Six steps for creating a trading plan
As the saying goes, ‘if you fail to plan, you plan to fail’. Obviously, creating a trading plan is no guarantee of success – but it does at least set you in the right direction!
With a strong trading plan in place, you’ll understand what trades to place and when – and most importantly, why. It takes a lot of stress out of your day-to-day trading and gives you something to measure your results against.
Step 1: Decide on your trading timeframe
The timeframe you choose to trade within will affect everything, from how often you make trades to what kind of analysis you apply. In other words, you need to decide what kind of trader you want to be (although this doesn’t need to be set in stone for your whole trading career).
A Long-term trader:
- Looks at daily, weekly and monthly charts
- Doesn’t need to watch the markets every day
- Leaves positions open for weeks or months
- Less vulnerable to sudden price movements and market volatility
- Likes to do a lot of fundamental analysis
- Adds stop loss and take profit orders for risk management purposes
A Short-term trader:
- Looks at daily and longer term intraday charts such as up to four hours
- Likes to check the market every day
- Prefers technical analysis to fundamental analysis
- Hopes to catch the next (smaller) trend in the charts
An Intraday trader:
- Looks at shorter term intraday price action movements such as hourly, 15-minute and five-minute charts etc.
- Analyses charts on a frequent basis
- More vulnerable to sudden price movements and market volatility
- Opens and closes positions typically within a day
Don’t have time to check the markets every day? You should think about being a ‘longer-term’ trader. Love making lots of frequent trades – you’re probably a day-trader at heart.
New to trading?
It can often be a good idea to start out as a long-term trader. Holding a position for longer gives you the chance to ride out any market volatility. And, provided you’ve set a sensible stop loss, it saves you from having to check the markets multiple times a day. As your confidence increases, you can move to trading on a shorter time frame.
Step 2: Choose your trading indicators
Many traders prefer to use two or three different indicators – and get a positive signal from more than one of them before making any trade. For more information about indicators please go to technical analysis.
Step 3: How much risk can you handle?
Some of your trades are going to be losers – that’s just a fact of trading. What you can control is how much you’re willing to lose on each trade and how you can mitigate your risks.
For more information about risk management, read this article.
Step 4: Decide when you’re going to open and close trades
This is also known as defining your entry and exit points – it’s the fine art of timing your trade to maximise your potential profits.
Basically, you should define a target for each trade and exit at that point (taking profit). Equally, you define the maximum loss you’re prepared to take and set that as your (potential) exit point (stopping losses).
There are a few different approaches to this:
- Set a stop loss order – so you get out of the trade with a ‘small (or smaller) loss’, rather than a big one.
- Set a trailing stop loss – so if the market takes a turn, you’ll automatically cash out and protect any profits you’ve made.
- Set a take profit order – so if your position hits your target, you’ll automatically cash out and take your profits.
You might also plan to enter or exit a trade because of breaking market news or macroeconomic data. For example, ‘I’ll exit the trade if the Federal Reserve raises interest rates.’
Whatever you decide, you should make sure you always stick to your entry and exit points. It can be tempting to exit a trade too soon (if you’re feeling nervous), or stay in a trade too long (if you’re feeling greedy). But if you based your trade on solid research and strong analysis you should follow that through.
Step 5: Write down your plan and follow it
Make sure you write down your plan. It may sound silly, but the act of picking up a pen and committing your plan to paper will make you a more disciplined trader and more likely to stick to the plan you’ve painstakingly created.
Step 6: Test, test, test (and test again)
Did we mention you should test? There is no way you can know if your strategy will be profitable unless you test it first. Start with some back testing. This means looking through past market data and seeing whether your strategy would’ve produced a profit or a loss over a previous time period (last week, for example).
Once you’ve back-tested your strategy, tweaking it and re-testing it if necessary, you’re ready. If you’re new to trading, you might want to try a demo account before risking any real money. Get familiar with the trading-platform and get used to the thrill of trading. Once you feel ready, take your strategy to the markets for real.