A trading plan is a document we create for ourselves that outlines exactly how we will trade and operate in relation to our trading activities. Having a trading plan, and following it, builds consistency and allows for improvement over time. Trading based on whim or ever-changing strategies and ideas doesn’t. Here’s how to build a solid trading plan to become a better trader.
Trading well doesn’t mean making a bunch of money and then losing it all. Or steadily losing with some big wins interspersed to prolong the inevitable.
Trading well means trading consistently. It means knowing when to step on the gas and when to hit the brake. And knowing when to do this requires having a plan that lays out how we will trade and when.
With a plan, we’re doing the same thing (that works) over and over again. We can see how it performs, and we can make incremental improvements over time to make bigger profits.
Without a plan, we are doing different things all the time, and therefore it becomes much harder to make improvements because we can’t be sure what is working and what isn’t.
Any trading plan is better than no plan at all. With that in mind, this article focuses on how to build a simple trading plan, which can be expanded into a thorough trading plan. After the simple part, keep building your Trading Plan by adding the additional elements discussed as you gain more experience.
On paper or the computer, write down all the sections discussed below, and then start filling in what you already have figured out. The empty sections tell you where you need to spend some time thinking and planning.
It may seem like a lot of work, but if you’re serious, it’s worth it. If you don’t put time into making a plan, then maybe serious trading isn’t for you. Most traders lose money, so a trading plan is one way to help make your way into the few percent that actually make consistent money.
Here is what to include in a trading plan:
Trade entry and exit rules (for both winning and losing trades).
Position sizing and risk management rules.
Which market(s) and time frame(s) you will trade.
How you will find trades (list? scanning?).
In what market conditions you will or won’t trade.
How you plan to improve (review, error tracking).
What your trading goals and objectives are.
How to handle big wins/losses, savings, taxes, compounding/withdrawals
The Basic Trading Plan – Market + Strategy
This section of the trading plan helps you build a strategy and decide what markets to trade so you have something reliable to trade with. It also touches on when you will and won’t trade, what timeframes you will trade, and how you will filter your trading choices
Which Market to Trade and When
Define which markets you will trade and the time frames you will trade them on. Are you going to day trade Crypto on a 1-minute chart? Trade futures on a 4-hour chart? Crypto on an hourly chart? Swing trade crypto on a daily chart? Trade lots of markets on various time frames?
At what times will you place your orders? Markets trade differently at different times of the day. And what order types will you use?
Filters
Filters further limit what you will trade. If you only day trade the BTCUSDT, then you don’t need a filter, you have already defined exactly what you will trade: BTCUSDT.
If you swing trade , how do you determine what asset to trade? Make a list of the acceptable ones based on their movement and spread.
If trading crypto you may wish to specify that any Crypto you trade must meet specific parameters. I only trade assets that appear on my scan list when swing trading. That assures that I am trading a crypto that is acceptable for my strategy. You may also want to trade coins that are strong or weak.
If you day trade Crypto, you may need a day trading scanning methodfor finding day trading coins that you can trade regularly. Or maybe you want a scanning method that will provide you with coins that are moving a lot that day.
Define how you will determine what you will trade. This is your filter. Having filters also makes it much easier to find trades, because you don’t need to look through all 10,000 coins on the markets for trading opportunities. You can filter it down to 50, for example, and find opportunities within those.
When to Buy
You have now defined what you will trade, on what chart time frame, and have filters to narrow it down.
Then, we need precise rules that tell us when it’s acceptable to buy. “The moving average is pointing up and the price is rising” is not specific enough. We need precise rules. It could be based on indicators, price action, fundamentals, or anything you want, but it needs to be precise.
What analysis tools will you use? Define them. If you keep changing the tools you use to make trades, your results will be inconsistent. I see people post charts and every time they have a different indicator on there. Be consistent in your approach.
For an example of what specific means, see the criteria for the Cup and Handle pattern. It is not just some random visual pattern. I require very specific things to take a trade. Then once everything sets up, I still have a trade trigger that actually gets me into the trade. By controlling the variables, I can see what works, what doesn’t, and how to improve.
How do you know when to buy? Well, you can use someone else’s rules, or you can simply look through many charts and determine what criteria were in place at good points to buy (in hindsight). Make a list of those criteria that were in play, and then go through other charts to see if they worked there as well. If they do, you may be on to something. If not, start over.
Once you have established your buy rules, draw pictures or take screenshots of those entry criteria (or complete trades) and include them in your plan.
Risk Management
Once you are in a trade, how will you control the risk of that trade? Many trades we take won’t move in our expected direction. How will you determine where to cut the loss?
Not cutting losses is not an option. If you want to be a trader, cut your losses. Hoping they bounce back is not a strategy and not a good plan.
I use stop loss orders. For each trade, before I take it, I determine where my stop loss will go, and I place it at the time of my trade. That way, if the price doesn’t do what I expect, I don’t lose much.
