Trading Plan

BEFORE YOU BEGIN TRADING - “Plan your trade and trade your plan.”

Before you even consider trading it is important to take the time to seriously question your intentions in the market. Are you trading for excitement or a rush? Are you interested in trading because you seek satisfaction on a purely intellectual level? Do you see trading as a hobby or as an additional avenue of investment? Are you looking for a way to fund early retirement or do you see trading as an opportunity to augment your savings? Do you need the profits that trading might bring to cover debts or other financial commitments?
Many traders do not know why they want to be in the market. By taking the time to honestly evaluate your reasons for trading, not only will you learn more about yourself but you'll also be forced to justify your commitment of hard earned capital to the market.

2. Developing a written trading plan When someone decides to start a business, the first task usually tackled is drafting a business plan. Most people would see this as mere common sense, however it seems the same logic does not apply to many new traders. Rather than planning how and where their capital is to be allocated, many new traders will launch headlong into a trading career with little regard as to their risk and profit objectives. By failing to have a trading plan, a trader will not know what to do when the market goes in their favor or worse still, when it moves against them. Without the structure that a trading plan provides, you will find yourself not only at the mercy of changing market conditions but also of your own conflicting emotions -a sure recipe for disaster.
Many successful and experienced traders use a plan that is consistent with their temperament and the amount of money they have in their accounts. While a plan will not prevent losses, at least it provides you with some guidelines to follow. You can and should make minor adjustments to your initial trading plan throughout the trading period, but do not let the ups and downs of the market affect your overall game plan. Do not abandon your original objective, unless the market conditions that led you to place your trade change. The trading plan therefore imposes the disciplined structure that is essential for long term success.
A written trading plan helps keep you from making poorly conceived, spontaneous, thoughtless, emotional trades. An unwritten plan often gets changed when the trader’s mood changes. A written plan keeps you from many trading pitfalls such as greed, fear, boredom, a need to be right, a need to be a victim, and masochism. While a trading plan may contain many elements, at minimum it should at least contain the following characteristics:

Select your investment universe (ie. Stocks, Options, Futures)
Appropriate account size (capital you can afford to lose. Allow for diversification).
Define your style of trading (aggressive, medium , conservative)
Define your time frame (day / short / medium / long term trader)
Have an entry rule (eg. Entry at the .30 of the retracement)
Add risk management parameters stop loss (fixed dollar, trailing,)
Outline your money management
How much to risk - percentage based on capital
Percentage of money to risk on each trade
Where to place stops
When to add to a winning position
When to liquidate part / all of a losing position
When to liquidate part / all of a winning position
Profit objective for trade / week / month / year
Impact of commissions and fees on trades – individual and overall
Are you over trading?
Back test the system as well as forward testing (referred to as paper trading)
Performance measurement (risk / reward ratio)
Determine your expectations
Determine your necessary requirements (resources to get the job done)
When should I start trading
Is trading for me?

A good trading plan is always complimented by a diary of your trading successes and mistakes. What you learn from your mistakes is more important. You paid for them, you may as well learn something from them, if you don’t remember them you are bound to repeat them. It often takes courage and cold hard unemotional judgment to stick with your trading plan.

3. Risk ManagementThe most common mistake made by traders is the lack of any systematic risk-management. The aim therefore, is to devise a systematic approach and define in detail, parameters of a risk-management system. Under such a system, profits, and in particular losses, are defined and stop-loss orders are placed.
ALWAYS USE STOP LOSSES!

