A trading plan is a systematic method of identifying and trading securities that takes into account a number of variables, including time, risk, and the investor’s goals. A trading plan describes how a trader will find and execute trades, including under what conditions he will buy and sell securities.

 

Understanding the trading plan

Trading plans can be built in different ways. Investors typically customize their own plan based on their personal goals and objectives. Trading plans should be quite long and detailed, especially for active day traders. They can also be very simple, for example for an investor who simply wants to automatically invest in the same mutual fund or exchange-traded fund (ETF) every month until retirement.

A trading plan not only describes what to do to enter a position, but also indicates when to exit. Investors with a buy-and-hold strategy can simply invest automatically and not sell until retirement.

Other investors may choose to invest automatically only after the stock market falls by 10%, 20%, or some other percentage. They then begin making monthly contributions. Or members in the third category could choose to invest automatically every month, but have a sell policy in place in case their investments start to drop too much in value.

 

Tactical or active trading plans

Short-term and long-term investors can use a tactical trading plan. Unlike automatic investing, in which the investor buys securities at regular intervals, a tactical trader typically seeks to enter and exit positions at specific price levels or only when very specific requirements are met. This makes tactical trading plans much more detailed.

A tactical trader needs to develop rules that determine when exactly he will enter a trade. This could be based on a chart pattern, price reaching a certain level, a technical indicator signal, statistical error, or other factors.

The tactical trading plan should also outline how to exit positions. This includes exiting with a profit or how and when to exit with a loss. Tactical traders often use limit orders to take profits and stop orders to exit losses.

The trading plan also outlines how much capital is at risk on each trade and how position sizing is determined.

 

Changing the trading plan

Trading plans are well thought out and researched documents written by a trader or investor as a road map of what they need to do to profit from the markets. Plans don’t have to change every time there’s a loss or difficult situation. The research that goes into the plan should help a trader prepare for the ups and downs of investing and trading.

Trading plans should only be changed if a better way to trade or invest is found. If it turns out that the trading plan is not working, it should be abandoned. Deals are not concluded until a new plan is drawn up.

 

Trading plan rules

Risk only 1% of your capital per trade. This means that the distance between the entry point and the stop loss point, multiplied by the position size, cannot be more than 1% of the account balance. This rule determines the position size because it is the only unknown that needs to be calculated.

Leverage or no leverage. The trading plan should indicate whether leverage can be used or not, and to what extent, if it is allowed. Leverage magnifies both profits and losses.

Correlated or uncorrelated assets. Part of the risk management process is determining whether and to what extent trading in correlated assets is permitted.

Trade restrictions. A trading plan may include restrictions that stop trading when things are not going well. For example, a day trader might have a rule to stop trading if he loses three trades in a row or loses a certain amount of money.

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