You may also want to consider other exits. Will you exit trades before major news announcements, like earnings for stocks? Will you hold trades through the weekend or not? Can you hold a day trade overnight? Whatever you decide to do, determine how and when you will cut your losses and other circumstances where you need to get out of a trade.
Also, consider whether you will use leverage or not? Leverage magnifies returns and losses.
Once you have established your risk management rules, draw pictures or take screenshots of those stop loss criteria (or complete trades) and include them in your plan.
Position Sizing
Position sizing is how much capital we allocate to a trade.
If day trading, we may use all our capital (and even more with leverage) on a single trade. When swing trading we may distribute our capital between several or many trades.
This article discusses some ways to position size.
How much capital we deploy on a trade isn’t random, it should be calculated and pre-planned.
Have position sizing rules for strategies you are comfortable with.
Also have position sizing rules for when you are starting your trading journey. You may want to start out with a smaller position size until a strategy (and you) prove yourself profitable.
If you start out trading a smaller position size, how will up build-up to the ideal position size? What does that process look like? What is your benchmark for knowing it is time to increase your position size?
You may also want position sizing rules for if you hit a losing streak. Does your position sizing method change? If it changes (like being reduced) how and when does the position size return to normal? How many losses in a row (or losing days or weeks) before you take a break or re-evaluate your strategy? I call these loss limits.
When to Take Profits
This is probably one of the hardest things in trading, at least psychologically. People typically have the urge to lock in small gains but then have regret when the price runs further. Or they try for bigger gains but then regret when a nice profit (but not a BIG profit) turns into a loss.
Define how you will exit trades. You could use a trailing stop loss (and there are many types) or a profit target. Or you could exit when you get a certain indicator or price action signal, or when the reason for the trade no longer exists.
Go through charts and experiment with different things to see if something works better. There is no perfect solution, only what works best for you.
When Not to Trade
You may get valid signals based on your strategy, but are there conditions where you aren’t allowed to take the trade?
When day trading, I don’t take trades right before major economic news announcements, and I have to close trades before the announcement. So I can’t be in trade right around high-impact news. When day trading, I also have volatility requirements. If the price isn’t moving much over the last one or two hours, I don’t trade, even if a valid trade signal occurs.
When swing trading , I stop buying into new trades if my market health indicators turn negative.
When won’t you trade, and why?
The times you choose not to trade should be periods where the strategy has poor or unpredictable performance. By looking through many past trades you may determine that many losses occurred during a certain time, around certain events, or shared common traits. You can use that information to avoid taking those trades in the future. Update your trading plan with the information.
Backtesting and Real-Time Testing
You now have entry and exit rules, and your position size tells you how much you are risking on each trade. You also know when not to trade.
You already went through charts to find your entry and exit rules, so you may already have a good idea of how your strategy performs, but it is a good idea to do more testing.
Go through historical charts, preferably in many types of market conditions (up, down, sideways, volatile, sedate) and see how the strategy performed based on your rules. If you don’t know where your exact entries and exits are on the historical charts, then the rules are not specific enough.
Write down all the profits and losses. This will give you an idea of how the strategy actually performed over the lookback period. The more trades included the better.
If the plan is profitable over many trades on the historical charts, implement it on a demo account and see how you do.
If you want to start live trading right away, use a small position size as set out in your position sizing section. This assures that you don’t blow through capital testing out an idea.
Updating the Plan
Updates to the plan are only made OUTSIDE OF TRADING HOURS. This way, we aren’t allowed to change our plan while we are trading when our emotions may be high and logic low.
Updates should be backtested and/or well thought out before being added. Updates must align with the other elements of the plan. The elements of the plan work together, and should not conflict. If an update creates a conflict, resolve it before trading.
Nothing gets traded with real capital unless it is in the trading plan and has been run through this process.
How You’ll Review and Improve
You have a plan you are going to trade. Awesome. Whether things go well or poorly, how are you going to improve? How are you going to track your trades?
Will you do a daily review of your trades? A weekly and/or monthly review? What are you looking for? Glancing over charts, with no action steps, doesn’t do much. Will you implement action steps for improvement and will you allocate time for making those improvements? How will you track your trading mistakes, and what constitutes a mistake for you? The main focus should be to determine if you followed your trading plan rules or not. If you did, great, if you didn’t, there is work to do.
Over many trades, if you find you did follow your rules but lost money, then the trading plan may need to be revised. The strategy you are using isn’t working.
If you didn’t follow the rules, then you have no idea if the trading plan works or not, and you have a really big problem (whether you made or lost money) because you have no idea if your results are repeatable. So here, you need to work on building your discipline and finding ways to follow your plan.
If you find you have trouble following your plan, the first step is to check out my video Why We Mess Up Trades. It provides some tools to help.