A plan is your roadmap towards doing the right things before, during, and after trading. It is not a strategy in and of itself, but a framework that allows you to build and execute a strategy.
In fact, if you want your trading strategy to work, you need to create a trading plan first. This article will walk you through all the elements of an effective trading plan and teach you how to create one.
What is a Trading Plan?
A trading plan is a detailed methodology for identifying the right asset class, defining entry-exit points, evaluating risk, and determining your profit goal.
It is the key to a successful trading strategy and serves as the foundation for managing your trading capital effectively, taking into consideration all aspects of trading and leaving no stone unturned.
Every seasoned trader will tell you that a trading plan is one of the key elements to becoming a successful trader.
That said, a trading plan in and of itself isn’t enough for entering the market. You need to combine it with the right psychology and philosophy.
Furthermore, you are unique and have a certain trading capital and outcomes that hinge on using it wisely. Your trading plan has to be personalized for your specific needs.
Purpose & Importance of a Trading Plan
The most commonly asked question is why do we need a trading plan? Is it really required? The answer is yes!
Let’s take an analogy to understand this better.
Mr. P. Fielder wants to become a cricketer. He thinks he start batting, bowling, and fielding as soon as this goal arrives in his mind. Can he do it? No.
Becoming a cricketer requires a step-by-step plan that can allow Mr. Fielder to become incrementally better at playing cricket.
This includes practicing rigorously, complementing on-field practice with strength and cardio work, and ensuring proper recovery.
Similarly, a trading plan will help you make logical decisions, instilling a sense of clarity and subsequent discipline.
More specifically, here is why you need an online trading plan.
1. Achieving Financial Goals
A trading plan can help you fulfill your financial goals, whether you want to stay consistent, grow your capital, or achieve aggressive profit targets.
2. Manage Risk Effectively
Every good trading plan includes effective strategies for risk management. It protects your capital by setting suitable stop-loss levels and specifying the maximum amount you are willing to risk in every trade.
3. Prevent Impulsive Decision-Making
Emotional trading is a common bias that traders often indulge in due to fear or greed.
An online trading plan acts as a safeguard, requiring you to follow predetermined rules and techniques and avoid being greedy.
4. Building Discipline
A well-defined trading plan is required for earning long-term profits. You cultivate discipline by sticking to your plan and trading based on analysis.
How to Create a Trading Plan
A trading plan does not have to be difficult and complex. A plan is better when it is simpler. A few components that your plan must have are as follows:
- The time horizon for which you want to hold the stock
- Your entry and exit strategy
- Your position size as per your risk tolerance
- Trading strategies you will use
- A trading journal for tracking progress
Here are the steps that you need to follow to learn how to create a trading plan:
Step 1: Set Your Trading Objectives
Before you enter the world of trading, you must first set achievable objectives.
Ask yourself, what do you want to achieve from trading? Whether it’s capital growth, consistent income, or both.
It is always better to divide your goals into short-term and long-term and make a plan accordingly.
Always be clear with your profit numbers, risk tolerance and the time you will dedicate for trading.
Step 2: Choose Your Trading Style
Identify your trading styles based on your personality, choices, and time commitment.
You need to decide if you like day trading i.e., closing the positions on the same day, or swing trading, when trades might be held for days or weeks.
Mainly, there are four types of trading styles: position trading, day trading, swing trading, and scalping.
Align your trading style with your goals and the amount of time you are willing to devote to trading.
Step 3: Develop a Trading Strategy
The foundation of any trading plan is your trading strategy, which outlines how you will approach the market.
You could consider both technical and fundamental analysis approaches, and set clear entry and exit criteria for trading.
Remember, there is no one-fit strategy for you. There are many strategies available and you need to select the one of your choice and customize it as per your goals.
Step 4: Manage Risk
It is very important to take some risk measures for every trade to protect your capital.
Decide the maximum amount you are willing to risk per trade and write down your profit targets from each trade.
Also, set a stop loss for every trade to safeguard your funds from unexpected/extreme losses.
Just follow this strategy and simply walk away when the targets are achieved.
Step 5: Analyze Your Performance
Financial markets are always changing so you must evaluate your trading results. Check if you are profitable, and if not, pinpoint where you are going wrong and make changes to your strategy.
It is also essential to keep a trading journal of every trade because it will provide you with the necessary information and allow you to evaluate your performance better. On Dhan, you can access a feature specially for this known as Trader’s Diary.
Example of a Day Trading Plan
Here is a how a day trading plan can look like:
- Goal: Set a reasonable daily profit goal, such as 2% of your trading money.
- Trading Style: Day trading style focusing on short-term price changes. So, the trading style can be aggressive.
- Strategy: Use technical analysis and chart patterns to look for breakouts and trends and potential entry and exit targets.
- Risk Management: Limit each trade’s risk to no more than 1% of the overall trading capital. Based on entry and exit points, decide a stop loss level.
- Performance measure: Review the trading strategy with tools such as Trader’s Diary and check how much profit targets were achieved. Adjust your plan if needed.
Conclusion
A trading plan is your roadmap to trading better. While serving as an essential tool for navigating all things trading, your trading plan will be pivotal to determining your goals and the actions required to achieve them.
Creating a trading plan can be difficult, but the efforts will be fruitful. It is important to have a clear trading plan to manage the complexities of the market with a systematic approach and make you confident and disciplined.
