In the business world, there’s an age-old adage: without a well-constructed plan, you’re essentially orchestrating your own failure. While it might appear cliché, individuals who harbour sincere aspirations of success, including traders, should adhere to this principle as if it were an unalterable truth. Ask any consistently profitable trader, and they’ll likely tell you that you face a binary choice:
1) diligently follow a meticulously outlined plan, or 2) succumb to defeat.
Should you already possess a meticulously drafted trading or investment plan, well done – you’re part of a select minority. Crafting an effective trading strategy or methodology demands a substantial investment of time, effort, and research. While success can never be guaranteed, you’ve triumphed over a major obstacle by formulating an effective trading plan.
So, what fundamental components should constitute a robust plan?
Here are 10 crucial elements that should be encompassed within every trading plan:
- Goal Clarity: First, for those venturing into trading, it’s imperative to define financial objectives, gauge risk tolerance, and establish a time horizon. These factors need to be set out clearly to ensure your trading endeavours work towards meeting your goals.
- Style Identification: A trading style must be delineated – one that resonates with your temperament, culture, and preferences. This chosen style – be it day trading, swing trading, position trading, or long-term investing – needs to be in synch with your aspirations and the time you can allocate.
- Strategy Formulation: Elaborate on a comprehensive strategy – a blueprint dictating your market approach. Specify criteria for trade selection, encompassing technical indicators, fundamental analysis, or a fusion of both. As you craft the strategy, elucidate entry and exit strategies, risk management tactics, and rules for position sizing.
- Pragmatic Expectations: Acknowledge that trading is far from a guaranteed route to wealth; it carries inherent risks. Anchor expectations for returns within reality and acknowledge the potential for losses. Steer clear of the allure of hasty profits or risking excessive capital on single trades.
- Thorough Market Scrutiny: Engage in meticulous market analysis to uncover potential trade prospects. Evaluate charts if relevant, scrutinise market trends, and be aware of news and economic data that could affect your trades. Be aware of the “bigger picture” (macroeconomic) that can shape the overarching market landscape.
- Risk Management: Imposing risk management strategies is essential for safeguarding capital. Allocate a percentage of your portfolio to each trade, sticking to the predetermined limit. This ceiling should equate to the maximum you’re comfortable losing per trade. Integrate stop-loss orders to limit potential losses and use take-profit targets to secure gains.
- Trade Management Strategy: Define your approach for overseeing active positions. Outline when to adjust stop-loss orders, extract partial profits (potentially employing trailing stops), or exit the trade outright.
- Sustained Trading Discipline: Having set out your trading plan, it’s important to stick to it. Steer clear of impulsive departures from the plan due to market-induced emotional responses like fear or greed. Cultivate an unwavering commitment to discipline and uniformity when executing and concluding trades.
- Surveillance and Trade Appraisal: A meticulous record of trading activities, including entry and exit points, rationale behind trade selection, and outcomes, is essential. Periodically reviewing and evaluating trades is pivotal for maturing as a trader. This introspective review enables the identification of patterns, strengths, and avenues for enhancement.
- Ongoing Learning Endeavours: Sustain your grasp on market trends, economic developments, and innovative trading methodologies. Read about trading and the markets, partake in seminars and webinars, track respected financial news sources, and engage with seasoned traders to improve your knowledge and proficiency.
Why should traders craft a plan?
Traders should carefully formulate a plan to uphold a disciplined and methodical approach in their trading endeavours. A well-structured trading plan is also good for eliminating subjectivity from trading decisions. By incorporating risk management strategies, such as defining stop-loss orders and determining position sizes based on risk tolerance, a trading plan helps avoid exposure to excessive risk and ensures the implementation of prudent risk management practices.
Determining risk tolerance in trading
When assessing risk tolerance, traders consider critical factors such as their financial standing, their level of investment aspirations, appetite for risk, as well as their experience and comprehension of financial markets. The use of a risk tolerance questionnaire or consultation with a financial advisor can facilitate the precise identification of one’s risk tolerance level.
Analysing trading performance
There are lots of ways to measure trading performance. Common techniques include calculating the aggregate return of trades, the win rate, average profit, and average loss.
Using benchmarks in trading
Benchmarks serve as guiding reference points to gauge the efficacy and accomplishment of a trading strategy. Frequently used benchmarks include market indices, the performance of professional fund managers, mutual funds, or predefined absolute return targets.
Optimal trading timeframes
The choice of a trading timeframe hinges on the trader’s individual style, preferences, available time, and the specific market or instrument being traded. Diverse trading styles—such as position trading, swing trading, day trading, and scalping—demand distinct timeframes, tailored to their respective strategies.
The Ultimate Takeaway
The fact remains that no trade can be guaranteed to win, no matter how good a strategy. A trader’s prospects rest on their strategy and their ability to manage wins and losses. Achieving success does not mean you can’t have losses. Indeed, you should expect losses as if they are a ‘business expense’.
Professional traders enter trades with the understanding that the odds are in their favour. By letting profits run and curbing losses, they might concede some battles but come out ahead in the end.
Conversely, many traders and investors falter by practicing the opposite – closing winning trades too early and letting losses get too big – contributing to inconsistent gains.
Successful traders treat trading as a business endeavour. Although profitability isn’t guaranteed, a well-crafted trading plan is essential for long-term success.
At Trendsignal, we can help you guide you through your trading journey. Providing you with our award-winning trading strategies and coaching.