What is a Trading Plan?
Unfortunately for a lot of people who start trading, many will find success difficult to achieve. One wonders what the minority are doing right that give them the advantage over the vast majority who leave the market with less money than what they had when they started trading. Sadly, a lot of those who fail walk away with very little of what they had originally.
So what is it that separates the successful from those who fail? If you ask anybody who has studied trading for any period of time, they will answer ‘psychology’. They will add that ‘your psychology’ is what will make or break you as a trader. Essentially, your mental ability to manage losses and profits, the good times and the bad, your capacity for risk management, and the self-discipline necessary to avoid becoming too greedy are all subsumed beneath the heading of ‘trading psychology’, along with many other similar skills and abilities. If we are naturally inclined to break all of the time-tested trading rules, how can we overcome those natural tendencies and therefore control our mindset?
One of the biggest reasons that our mindset is such a determinant of our trading success is that our emotions influence our actions. Irrational emotions have little place in our trading; however, removing our emotions from our decision making is easier said than done. It is our emotions that cause us to break the trading rules that have been proven to work over hundreds of years.
Must Suit You
First and foremost for a good trading plan is having a plan that perfectly suits you and is right for you. The best traders have discovered an approach that they are very comfortable with and confident in … however most importantly it suited them. None of them have found any magical solution nor have they found that perfect trading approach that gets it right every time.
Then of course, how can you possibly develop an approach that is right for you if you really don’t know yourself? I believe that the first part of assembling your trading plan should be to conduct a self-assessment.
A good trading plan suits who you are, and many other factors including even the seemingly unimportant things like how much time you have to commit to your trading, your level of computer proficiency, your environment and your tolerance to risk. The last one is important.
Most people have a different tolerance to risk and managing risk is a vital part of trading well consistently. So if we all have a different tolerance to risk, clearly we won’t all have the same level of comfort and confidence in the same trading plan. Therefore, we all have to discover that approach that suits us as an individual person.
Some of the more important factors include your personality traits like patience, confidence, decisiveness, emotional stability, mental agility, and probably most importantly, your attitude.
Another key ingredient to the trading plan is the ease in which you can execute it … over the years, I have had the pleasure of speaking to thousands of traders from many countries and during this time, I have learnt many things. Based on these conversations and my own observations, I am convinced that generally people fail at trading for two main reasons.
First, the majority of actions required for success are counter intuitive and if people are not aware of this, they often consistently make poor trading decisions. Second, and backing up my point here about ease of execution, when people realise that trading is not as easy as they thought it would be, they tend to overcomplicate their trading plans which often causes further problems. Software now available with a myriad of technical indicators probably doesn’t help this situation.
Keep It Simple
Whenever I speak to people, I mention that a trading plan needs to be simple as it makes it easier for us to follow it. Furthermore, simple approaches have proven over time to work.
When you think about it, the time tested trading rules like cutting your losses, letting your profits run, follow the trend and keep trade sizes small (just to name a few) are based on very simple concepts.
For example, after you enter a trade, if the price moves down to your pre-defined initial stop loss point, then close the trade and cut the loss. It sounds simple because it is. The others are just as simple. Don’t overcomplicate your trading plan – it doesn’t need to be.
Finally, some advice for putting one together … obviously having a trading plan facilitates your decision making by helping reduce the influence of your emotions from the equation and, therefore, will hopefully make you trade more efficiently. The best way to ensure you get the most from your trading plan is to write everything down. I believe your trading plan should take into account three broad areas (nothing new here), as follows:
your trading mindset (or psychology)
your money management (position size, pyramid strategies, and so on)
your trading method (requirements for trade initiation, filtering processes, daily routine, and so on)
One thing I have experienced over the years is many people who accept that a trading plan is an essential requirement to trading well, yet they don’t know where to start to put one together. I accept that it can be overwhelming at first to tackle this issue.
3 Key Decisions
So let me simplify this for you. There are three key decisions you need to make when trading and if we think in these terms and your trading plan answers each question, then you may have the makings of a simple yet robust trading plan. Despite what I listed previously as the three broad areas in your plan, your trading boils down to the following:
Under what circumstances will you enter a trade?
How much money will you commit to the trade?
Under what circumstances will you close the trade?
Never picture your trading plan as a detailed document containing pages and pages of information because then it will overwhelm you and may deter you from compiling one in the first place. Think in the simple terms above and once you have answered the above questions, then you can add some detail to it as time goes by.
A trading plan is simple, easy to execute, and most importantly suits you and your personality.