In the heat of the moment, making objective decisions about your trades can be difficult, leaving you at the mercy of emotion and gut feeling. A trading plan helps you make logical decisions, even when the stakes are high, by defining the parameters of your ideal trade – including desired profit and acceptable loss – as well as your overall trading strategy.
What is a trading plan ?
A trading plan is a comprehensive blueprint for your trading activity. Your trading plan can include anything you would find useful, but it should always cover:
Attitude to risk
Risk management rules
Markets to trade
Your trading plan should be unique to you – though you could use a friend’s plan as inspiration, remember that the level of risk they are willing to accept could be vastly different to yours.
How to make a trading plan ?
Here are five simple steps to follow when creating a trading plan:
1. Define your goals
Write down what you want to achieve from your trading. If possible, break it down into daily, weekly and monthly targets.
2. Assess your market knowledge.
Be honest about your expertise. Which asset classes, regions and markets do you really know? Focus on the areas you understand, and start filling in any gaps in your knowledge. This is very important as the markets you intend to trade will inform your trading plan. For example, a forex trading plan may be very different to a stock trading plan, as market opening hours, volatility and position/contract sizes vary.
3. Decide your acceptable risk
How much of your total capital are you willing to risk on a single trade? And, if you have multiple positions, how much are you willing to risk overall? Most novice traders start off with lower risk, but deciding your own risk limit is important.
4. Set your risk-reward ratio
It also helps to decide what potential reward you need from your accepted level of risk. Traders often like to use a risk-reward ratio of 1:2 or higher, which means your possible profit on each trade is at least double your potential loss.
5. Start a trading diary
Keeping notes of all your trades from each day and the rationale behind your decisions is a great way of finding out what is working, and what isn’t. Make sure to review which strategies have helped you to achieve your goals.