Sometimes, trading can feel like you’re trying to get around without a map in uncharted wilderness. As a trader, you might not feel like you have a sense of direction, and there are all sorts of potential pitfalls and dangers that you might encounter. So how can you get your bearings and find your way? That’s simple: make a trading plan, and stick to it.
A trading plan is sort of like a self-made map that you make to plan out a trade before you execute. It doesn’t take a ton of time to make a trading plan, but it can offer some long-term benefits. Here, we’ll discuss what trading plans are and how they can help your trading career.
What is a trading plan?
A trading plan is an outline of any given trade. It defines why you’re making the trade, and when and how it will be executed.
A trading plan takes into account your own personal trading style, risk tolerance level, and expectations for any given trade. When you follow your trading plan, you’ll be better able to keep a level head while trading, thus minimizing mistakes and losses.
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Do you need a trading plan?
Listen: trading plans are not sexy. For that reason, many traders are quick to dismiss them as unnecessary. Instead, they choose to focus on the more exciting aspects of a trade, like hot stocks, chart spikes, news, and catalysts.
However, this is a big mistake. While these factors can certainly help in choosing the best stocks to trade, for the best results, these factors must be combined with a plan to deliver the most reliable results.
So, do you need a trading plan? Strictly speaking, it’s not necessary to make a trade. However, if you want to follow the trajectory of successful traders before you, then yes, a trading plan is highly suggested.
Planning: the key to long-term trading success
A trading plan allows you to have a clear cut plan of attack for entering and exiting a trade. It makes all the difference between a calculated trade and the “hold and hope” mentality that causes so many traders to lose money.
Without a trading plan, you’re pretty much gambling. You might win here and there, but your progress won’t be as reliable as it would be with plans in place. Many traders who don’t employ trading plans begin to see that their losses begin to exceed their gains, and they ultimately give up on day trading. Don’t become a cautionary tale: make a trading plan every time!
Tips for creating a trading plan
Now that you’re sold on the benefits of making a trading plan, how do you actually do it? Here are some tips for success.
Set goals. What do you hope to gain from this trade? Try to set realistic goals for profits. This is something that becomes easier with a little experience. For instance, as a trader becomes more established, he or she may determine that a trade isn’t worthwhile unless the potential profit is at least double or triple the risk.
Focus on risk. What’s your personal risk tolerance level? Only you can answer that. Before you enter a trade, consider how much of your portfolio you’re willing to risk on a given trade. While many stick to the 2% rule when trading, if you have a small account, you may decide to risk a little bit more to gain a bigger position.
Be sure to do your research. Before you enter any trade, be sure to do your research. Seek out the big gainers, evaluate the stock charts and research potential catalysts that could affect the value of a stock. Be diligent in doing this, as it can help you determine if the stock is going to perform how you’d like. You can never know 100%, but you want to be able to say you did all you could to make this determination.
Plan your entry and exit. Make a specific plan about when you will enter and exit a trade. Decide what buy signals will be your own personal green light to enter a trade, and only enter once they are met. You can set specific criteria with Stocks to Trade so that you can determine when stocks are meeting your standards to buy.
But don’t just focus on buy signals. Place equal importance and consideration on when you plan to get out of a trade. First, consider what you’ll do if a trade starts going sour. What is your stop loss–when will you pull out if things aren’t going your way? Make a resolution to actually get out at this point, and don’t take it personally. Alternately, what’s your profit target? Be willing to get out once your profit target is met without getting cocky.
Write it down. Write down your plan. Literally. There’s a sense of accountability that comes with physically writing down a trading plan, and keeping it in a prominent place in your work area. When your trading plan is literally staring you down while you work, it will be more likely to keep you accountable.
Review the trade afterward. After the trade is done, take some time to consider how things went. Keep notes on your trades in a trading journal or log. You can gain insight into what went right or wrong so that you can inform future trades. It can also improve your practice of creating a trading plan, informing you about what aspects you have to be more diligent about considering.
Long-term benefits of trading plans
Trading plans can truly change your relationship with trading. In essence, they can transform your mentality from chasing the most bright and shiny stocks to being a calculated hunter of profits.
By creating trading plans, you can begin to find ways to be reliably and consistently profitable. Ultimately, there are many factors beyond your control in trading. But it is possible to control when to pull out of a trade, thus minimizing your losses. This makes learning how to create a trading plan a vital part of your trading process.