A trading plan is critical to trading success. Not having one doesn’t make profits impossible, but it does make it extremely challenging to be successful over the long term. A trading plan provides focus, peace of mind, and constraints to allow you to realize when you need to switch something up - whether that’s trading a smaller size or taking a break from markets altogether.
Watch our coaches talk about creating a trading plan in this episode of Coach's Playbook.
Step 1: Define the Basics
There are three main basics that you will have to work out as you develop your trading plan. Those include:
- Plan your schedule. Most futures markets trade 23 hours a day - so it can be easy to get wrapped up in it. But markets don’t move and aren’t as liquid at all parts. For U.S. equity futures like the S&P 500 ($ES) and Nasdaq ($NQ), the most liquid times are from 7 AM CT to 11 AM CT. If you can only trade between 5 PM CT and 11 PM CT, you may look to currency futures, like the Japanese Yen ($6J).
- Match the product(s) with your personality. Do you prefer something that moves more or something with a slow grind? The S&P 500 and U.S. Treasury Bond ($ZB) would fall into a category with more liquidity that tend to have slower moves through the day. Conversely, Crude Oil ($CL) can easily swing $0.10 or $0.20 while it’s waiting for a trend to take hold.
- Map your long-term objectives. The most detrimental part of a trading plan can be setting unrealistic profit targets that rush your development. It is incredible how quickly trading can compound if you take a longer term view. But trying to rush it will almost assuredly result in failure. If you go into a day saying, “I have to make $1,000 today,” it will be much more likely that you lose $1,000. Start small - and build.
Step 2: Establish a Time Frame for Your Trades
Your time frame determines a lot of your trading setups and strategies, so you want to be conscious of it. Many new traders get caught up in a shorter time frame, exposing them to outside noise.
Instead, start the day by looking at the trends in your market on a weekly basis, then break it down to daily and hourly. Once you have the big picture view, you can move on to 15- or 5-minute charts.
You might also want to think about what time frame fits your personality. More analytical traders may want to focus on the bigger picture. However, a short time frame might be right if you want to be constantly involved and engaged. How can you know which is right for you? Test it out. Try different products and time frames until you find the one that speaks to you.
Step 3: Create Risk Management Rules
Decisions are harder to make in the heat of battle, so you want to add risk management rules to your trading plan. For instance, you want to:
- Be smart about your risk / reward ratio. You want to be able to make up for multiple losing days with one good trade. However, if a bad day can wipe out weeks of your hard work, then something is out of whack.
- Know when to get out. Losses happen, but let’s say you average $300 a day in profits. Taking a $2,000 loss makes no sense - it would require you to have seven average days of gains to recoup. Pick a max loss that works for you, and walk away if you reach it. This makes it easier to come back from a loss.
Bonus tip: Exit strategies are important when you’re winning, too. You can keep trading when you’re up, but you may risk everything you’ve made. So decide when you’re going to walk away when you are up money as well.
- Identify your stressors. Are you sick? Hungover? Stressed about a meeting at work? Any of these can muddy your thinking. Know what causes you to make mistakes and take the day off from trading if you need to. The market will still be there when you come back.
Controlling your losses is a good way to come out ahead in the long run.
Step 4: Track Your Emotions
The highs and lows of trading make it an emotional business, and unfortunately, a lot of traders let their emotions get the better of them. They let bias seep into their decision-making or start revenge trading when the market shifts.
The more aware you are of how you feel, the more you can use that information to manage your risk. Write down your feelings during trades. Then go back over it to look for trends. A sudden spike in anger may mean it’s time to get out.
Step 5: Set Process Goals
Maybe it seems counterintuitive, but using profit targets as your main goal can have a negative impact on your trades. Deciding you want to reach a certain dollar amount every day - or even every week - can cause you to drop your strategy. You stop trading what the market gives you and start taking risks because you want to hit your goal. Worse? Without a strategy, your results are based on luck, not skill.
Your better option is to create process-related goals that focus on decisions and let the profits follow. These may include:
- Creating a system for scaling in and out of a position.
- Only entering trades when they meet predefined criteria.
- Setting an exit point for a trade.
This isn’t to say that profit targets don’t matter. But using them in the short term often means you end up forcing trades.
If you have any questions or feedback, please leave it in the comments.