Building An Effective Trading Plan
By Tracy-Lynn Ball
Disclaimer: This is for demonstration purposes. You are responsible for your own set-ups and it is expected you do your own testing, planning and execution with the understanding that trading has risks associated with it and you shouldn't trade with money you can't afford to lose.
Why build a trading plan? Do I really need a plan? Don't I just buy low and sell high? These are questions I'm sure every trader has asked at one point or another. For the most part, these questions make sense until you take a moment to think about the issue. We've all heard the stories and maybe even know a few people who lost their life savings or didn't hit their financial goal by the time they reached the age of retirement, resulting in being forced to work yet another year or even two or three.
Maybe you've dabbled in the stock maket and invested in something that was doing well but left you asking yourself, "now what?"
Worse, maybe you invested in something and watched it, from the moment you bought it, continue to lose money until the frustration and panic left you with nothing but a sour taste in your mouth and an account value of $0.00.
Maybe you have decided you want to pursue trading as a part-time career, hobby, or start-up with the intention to become a full-time trader. Regardless of the reason or your experiences, we've all heard the Benjamin Franklin quote "if you fail to plan, you are planning to fail". Investing, swing trading, position trading, or day trading, should all have a plan.
"If you fail to plan, you are planning to fail" - Benjamin Franklin
The following outline is what I highly recommend to all my students. These are personal preferences that I have found effective in my own trading and are geared towards the full-time day and swing trader. This roadmap is a starting place for your own plan. Use all the components, some of the components, or add additional ones that make sense for your own goals.
Before you start building your trading plan, or any plan for that matter, it's important to identify your end goal. What do you want to achieve and just as important is WHY you want to achieve it. The WHAT is important for building the direction or the content of your plan, the WHY helps you stick to it!
"The WHAT is important for building the direction or the content of your plan, the WHY helps you stick to it!" - Tracy-Lynn Ball
There are FIVE components to every effective trading plan: Commitment, Set-Up, Trade-Management, Accountability, and General Rules. Let's take a closer look at each of these components.
This section spells out exactly what it means... it's the place where you commit to your plan. In this section, I have a very specific time commitment written into my plan. Usually it is a one-to-three month time frame that is stated, commiting to following my plan without deviation for the duration of this commitment.
Why is this important? In the stock market, there are many changing variables that affect market direction and sentiment. Sometimes this can create market cycles that may or may not work in your favor. There can be down days, weeks or months just as there can be up days, weeks or months.
Additionally, trading is a numbers game. Being a successful trader is not about one trade. It's not about one win or one loss. It's about the average over a duration of time. Over time, if you win more than you lose, you'll find success in trading. One of the mistakes I see newer traders do, and I'm guilty of sometimes myself, is starting out with a trading plan for the first time, hitting a losing trade... and feeling like it's the plan's fault and inevitably they start making changes to the plan.
Here's the problem... If you actually took the time to test your plan to see that it works... If you found after back trading for several months that it did in fact work... Then you execute your plan and you snag a loser out of the gate either one of two things is happening.
You failed to recognize during your back trading that you are going to have losing trades and now that you have a loser, the emotion of losing is affecting your ability to tolerate your plan.
You did not follow your plan. You changed something. You did something slightly different. Moved a stop too soon. Chased a trade. Hesitated. Something.
Whatever the issue... it's most likely NOT your plan. So if this is you, the next step is to evaluate the trade you took and ask yourself, did I follow my plan? If the answer is yes, the next question is does my strategy ever have losing trades? If the answer is yes, the next question to ask in the event of consecutive losers, is does my plan typically have this many losing trades in a row. Answering yes to all of these questions should give you the confidence to STICK TO THE PLAN. If you answered no to any of these questions, it's time to evaluate what you are doing and you may need to reach out for help to figure that part out.
You could call this the trigger, the set-up, necessary conditions... whatever you call it, summed up, it's what you're looking for. In this section, you can have multiple set-ups but I like to keep them blocked together so they are easy to read. Keeping it simple is key here. Yes, no scenarios. If-then statements are best. The easier you make the conditions with simple yes, no answers, the easier it will be to execute the set-up. Imagine a checklist before launching into space.
