1. Understand the market before you start trading.
Having a solid understanding of the market you will be trading in is crucial to building a good trading plan. Having a strong knowledge base will help you confidently navigate the vast amount of information in the trading world and make better informed trading decisions.
No matter what financial instruments you choose for your trading journey – Forex, indices, commodities, or others – there are three main points that a day trader needs to focus on:
Market Terminology - Key Characteristics of the Market
Factors affecting price movement
2. Determine market conditions.
Assessing market conditions, in short, means identifying strong trading signals that provide trading opportunities. To determine this, you must be able to analyze the market you have chosen.
There are two main ways to do this – fundamental analysis and technical analysis. The main difference between the two is the type of data used to predict future market movements.
Technical analysis relies on the past price movements of a financial instrument, while fundamental analysis studies the economic and financial factors that may affect the markets in the future.
3. Know where to enter the market
In trading, an entry point refers to the price level at which you want to open a trade. As you analyze the market, you will often see that the markets are ripe for trading, while at other times it may be better to take a sideline position. If the trading signal you have identified is strong, you can open a trade immediately. However, if you are unsure of the current market conditions or the available information provides conflicting signals, it may be better to wait and see if a stronger trading signal is available.
4. Assess your risk tolerance.
New traders tend to be very risk averse and often focus too much on losses, or, in worse cases, refuse to close a losing trade. They increase their exposure to risk in the hope that the market will turn in their favor. Successful traders realize that there is potential risk in every trade.
Therefore, determining the appropriate level of risk before you start trading and sticking to it is one of the most important steps in developing a successful day trading strategy. A cautious day trader will not risk more than he can afford to lose.
The amount of capital you can risk on each trade depends on your overall trading account size and level of experience. Many traders use a risk level of 1-3% as a benchmark, while beginners prefer to start with 1% to get used to the process. For example, if your trading capital is $10,000, you might decide to risk 1% per trade, or $100. However, this percentage should be in line with your personal risk tolerance and trading strategy. It is not available in the market yet. In this case, you can place a pending order that will be executed only when the price reaches the specified level. Pending orders can help you manage your risk and ensure that you enter the market according to your pre-defined plan.
5. Understanding the risk-reward ratio
The risk-reward ratio is the balance between the amount you are willing to lose and the return you hope to achieve. After determining the level of risk you are comfortable with, the next step is to choose the level of return you want. As with a risk level of 1 to 3%, a risk-reward ratio of 1:3 is generally accepted among investors.
This means that you should not expect more than three points of return for every point you risk. So, with a trading capital of $10,000 and a risk level of 1% ($100), your target return should not exceed $300. However, beginners often prefer to start with a lower return level as well and set their risk-reward ratio to 1:1, which is $100 as a target return for every $100 of risk.
In many cases, a reasonable return target also depends on the financial instrument and the market you are trading in. For example, you should not expect a price move of 300 pips from an average market move of 100 pips.
6. Control your capital
Price movements in any trading market are beyond your control as a trader. What you can control is the negative or positive impact any of them will have on your trading account. Risk management tools, such as stop loss and take profit orders, will help you keep your risk-reward ratio under control and avoid unwanted and unexpected outcomes.
In general, every trade you make has only three possible outcomes:
The market is going in your favor = you win
Market moves against you = you lose
Market is trading sideways = no profit, no loss
To control your trading account, features such as Take Profit to lock in your profit on successful trades and Stop Loss to limit your losses if the market moves against you are available to use.
Following our previous example, for a $10,000 trading account with a 1:3 reward-to-risk ratio, a stop loss order could be set at $100 and a take profit order could be set at $300. While many trading platforms will automatically calculate and display potential profits when setting take profit and stop loss levels, it is important for traders to understand how these levels relate to the price movement of the financial instrument they are trading.
As mentioned earlier, following your pre-determined risk level without changing it for trades that are already in progress is crucial. Many traders have made the unfortunate mistake of adjusting their stop loss orders lower and lower on a losing trade until they reach a point of losing capital. Other traders have adjusted their take profit orders higher and higher only to see their profits disappear as the trade suddenly and quickly reverses against them.
Sometimes you will find yourself in a third scenario, where the financial instrument you are trading moves sideways for an extended period without achieving the desired gains and without triggering the stop loss. In such cases, traders often prefer to exit the trade manually, re-evaluate their trading plan and wait for a stronger trading signal.
7. Review your trading plan.
The easiest way to re-evaluate your daily trading plan is to go through each step of it and check if the information you previously outlined is still valid and useful. That’s why reviewing it is essential.
Here are some examples of steps that can be included in any trading plan:
Review of the previous trading session
Analyze current trading opportunities
Current macro market analysis – news, economic reports and other factors that affect the markets
Partial Analysis of the Current Market – Review of Charts and Technical Indicators
specific entry point
A specific risk you are comfortable with for each trade.
Setting stop loss and take profit levels
Every trading plan is unique and depends on the trader’s personal goal. You can follow the same steps or create different steps to suit your trading needs – no matter which option you choose, reviewing it can help you stay on track.
8. Put your plan to the test.
Implementing your trading plan steps is just as important as constantly reviewing them. Use a demo account for your trading platform to test it in a simulated real market environment without any risk.
Making an effort to practice trading on a demo account can help identify weaknesses in your trading plan and allow you to adjust it when necessary. To give your trading plan a real test, keep in mind that when trading on a demo account, it is important to follow your plan and execute each step as if you were trading in a real environment.
This means not opening or closing trades unless your plan indicates so, respecting all stop loss and take profit levels and making adjustments or course corrections only after the end of the trading day, not during it.
9. Remove emotions from the equation
Uncontrolled emotions are one of the main reasons why traders abandon their trading plan and fail to achieve the result they are looking for.
When you start trading, it is important to remove any non-trading influences to allow yourself to trade with clear focus and have a better trading experience.
10. Find out what type of trader you are
Once you have worked with your trading strategy a few times, you will start to notice that some trades work better for you than others. That is when you know it is time to discover your trading personality.
Understanding your trading personality can help you achieve a more positive trading experience and results. Some traders are more comfortable taking short-term trades with large trading volumes, while others prefer a slower, longer-term approach.
Determining which trading style suits you is just as important as knowing your personality in the market you decide to trade. There are many assessments available online to help you learn more about yourself in the trading environment, as well as many books and articles written about trading psychology and financial behavior. Discover who you are as an individual and how that can apply to your trading psychology and strategies.
