Download the Schwab app from iTunes®Get the AppClose

5 Steps for a Smart Trade Plan

When you buy a stock, it’s likely because you sense an opportunity. But how often do you establish the parameters for making profits? How will you know when to get in or out of a trade?

These are questions you should ask yourself before entering a trade. Creating a step-by-step trade plan—a blueprint for how to build positions and reshape them as conditions warrant—can help you develop a disciplined approach to your trading.

Before beginning any trade plan, perform a quick self-evaluation:

  • Are you buying a stock for fundamental or technical reasons?
  • Which investing style do you prefer (e.g., growth or value, trend or countertrend)?
  • Determine your view of market sentiment: Is momentum generally tilted up or down?

Once you have your bearings, and you’ve identified a list of stocks or exchange traded funds (ETFs) based on your research analysis method—fundamental, technical or both—you’re ready to embark on the actual planning. Here are five key steps to help you create a smart trade plan:

Know your time horizon

How long do you plan to hold a stock? What purpose will it serve in your portfolio?

Your trade time frame depends on your trading strategy. Generally speaking, traders fit into one of three categories:

  • Single-session traders are very active and are looking to gain from small price variations over very short periods of time.
  • Swing traders target trades that can be completed in a few days to a few weeks.
  • Position traders seek larger gains and recognize that it often takes longer than a few weeks to achieve them.
  • Determine your entry strategy
    Once you have a list of stocks and ETFs you’re considering, look for entry signals—for instance, divergences from trend lines and support levels—to help you place your trades. The signals you employ and the orders you use to make good on them hinge on your trading style and preferences.
    Let’s look at an example of a potential breakout stock, one that is moving outside a support or resistance level with increasing volume.
Illustation of a stock poised for breakout

In the chart above, XYZ has just broken through a resistance level—the price level where selling might be strong enough to prevent further price increases. In general with breakouts, consider limiting trades to stocks that have broken through resistance areas and where trading volume is above average, not just for the trading day but for the specific time of day. In this particular example, a trader might consider buying XYZ at $123 (the “entry”) and placing a stop order at $120. If the stock drops below $120, this stop order would become a market order to sell the stock. However, there’s no guarantee that execution of a stop order will be at or near the stop price, so risk is not entirely eliminated.

Another potential scenario is a stock that is experiencing a pullback. As you can see in the second chart, the stock has fallen from a recent peak. In the event of a pullback, look for some area of support—a price level at which demand might be strong enough to prevent further declines—such as pulling back to a moving average or an old low. Some traders even wait until the stock moves above the high of the previous day—a sign that the pullback might be over. In this example, XYZ is still trading above the support level of $30.50.

Illustration of a stock that has pulled back

Examples are hypothetical and for illustrative purposes only.

Plan your exit

When it comes to an exit strategy, plan for two types of trades: those that go in your favor and those that don’t. You might be tempted to let favorable trades run, but don’t ignore opportunities to take some profits.

For example, when a trade is going your way, you could consider selling part of your position at your initial target price to make gains, while letting a portion run.

To prepare for when a trade moves against you, you can set sell stop orders underneath a stock’s support area, and if it breaks below that range, you can choose to sell.

Determine your position size

Trading is risky. A good trade plan will establish ground rules for how much you are willing to risk on any single trade. Say, for example, you don’t want to risk losing more than 2–3% of your account on a single trade, you could consider exercising portion control, or sizing positions to fit your budget.

Here’s a scenario: A trader with $150,000 in total capital is interested in a stock trading at $67 a share. This trader’s maximum budget per trade is $15,000, or 10% of the account. That means the maximum number of shares of this stock the trader can buy is 223 ($15,000 ÷ $67). Let’s say the trader’s risk per trade is 2%, meaning the trader wants to lose no more than $3,000 of his or her total $150,000 on the trade. Dividing that sum by 223 shares reveals how much the stock can drop per share ($13.45), establishing a stop price for limiting losses ($53.55). The trader may never have to use this stop order, but at least it’s in place if the trade moves the wrong way.

Review your trade performance

Are you making or losing money with your trades? And importantly, do you understand why?

First, examine your trading history by calculating your theoretical “trade expectancy”—your average gain (or loss) per trade. To do this, figure out the percentage of your trades that have been profitable vs. unprofitable. This is known as your win/loss ratio. Next, compute your average gain for profitable trades and average loss for unprofitable trades. Then, subtract you average loss from your average gain to get your trade expectancy.

How profitable are your trades?  

 

Win/loss ratio

Average gain/loss

Average profit per winning trade/average loss per losing trade

Profitable trades

40% X

$500

= $200

Unprofitable trades

60% X

$-250

=-$150

Trade expectancy

 

$50 per trade

 

 A positive trade expectancy indicates that, overall, your trading was profitable. If your trade expectancy is negative, it’s probably time to review your exit criteria for trades.

The final step is to look at your individual trades and try to identify trends. Technical traders can review moving averages, for example, and see whether some were more profitable than others when used for setting stop orders (e.g., 20-day vs. 50-day).

Sticking to it

Even with a solid trade plan, emotions can knock you off course. This is particularly true when a trade has gone your way. Being on the winning side of a single trade is easy; it’s cultivating a continuum of winning trades that matters. Creating a trade plan is the first step in helping you think about the next trade.

What You Can Do Next

Giving Made Easy
Calculating Potential Profit and Loss on Options

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Schwab does not recommend the use of technical analysis as a sole means of investment research.

Past performance is no guarantee of future results.

(1219-9UGH)

Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.