Only after checking all the boxes are you clear for launch. Yes, trading can be this simple. Take for example a hammer candlestick set up.
Is it a hammer candle? If yes, go to step 2. If not, check other setups or no trade.
Did the lower wick break through support? If yes, go to step 3. If not, check other setups or no trade.
Did the body close above that support level? If yes, go to step 4. If not, check other setups or no trade.
Enter with a stop limit above the high of the hammer with a stop below the low of the hammer.
This type of format for a set-up helps make the decision making while trading very easy.
This is one of the components I see missing in many new trader trading plans. "I'm in the trade. Now what?" Having a plan for entry is one thing, but having a complete plan including an exit strategy is pivital to a successful trading plan. Getting in is easy... getting out not so much. Having a tested simple exit strategy will prevent you from staring at the charts like a deer in the headlights.
I like to keep the exit strategy just as simple as the set-up. If-then or yes-no statements. In this section I will include a checklist for when to cancel a set up, when to take profit and when to move my stop. This part of my strategy, once fully developed, was a game changer for my consistency as a profitable trader. I have heard it many times, "I'm in XYZ stock, I'm up so much, what should I do?" I've also seen many times, a trade is moving in a profitable direction only to turn around and completely wipe out all the gains while the trader is trying to figure out what to do next. Trading is fast. Decision making is fast, especially while day trading. Simplifying the process makes our ability to execute in a timely manner more conducive to success.
This is a big one. You worked hard for your money. Scrimped and saved, went without so you could deposit money into your savings. Somehow, you managed to save enough excess money that you finally have a trading account. So take it seriously. There are more efficient and less costly ways to stay warm than burning money. How do you take it seriously? You make sure you are accountable.
Trading is an entrepreneurial venture. If you're not an entrepreneur then you're either independently wealthy making you a dependent on your trust fund, or you're an employee. Leaving the trust fund out of the discussion, as an employee we have a few driving factors that keep us getting up in the morning and mustering the strength to drag ourselves off to work.
We all need to pay bills to live. Some way, somehow, this is a fact.
Pride and work ethic depending on who you are (optional)
Reputation or peer pressure
When we do our job well, we are rewarded with new skills to add to our resume that potentially allow us to move up the ladder and find employment that pays more or provides more personal satisfaction, or we are rewarded with a raise or bonus. When we do our job poorly, we are penalized with a reprimand, a letter in our employment record, or worse, fired.
As an entrepreneur, we are now relying solely on the driving factors that get us out of bed everyday, while the rewards and consequences of how we perform our duties are now left to us. We are our own governing boss. I've seen many failures occur simply due to a lack of self accountability in the absence of external accountability.
This section is where I outline my driving factors. My WHY. Why do I have this plan? What is my end goal? What are the consequences of doing this well and what are the consequences of doing this poorly? It is just as important to lay out rewards for following your plan as it is to identify actions needed if you break your plan. I also recommend, if you struggle with self accountability, find an accountability coach or partner. If you struggle with self accountability in trading, I'm pretty sure it will surface in other areas of your life as well ultimately preventing you from ever achieving your full potential.
I use this section to define my overall risk management. Rules you want in your plan that don't fit in any other category go here. The set-up and trade management section focuses on the individual trade. This section will focus more on the entire portfolio.
What is your max risk on a trade? How many losses can you have in a day, a week, a month? How big of a drawdown will you allow at any time? What happens when any of these limits are met? Will you trade immediately after a losing trade or will you take a quick break to clear your head? Should you trade in the afternoon session, morning session, pre market, post market, or do any of these times lead to poorer performance? Can you go from green on the day to red on the day? (hint: never go from green to red ;) )
Adopting these categories for your trading plan will get you one step closer to reaching your goals and achieving your dreams. Adapt it, structure it, put your own personal touches on it. Once you've built your plan, it's time to test it. I recommend back trading your plan over at least a three to six month duration and longer is better. Testing your plan will build the confidence and the habit needed to effectively execute it with real money. Your trading future starts here.