A stop loss order is an order placed at a predetermined price to attempt to liquidate your position if the market moves against you. Its purpose is to attempt to limit your loss. However you must be aware that there is no guarantee that your stop loss order will be filled at your price. Don’t use mental stops - mental stops get moved. Not using a stop loss is like walking a high wire without using a net. You might get your adrenalin fix, but one bad slip can kill you.
Absolutely, positively do not remove or move your stop-loss father away. Place stops on the basis of how much money you are willing to lose on each trade. This amount is always a percentage of the equity in your account. Most professional traders never risk more than two - three percent of capital on any given trade. Figure your stop losses ahead of time when you have a clear head and are not thinking crazily because the trade is going badly. Do not move your stop loss unless you have a profit and then move it only as a trailing stop.
Design your exit strategy up front, before the trade is even initiated. When you put on the trade, use an OCO (One Cancels the Other) order and enter both a protective stop and a profit target stop. Placing a money management order such as this in a quiet time stops you from making emotional decisions during the heat of battle. If you hear yourself saying “I promise I will liquidate the position of this loser when it comes back to where I bought it” then it is probably to late. The market doesn’t know or care where you got in! Some traders fall into the trap of getting “married” to a position finding it hard to unwind the position when it goes against them.


Price is a loaded gun that can go off in either direction. Don’t get caught up with what a trader, a report or a news item says it should be doing. You must respect what price can do! Never buy just because the price is low or sell because the price is high. ALWAYS ask yourself - “Am I making this trade based on rational thinking or emotion?”

4. Diversification Diversification is the key to any trading plan. Look at a number of markets with one program or have a number of different programs for one market allowing for increased versatility in varying market conditions. It’s well documented that dividing capital among unrelated markets can reduce risk. For example Program A, may only provide signals in a certain market type, whereas Program B may provide signals in other market types. Strict control of trading capital is possible with the application of basic common sense principles. Concentrate and focus on a few select markets and completely master them - this is the tendency of professional traders.

Your first trading rule should be to protect and preserve your trading capital. The name of the game is to survive so you are around to take advantage of any market opportunities.
5. Money Management The principles of money management and risk control are perhaps the most important issue that any trader will face. Put simply, unless traders know how to manage their money correctly and keep their losses to a minimum, their career as traders are sure to be short lived.

Money management is critical.

Money management is critical to not only succeeding in the market but also staying in the market. Like all aspects of trading there are no hard and fast money management rules. Money management can simply be defined as `how much capital to risk?' and `how many contracts to trade?”. This is one of the most crucial concerns a trader faces; it determines your risk and profit and is often a technique neglected by traders.
The belief is that the markets will reward us with profits in due course and that we cannot force profits from the markets in the interim. You cannot predict the future, merely enable yourself to align with the current `line of least resistance' and therefore increase the overall probability of success.

Losing trades are inevitable to any trading plan and it's the ability to manage these losing periods and the your primary role of preserving capital that will enable long-term survival and capital appreciation. You must anticipate losses, expect them, plan for them, embrace them, grab them. Your first loss is your least loss. Most importantly do not take losses personally. They are an integral part of successful trading.

Sound money management philosophy and skills are absolutely fundamental to success to keep losses small. Successful traders work according to probabilities, aiming to win on average more than they lose. Whatever the approach, money management reduces the need to find the perfect system. Following are a number of very basics rules to help you get started:
Trade only what you can afford to loseTrading is risky, so do not fund your trading with core finances - that is, money which if lost could place you into financial difficulty ie. Do not use credit cards, personal loans, overdrafts etc.
Failure to use stop loss ordersWith so much written about the merits of stop loss orders it seems inconceivable that some traders still refuse to use them. By using a stop loss, a trader attempts to set limits as to their maximum draw down from a trade. When a stop is triggered, this tells the trader that their original market view was incorrect and it is now time cut their losses and enter the market another time. Traders who do not use stops are destined to turn small losses into large ones. In turn, this breaches their trading plan and forsakes the money management rules so critical for long term success. When setting stop loss orders or trading through the stop level (market gaps) the impact of slippage also needs to be considered (ie the possible cost in terms of the bid/ask spread that may have to be paid to exit a position).
Place intelligent 'stop loss' ordersIt is essential to use stops to ensure losses are limited in the event the market moves against you. However avoid setting them at fixed amounts, either too close to the current price or on obvious support and resistance levels.
Large loss of capital If your account equity declines by 50% at any stage, trading should be halted immediately and indefinitely until you reassess your trading goals. It is imperative to keep your individual losses small. The table below shows you the returns you will need to generate based on the loss of your original capital. If you lose 50% you need to make 100% return just to break even – a very difficult task.

