Trading Plan
A Trading plan is a list of rules for entering and exiting positions, and managing capital and risk when trading on financial markets.
8 minutes for reading
What is a trading plan?
A trading plan includes clear rules and instructions that help the trader execute trades in financial markets. This plan outlines trading objectives, market analysis methods, criteria for entering and exiting positions, risk and capital management, and other significant aspects required for successful and consistent work in the market.
The trading plan helps the trader follow the strategy in a disciplined way, avoid emotional decisions, and enhance the efficiency of their trading operations. It can be revised depending on the experience and changing market conditions, but its role remains unchanged – it serves as the basis for executing trades.
Why is a trading plan necessary?
- It sets out clear rules for the trader, thereby helping adopt a structured approach to trading and avoid random and emotional decisions, which might impact the trading results
- It incorporates risk management strategies determining what capital amount can be risked in each trade and what measures to take in case of losses. This helps reduce potential losses, save capital, and ease the level of emotional tension
- It outlines trading objectives, such as income, capital growth, or adherence to a specific strategy
- Thanks to clear rules and strategies, it helps assess the results, carry out an analysis of trades, and improve methods based on the experience gained
- It may be flexible to adapt to market and trend changes and also to new experience
The main risks of trading without a trading plan
- High possibility of losing capital due to an unstructured approach to trading
- Highly emotional and insufficiently rational decision-making process
- The absence of materials and an analytic base to correct mistakes
- Low probability of gaining positive trading experience and having a chance to learn efficient asset management methods
The main components of a trading plan
1. Identifying trading objectives
- Identifying long-term financial objectives of trading. For example, creating an additional source of income, ensuring financial independence, or saving funds for travelling or education
- Setting short-term financial targets for trading. The long-term objectives are divided into daily and weekly ones. For example, certain amounts of income and a number of successful trades for a specific short period
- Specific description and measurable targets. For example, “generating a profit of 10% a month” or “executing 70% successful trades”
- Achievable targets. The targets should be achievable and correspond to the trader’s experience and resources, as well as the current market conditions
- Adaptation. Targets may be occasionally revised to keep them relevant to the changing market conditions and the trader’s financial position
2. Choosing a trading style
Choosing a trading style is essential to identify analysis methods, the time required for trading, the frequency of trades, and the risk level. Traders may combine various styles depending on market conditions and their preferences.
- Scalping – entails short trades focused on profiting from small price fluctuations. Trades are executed on a timeframe from one minute to an hour, which implies numerous entry points
- Intraday trading – involves executing trades within a single day, closing positions before the market’s closure. It primarily operates within the Н1-Н4 timeframe
- Swing trading – is a style that suggests holding positions from several days to weeks, and sometimes even months, to lock in profits from corrections of price movements or market trends. Swing traders strive to catch market “waves” and profit from price fluctuations after the trend solidifies. This style typically operates within the H4-D1 timeframe
- Medium- and long-term trading – involves a trader checking the trading terminal several times a year. The number of trades is relatively low, and the emotional strain is minimal. This style is mostly applicable to the stock market
- Algorithmic trading – employs computer programmes to execute trades in financial markets. It is based on developing and applying algorithms that automatically make decisions regarding position entry, exit, and management based on preset rules. These algorithms can rapidly analyse market data, execute orders, and manage risks
3. Formulating strategies for entering and exiting positions
- Market analysis methods – determining the analysis methods used, such as technical analysis (the use of charts and indicators), fundamental analysis (study of economic data and news), or a mixed approach
- Signals for entering positions – describing specific conditions or criteria that indicate the necessity to open a position (for example, a crossing of the Moving Averages, support and resistance levels, indicator signals)
- The Stop Loss and Take Profit levels – determining position exit points to protect against potential losses (Stop Loss) and lock in profits (Take Profit)
- Managing orders – setting rules and types of orders like market orders, pending orders, and conditional orders for the best possible position entry and exit
- Considering volatility and market conditions – adapting the position entry and exit strategy depending on the current volatility and market environment
4. Choosing a capital and risk management method
This refers to a set of rules helping traders use their funds more effectively to generate maximum profit with a minimum risk. Let us talk about some of them:
- Position size. It is determined as a percentage of the capital allocated for a certain position. It helps control the risk level and save capital in case of an unsuccessful position
- The Stop Loss amount. The Stop Loss level is set as a percentage or points from the price entry level. It shows the maximum losses the trader is ready to incur per position
- The Take Profit amount. Targets are being set to lock in profits in positions. This allows the trader to protect the profit earned and control the ratio of risk to potential trading gains
- Diversification rules. A maximum number of positions opened simultaneously in various instruments or markets is determined to reduce the risk of capital concentration
- Exposure per trading session. There is a limit on total risk, to which traders are ready to expose their capital within a certain period, like a day or a week
- Adaptation to capital changes. Position size is regularly updated in line with changes in the trader’s total capital to ensure conformity with the capital management strategy
5. Keeping a trading log
Keeping a trading log helps the trader improve their strategy, enabling more informed decision-making and learning from past experiences, which is crucial for developing and enhancing trading performance.
- Recording all the positions. The trader records each position, specifying the entry, exit, volume, direction, Stop Loss and Take Profit levels, opening and closing time, and other details
- Recording motivation for each position. The trader specifies what motivated them to open a position, including market analysis, indicator signals, or primary factors affecting the decision
- Analysing results. The trader evaluates each position, records the profit generated or losses, analyses the key reasons for successful and unsuccessful positions, and records a psychological status
- Studying patterns and trends. Reviewing and analysing recurrent scenarios in positions to identify behavioural patterns, which might be used in future trading
- Planning improvements. Determining areas of improvement in trading processes and methods based on analysis of results and patterns, to continuously develop and enhance the strategy applied
6. Studying psychological aspects
- Emotional control. Working on an emotional state when trading to prevent reacting to stress, fear, or euphory, which might impact reasoned decision-making
- Discipline and patience. Developing a strategy to maintain discipline in implementing the trading plan and patience while waiting for suitable conditions to open positions
- Fear and greed management. Developing skills to identify and control fear and greed to avoid these emotions interfering with decision-making
- Adaptation to losses. Planning and developing strategies to cover losses, learning from them, and using them as lessons for future trading
- Consciousness. Understanding a trader’s strengths and weaknesses to help them better control their emotions and behaviour in trading situations
The key metrics of efficient trading
- Profit/Loss ratio. A high ratio of total profits to total losses usually indicates a successful strategy
- Win Rate. The higher the win rate, the better
- Average Profit to Average Loss. The ratio evaluates how much winning trades exceed losing ones. The higher the ratio, the better the strategy
- Max Consecutive Wins/Losses. It helps provide insights into the strategy stability
- Sharpe Ratio. It evaluates the ratio of additional returns to the risk undertaken to achieve these returns. The higher the Sharpe Ratio, the better
- Risk/Reward Ratio. It measures the ratio between potential profit and risk in each trade. The higher the ratio, the better
- Max Drawdown. It measures the maximum capital reduction or maximum loss on the trader’s maximum account value. The lower the indicator, the more stable and less risky the trading strategy