How To Create Your Trading Plan

Do you have a written trading plan? Most traders don’t. In fact, the vast majority of traders have no real plan at all. Most are so anxious to begin trading that they bypass this very important step.

Trading is fun, exciting, and at times can be very stressful. A well-written and strictly followed trading plan will improve your bottom line, reduce stress, keep you focused and on track. Without one, you’re lost—you’re more likely to overtrade, trade on hunches, trade on someone else’s advice, and make a host of other hazardous mistakes.

Since trading is a business, it requires a business plan. All the companies whose stock you trade have business plans in place; all NFL teams have specific plans for dealing with every opponent.

With a plan, you have definite rules to trade by. There will be no question about what to do, and when to do it. You have your own trading bible, a document you created, something you will live by.

So where do you start? Read on.

STEP ONE -- Questionnaire

The first step in creating your trading plan is to answer some important questions — about you, your trading and your goals. As you answer the following questions, you’ll be forced to think through critical issues that will affect your trading success. We all have "loose ends" that act to sabotage our trading, even if only slightly; identifying these and tying them up is going to make a positive difference. You’ll need at least an hour to complete the questionnaire and plan. Ready?

Answer the questions below. When answering them, you’ll get some great ideas and insights; make sure you jot those down as well. Don’t just mechanically go through this list giving short answers. Take it seriously and do some real soul-searching. The document you will create from it could change your trading life. Above all, be honest.

1. Why do I trade?

2. What do I trade? What do I prefer trading? What am I most comfortable with?

• OTC stocks?

• listed stocks?

• futures?

• options?

3. What time frame do I prefer to trade in? (day, swing, intermediate-term, etc.)

• If I'm a daytrader, do I ever hold a position overnight? Under what circumstances?

4. What position size do I trade?

• Am I trading a comfortable size?

• Is it too large? Too small?

• Do I increase my position size when I'm feeling confident?
  --What are the results?

• What percent of my total account am I trading?

5. How many positions at once am I comfortable trading?

6. What overall market conditions must be met for me to trade?

• What conditions do I avoid?

7. What are my trade entry signals? Am I using them effectively? Do I use a combination of signals?

• specific pattern(s)?

• oscillators?

• moving averages?

• other indicators?

8. When do I get out of a winning position?

• What are my rules? Do I have any?

9. When do I get out of losing positions?

• Do I always use protective stops?

• What are my rules?
  --percentage
  --set dollar amount
  --support/resistance levels
  --volatility-based
  --fear

10. What do I do when I have a losing streak?

• How do I define a losing streak?

11. What specific money-management tools do I use?

• How much do I risk on each trade?

• If I were stopped out of all my positions at once, what would the result be?

12. Do I trade both long and short?

• Do I need to?

• Am I comfortable with going short?

• What is my experience trading on the short side?

13. How do I trade the open? Or do I? Should I?

• What is my gap-up strategy?

• What is my gap-down strategy?

14. How do I create my watchlist?

• How can I improve it?

• How often do I update it?

15. What is my trading style? What traders do I follow?

16. What do traders that I admire do that I don’t do?

17. How much time do I spend daily outside market hours doing research/homework?

• What is my routine?

• Do I have a routine?

• How much better would my trading be if I were more disciplined about this?

• What specifically needs to be done?

18. What is my annual income goal?

• Break it down to daily/weekly goals (i.e. $250,000 = $1000/day or $5000/week)

• Or 10 points per week on 100 shares

• What do I need to do to achieve this goal?

The next two questions are designed for new traders:

19. How much money will I start out with?

• What percent of my net worth does this represent?

20. When do I plan on becoming profitable? (if not already)

• How long will my “tuition” period last?

When this exercise is complete, you’ll have two things:

1. A better understanding about yourself, and your trading

2. The basis for your Written Trading Plan.

STEP TWO – Writing Your Trading Plan

The answers you just gave will be the basis for your Trading Plan. The questions should have crystallized in your mind certain things you are doing right—and wrong. Think about your answers and the way you would want your trading to be, the way you know it should be. You’ll be creating a set of rules to live by--rules of your own making. Think of this as your personal mission statement, which, as Stephen Covey writes in 7 Habits of Highly Successful People, "becomes a personal constitution, the basis for making major, life-directing decisions."

Create a document entitled “(Your Name) Trading Plan.”

The format is up to you. You can make this like a legal document if you want (i.e. “I, _________, will abide by the following trading plan, ” or come up with your own structure. Make your plan very specific.)

You’ll need to address the following areas:

Goals

• long-term, short-term, daily

• make them specific and realistic

Tasks

• what do you need to do to get there?

Trading Rules

• you’ll use these daily

• make these very specific

• (this is perhaps the most important section)

For trading rules, here are some ideas:

“I will only trade stocks with Relative Strength over 85.”

“I will never allow a profitable position to turn into a losing one.”

“My daily goal is X.”

“I will only trade 100 shares until I’m profitable for three straight months.”

The end result is like having all the best material in the best trading books in one document.

Again, I emphasize that you should be very specific and complete, including any and every trade/market condition you can think of. Don’t leave any stone unturned. You’ll be referring to this document in times of uncertainty, fear, greed, confusion. You get the picture. This document will keep you out of trouble, keep you focused, and keep you on track.

If you get stuck, imagine what an NFL coach tells his team during Super Bowl halftime. The talk probably has a lot to do with getting back to the basics. Success in trading is not unlike success in professional sports: executing the basics extremely well over and over again makes a winning season. If you are a regular reader of this site, you KNOW what the basics are. In the heat of battle, though, a written reminder right in front of your face is helpful. If you don’t write this out, it’s useless.

Make sure you sign and date your document; this shows your commitment to it. Post it at your workspace where it’s always visible. You’ll be referring to it often.

To keep you focused on only the best setups, print out a few of your ideal chart patterns and keep them close by. These can be patterns from a book, but it’s more effective if it’s from a real trade you did. This reinforces the pattern(s) in your mind and reminds you what you’re looking for. While you’re at it, print out some patterns that didn’t work out, so you’ll stay away!

Once your plan is written, it’s important to review it on a regular basis. This is done for a number of reasons:

--to track profitability
--to track how closely you are following your trading rules
--to identify areas that need improvement.
--to modify it as needed

Studies show people with written goals tend to be more successful than those with no goals; traders are no exception. Your trading plan is the rudder that steers your trading in times of uncertainty. It is also the yardstick by which you can measure your success, or lack thereof, as a trader. Following your trading rules keeps you disciplined, especially if you’re tempted to trade too much.

For those of you who already have a trading plan, do you refer to it often and follow it consistently? Why, or why not? Have you updated your plan over time? What has been the impact on your trading?

Finally, keeping a trading log in conjunction with following your trading plan is a must if you want to improve your results. A well-documented log helps you review your good, as well as bad, trades. You’ll be able to see just how closely you’re following your rules, and make the necessary adjustments.

Write your plan, stick to it, and watch the positive impact on your trading. You’ll wonder why you didn’t do it sooner.

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