Smart money management starts with the trader starting with enough capital to withstand several losing trades. The trader must also conserve enough money to be able to add and keep adding to the infrequent, substantial, profitable move.

6. Psychology of TradingUnless a trader conquers their emotions trading will be simply a costly pastime! Perhaps the single most important aspect of trading and yet the one that is paid little attention to by the average trader is the psychology of trading. Successful traders always acknowledge the importance of psychology in their trading. Traders must be disciplined and remain emotionally detached from the market. Trading requires the management of emotional states. A new trader will experience a gauntlet of emotions as they enter the markets for the first time - fear, anxiety, panic, exhilaration, even greed - these are all emotions the novice trader should not only expect but be prepared to face. Emotional imbalance impairs your ability to make congruent decisions.
Almost all traders agree that knowing the emotional reasons behind why you are in the markets and why you trade the way you do would unquestionably make you a better trader. Motives include:

A need for excitement
Simply wanting to have fun
Unbridled greed
A subconscious desire to experience fear

The most optimal state for successful trading is one of complete emotional detachment - to remain calm and to act in accordance with your strategy. Such detachment includes both negative and positive emotions - the key word is to remain "cool". Following are the most important points any trader should observe in trading psychology....
Know your purpose.Know why you are trading - for the thrill, for the challenge, to make a consistent living - whatever the reason, you will enjoy the experience more and trade better if you know your purpose A common problem that new traders have is that they approach the market with unrealistic expectations. Rather than seeing trading as a business which requires both time and intellectual commitment, some traders see the market as nothing more than a place to make 'easy money'. Of course a few of these traders may be fortunate enough to do well over the short term however invariably their inexperience and overconfidence catches up with them. When this occurs, the losses are often so large that it prevents them from returning to the market in the future. Success in the futures market is not impossible however prospective traders need to understand that trading requires dedication and hard work. Only when this is given, will the rewards be forthcoming.

Maintain mental clarity.One of the keys to successful trading is mental independence and clarity - the ability to free yourself from concerns that might distract your trading. Whether they’re family, friends or financial concerns, always aim for a complete clarity of mind in your trading. Being clear in your goals and maintaining your mental focus will help you to stick to your plan and not make rash decisions based on emotion.

Accept that the market is always right.The market cannot be controlled by one person so you must accept that it will move regardless of your wants or needs. Fear, greed and hope can cloud your vision of the market and can cause emotional responses detrimental to your trading. The market will also go where it wants. Do not become enamored with a losing position. If you get it wrong - admit it, get out, conserve your equity and wait for another opportunity.
Don't follow the crowd.When the newspaper calls a bull market, it is possibly that time to sell. Most traders are uncomfortable when the position is popular with the general public however the opposite may be true if the "crowd" consists of mostly institutional traders.
Keep fresh.Trading can be stressful and if done daily, you can become tired and your judgment dulled causing you to begin to lose money. It makes sense to have a break every now and again and do something completely unrelated to trading. This can often give you a new look at the markets and sharpen your trading skills.

Keep healthy.You will think clearer if your trading activities are blended with physical activity. Whilst trading is time consuming and stressful, it provides the opportunity for growth - both financially and personally - not found in any other arena. It therefore makes sense to give yourself every chance to be successful by incorporating exercise into your trading day.
Positive ReinforcementCongratulate yourself and feel good about a trade when you have done what you were suppose to do, according to your trading plan, regardless of the profit or loss. Don’t get overly excited about winning or too depressed about losing. Try to maintain an even keel and a professional outlook. Ego-inflation can lead to major losses as winning creates powerful emotions that distort reality. The more you win the better you feel and the ego takes over.

Recognize that you are the person responsible for your winning or losing - don’t blame the market or the adviser. Losses are an opportunity to focus on whatever problems occurred. A successful trader quantifies, analysis, truly understands and accepts risk. Emotional and psychological acceptance of risk is what determines your mental state in each trade. Individual risk tolerance makes each trader different. Select a trading methodology that reflects your tolerance for risk.

