading Systems

Notice I have not even talked about entries and exits until now, as they are irrelevant if you do not get your risk management right. Having risk management in place alleviates the pressure of needing to nail the perfect entry and exit on each individual trade.

Most people focus on the entry, when is the best time and price to get in and pay no attention to when and where to exit.

This is a mistake because most people simply cannot sell when they are down on a position because they do not like taking a loss. Getting over this is your number one priority or will never make it as successful trader.

I, on the other hand focus on exit first.

I will always know when I will be exiting before I even think about the entry.

Without a solid exit plan and rules, entry should not even be on the agenda.

So set out your strict exit and entry rules hard on paper while markets are closed. Never ever, change these in mid-flight when the markets are open because you are then subject to trading on emotions rather than rationality.

These strict rules will be your guiding light when the pressure is on and the markets are open.

  1. Market Analysis

This is what separates the professionals from the amateurs but it will take time, as it is part art and part science. When people talk about intuition, it is usually because they have traded for years and get the feel of the markets. The so called 10,000 hour rule.

However, when you first begin, it is best to stick with the science of strict market analysis criteria which you have set up to gauge where the market is.

Most amateurs have a myopic view on only the stock they are about to enter into without knowing the overall market environment. Let this not be you.

It can be a combination of fundamental factors as well as technical factors. I personally like fundamentals like employment data, consumer confidence, other economic numbers like inflation etc. and market volatility.

These combine to give me a feel of the market risk level and tell me if I should stand aside and if I do participate, how much to invest in each opportunity based on current market risk.

  1. Constant and Never Ending Review

Now to one of the most important aspects of trading, the post mortem of the day. Now you have gotten over the excitement of the entry and exit of your positions, it is time to not only tally up the profit or losses, but to look at each trade completed and review how you went in regards to how much you stuck by to your plan and execution rules as opposed to your profit or loss.

These are what makes you become a successful trader over time and it does take time.

Even to this day, there are times when I forget to visualise because ‘I am in a bit of a rush or I don’t’ do my post trade analysis just as well as I should, but at least I am aware of this which allows me to do better the next time. There is always room to improve my performance.

So even having being involved with the markets for two decades, I like you are still learning and will likely never stop learning. This is what keeps me excited every day and I hope it does the same for you too.

by Terry Tran

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