Virtually every aspect of life runs smoother when there's a plan compared to when things are handled on the fly. Imagine a football team with no game plan. Consider your likelihood of success if you started a business with no business plan.
A trade plan is important, not only if you trade actively, but to complement your overall investment plan. While trading discipline doesn't assure success, it can improve your chances.
What is a Trade Plan?
In many ways, a trade plan is a business plan. It should outline what you're trying to accomplish and how you are going to accomplish it. Every trade plan is a little different, so there's not one template that will work for everyone. Consider the following eight items when constructing your trade plan.
- The products you will trade
- The trading strategies you will use
- How much money you'll invest in each trade
- Expectations of profitability
- Your loss thresholds
- How you'll make your investment decisions
- Trading resources you rely upon and time allocation
- A trading log or method for tracking results on both open and closed positions
Keep in mind, your trade plan doesn't have to be complicated. However, it should allow you to manage and track these key items. Crafting a plan that is too complicated will mean that you won't use it.
Most importantly, your plan should be a work in progress. As you refine your approach, you can add more detail to your plan over time.
Here's an example of a simple trade log you can create using an Excel spreadsheet.
Now that you know the key components of a trade plan, let's take a look at some steps that may help you with successful implementation.
One of the prime benefits of a trade plan is that it allows you to realistically evaluate your trades.
To be a successful trader, you need to establish reasonable expectations for risk and reward. Your risk expectations, in particular, should be very clear. Don't minimize the importance of risk evaluation. Recognize also that your performance will be impacted by the action of the overall market.
Lastly, be realistic about your success rate on individual trades. It's impossible to be profitable on every trade.
Keep Emotions in Check
As most every experienced trader will tell you, learning to control your emotions is key to success. Having a trade plan is great for this, because it provides the structure for making decisions based on discipline, not emotion.
Remember, trading involves losses. The goal is not to win on every trade, but to have more profitable trades than unprofitable trades, or to make more on your winners than you lose on your losers. When you allow your emotions to control your trading, you're more likely to make bad decisions.
Here are two guidelines to consider for your trade plan that can help you rely on discipline, not emotion:
- Avoid increasing the size of your trades to try to gain back your losses sooner—in most cases, you should do the opposite.
- Avoid letting margin requirements drive your decisions and refrain from using up all of your buying power.
Test It out First
Success in nearly any endeavor takes practice, and trading is no different. You should paper trade any new strategy for a time before you allocate real money to it. As you trade you'll explore different strategies, asset classes and methodologies. Consider tracking your ideas for a period of time before placing money on them. If you are itching to place a trade, leg in with a small investment.
While success at paper trading doesn't assure success with real money, skipping this step could be a very costly mistake. Remember, it's free, and you just might find that your new strategy doesn't work.
The Beauty of Simplicity
For most trade plans, simple strategies typically make the most sense—complex strategies can have unintended consequences if you don't fully understand the dynamics involved.
To be a successful trader, you have to develop a strategy that you understand and that you believe gives you the best chance at success. Don't allow anyone to talk you into strategies, markets or products that you don't understand.
Keeping things simple doesn't mean being lazy. One of the biggest mistakes you can make is quickly acting on the recommendations of trading "experts". Every trader has a different personality, different goals, different expectations and a different tolerance for risk. What works for one trader may not work for another.
Once you have a built an approach that works for you, maintain a constant state of learning. See how other approaches might compliment your plan. Test, learn, apply, and evaluate.
A Plan to Live By
We close with these basic, common-sense suggestions to consider weaving into your trade plan:
- If a stock moves against you and you wouldn't buy it at the today's price, consider selling it.
- No matter what happens, the market does not "owe" you anything.
- The market doesn't know and doesn't care what you paid for a particular stock.
- The market can remain irrational a lot longer than your capital can hold out.
- Learn from your mistakes.
- When in doubt, wait it out. In other words, if you're not sure what trade to make, don't trade.
- Don't let an unrealized gain become a realized loss—use available tools to manage risk
- Capital management and limiting your losses are of paramount importance.
- Define your profit-and-loss targets before you establish a position.
- Cut your losses and hold on to your winning stocks.
- Have a methodology for determining how much risk you're willing to take on each trade.
Remember, sticking to your trade plan can help bring discipline to your trading.