7. Discipline

Like most things in life, you won't succeed without discipline. Discipline is adhering to your established trading plan, including 'stops' and entry points. This is the most difficult yet most important rule of them all. For traders to become consistently profitable, they must have a high level of self-discipline with a well-defined trading strategy that essentially maximizes profitable trades and minimizes losing trades.

Drafting a trading plan is relatively straightforward - but it is the discipline to follow that plan that will distinguish capable traders from all others. During periods of profit, adhering to a trading plan is comparatively easy.

A speculator, no matter how knowledgeable, capitalized, or confident will never be consistently successful without discipline. During periods of loss, however, the very same trading plan will appear rigid and constricting - and it is at such times that a trader will be tempted to depart from the plan. Although you might want to deviate from your trading plan, doing so invalidates the reason for preparing it in the first place. Remember the purpose of the plan was to provide guidelines to follow. Breaking from it will invariably lead to risk exposure that you were originally unprepared to take. The difficulty in maintaining the required level of discipline is one of the main reasons many traders adopt a system driven trading approach. These traders include professional hedge fund managers and Commodity Trading Advisers who use computer models to generate their buying and selling orders (ie there is no discretionary or 'gut feel' trading done).

The equity, futures and options markets are unpredictable in nature and thus cause a natural amount of inherent anxiety among the participants. The speculators ultimate success depends upon quickly identifying a losing trade, admitting the mistake and having the discipline to get out of the trade with a minimal loss rather than being stubborn and compounding a loser into an even bigger loss.

The lack of discipline can cause a trader to:
Abandon their trading plan.
Rush into or out of trades without enough information.
Be impatient and trade impulsively.
Trade too many markets with too little information and capital.
Ignore charts.
Fall victim to your emotions.
Not utilize stops.

By planning every trade from beginning to end you are forced to think about how far the market might move against you or with you. You can’t control the markets and most traders do a good job of trying to control themselves. A written trading plan is the only answer. It is critical that you create your plan when you are thinking clearly.

8. Testing a trading Plan

Before they begin in the market, some traders find it helpful to 'paper trade' the market for a while. This involves taking 'hypothetical' positions in the market and then monitoring these to see what the outcome will be.

Before doing any physical trading at all, the first move is to start by paper trading. A trading plan must be able to be measured. E.g. “I’ll risk no more than 2% of my capital on any given trade”. It can’t say “I won’t use too much of my equity for margin.”
Traders whose systems are more technical in nature will 'back test' their system against historical market data to determine the success of the system in that particular market. A trading system can be as simple as a few rules or as complex as a Black box technical analysis package. The key is that the system matches your personal trading style. You can either create a system from scratch or buy a ready made package. Either way it is advisable to test the system with dummy trades before doing the real thing. Some experts recommend 10 years of back testing with historical data (black box systems) where as others recommend a shorter time span for the testing of a simpler system. It is very important to perform your own testing on any 'off the shelf' systems, and not rely purely on the seller's recommendations.
While all of these techniques are beneficial, prospective traders need to be aware that simulated trading - no matter what its form, does have its pitfalls.

Experienced traders will often say that there is no substitute for having real money in the market. Depending upon traders own discipline, the way they react in this circumstance could be very different compared to when the trade was purely hypothetical. In addition, while a market's past performance can provide some general clues as to its price behavior, there is no guarantee that this will be repeated in the future.

9. Other Requirements

Just like when drafting a business plan, a trader needs to consider what resources are needed to get the job done and the cost of these resources. While competition between vendors has forced the price of such services down, in the context of trading, the largest outlays are related to the costs of obtaining price data and the costs of any systems used to analyze this data. Many systems include market news, risk management software and a range of popular technical analysis indicators. Other vendors provide dedicated stand alone software packages with highly sophisticated technical analysis programs.

In addition to this expense, other expenses such as brokerage and exchange fees both of which are levied on a per trade basis, must also be considered. Finally the trader must also take into account other one off costs such as the purchase of computer hardware and software as well as ongoing cost such as electricity, rent, phone and internet provider charges.